Zimmer Biomet's Regulatory Tussle
It will take many months for the wide-moat medical device firm to address the issues raised by the FDA, and this situation might drag on revenue growth in the near term, which could depress shares.
Despite the worrisome Form 483 filed by the Food and Drug Administration regarding Zimmer Biomet’s (ZBH) manufacturing facility and processes, we’re holding steady on our $131 fair value estimate, as even our worst-case assumptions only reduce our intrinsic value by 5%. Nonetheless, we expect it will take many months to address the issues raised by the FDA and this situation might drag on revenue growth in the near term, which could depress shares. At this point, we think this situation holds few implications for Zimmer Biomet’s wide economic moat, which stems mainly from switching costs. The firm’s access to the large pool of trained surgeons and practitioner reluctance to retrain offers a cushion that grants Zimmer Biomet some time to rectify matters with the FDA.
Upon hearing rumors that Zimmer Biomet had been caught in the sights of the FDA last month, we’d filed a request under the Freedom of Information Act. At the time, we were skeptical that any recent Form 483 directed at the firm existed, as in the past, we’ve seen other medical device firms take a more proactive stance in these situations to reassure investors that management was working decisively to resolve the FDA's issues. In the ensuing four-week period that was required to process our FOIA request, a Form 483 had been issued to Zimmer Biomet.
Compared with redacted Form 483s that we’ve seen issued to other medical device firms over the years, this one is substantially more extensive and serious. For example, the FDA raised issues with water samples that failed to meet acceptable microbial and endotoxin tolerances, and the possibility of particulate contamination of some clean rooms. We are perhaps most troubled by this Form 483 because the FDA had already raised a number of these issues at least two years ago. Based on the FDA’s current assessment, the firm has not adequately resolved these issues and it continued to ship product manufactured under these conditions during that period.
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Debbie Wang does not own shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.