The Miracle of Warsaw, Indiana

One of the more interesting figures of the American Revolution is Thaddeus Kosciuszko, a Polish army officer who was so moved by the patriot’s cause that he came to the colonies to join the fight. Kosciuszko was named head engineer of the Continental Army, and his help was critical at the Battles of Ticonderoga and Saratoga.

The good citizens of Indiana and Mississippi both named counties in his honor. The Hoosiers went one better, and named the county seat Warsaw as a salute to Kosciuszko’s heritage.

It might seem strange that a city in the heartland has the same name as the capital of Poland. But Warsaw, Indiana isn’t like most towns. In 1895, the city was altered forever when a salesman named Revra DePuy decided that he no longer wanted to work for other people. So he did what any American would do: He became an entrepreneur.

DePuy was a splint salesman. At the time, fractures were set with wooden splints. DePuy had a revolutionary idea. He used metal splints instead of wood. The metal could be bent to fit any person. So in a garage in Warsaw, DePuy launched the town’s orthopedics industry.

DePuy’s business did very well, and within a few years he hired Justin Zimmer to be his first sales manager. After DePuy died, Zimmer wanted to buy the company but wasn’t able to. So, like DePuy before him, he also started his own orthopedic business right in Warsaw. The orthopedics industry grew and grew and grew. Soon, the advent of plastics launched the industry into a new age of design and innovation.

In 1977, four entrepreneurs, Dane Miller, Niles Noblitt, Jerry Ferguson and Ray Harroff (two of whom worked for Zimmer) branched out on their own. Right in Warsaw, they formed another orthopedic company which they called Biomet Inc. (BMET). In their first year, the company recorded sales of $17,000 and a loss of $63,000. Despite the modest start, Biomet has delivered record sales and earnings every year since. The company has one of the best track records in American business Remarkably, the four men are still active in Biomet’s operations.

If any business could be described as the perfect business, it might be medical devices. The business has demographics on its side, and the industry is constantly driven by technology and prices increases. The stocks tend to be very stable, and highly profitable. Several stocks like Medtronic (MDT), Zimmer (ZMH), Stryker (SYK), Biomet (BMET) and St. Jude (STJ) have been market-beaters for years. According to data available at Professor Kenneth French’s Web site, medical device stocks have increased 370,000% over the last 65 years, that’s more than 30 times better than the overall market.

Today Warsaw is the backbone (sorry) of the global market for replacement hips, knees, shoulders. Heck, if you break it, Warsaw can make a new one. Today, knee and hip replacements are quite common. Warsaw probably controls about 40% of the worldwide orthopedics business. DePuy Inc. is still based in Warsaw. A few years ago, it was bought out by Johnson & Johnson (JNJ). Zimmer is also still in Warsaw as is Biomet.

Today, Biomet employs over 6,000 people. This year, it should have over $2 billion in sales. There simply aren’t many companies that have done as well as Biomet. For the last 10 years, the company has paid an annual dividend that has increased each year. Since 1982, Biomet’s stock has split nine times for a total of 162-for-1.

Despite Biomet’s past success, the stock hasn’t done much recently. The shares nearly got to $50 in 2004, but are now around $36 even though the rest of the market has been making new multi-year highs. There have been concerns that the industry is under pricing pressure. I understand the worry. Price increases are the heart and soul of orthopedics. Biomet enjoys gross margins of 70% and net margins of 20%.

The second quarter (ending in November) was pretty embarrassing for Biomet. The company had said it would earn 42 to 44 cents a share. It turns out, they earned just 41 cents. If that weren’t enough, Biomet said that for the third quarter (ending in February), it would earn 43 to 44 cents a share on sales of $510 to $520 million. That was below Wall Street’s estimate of 46 cents a share and $529.4 million. Last year, Biomet earned 40 cents a share. Mind you, this is a very stable business. For years, forecasting Biomet’s profits basically meant adding 18% to whatever they did last year.

This morning, Biomet reported third-quarter earnings of 43 cents a share on sales of $506 million.
The important fact to keep in mind is that Biomet is a very efficient company. It has no long-term debt. Return-on-equity is regularly over 20% Also, the company’s P/E ratio is at the low end of its historic range. Biomet’s CEO, Dane Miller (one of the four founders), has consistently dismissed worries over pricing pressures. I’m inclined to take his word over that of Wall Street analysts.

Miller said: “We remain comfortable with analysts’ sales and earnings estimates of $530 million to $540 million and $0.45 to $0.46 per share for the fourth quarter of fiscal year 2006.”

2006…….$2020.0…..$1.68 (my estimate)


Posted by on March 21st, 2006 at 6:00 am

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