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Small-Cap Recap: I'll Take a Hip,Two Knees, a Shoulder and the Cash


Cash cows are my kind of babes!!


If there ever was an ocean of cross-currents, it is the present state of the replacement body parts business. On one paw we must deal with DOJ subpoenas over marketing shenanigans, cost-cutting efforts by third-party payers, worldwide cage-match style competition, and slowing EPS growth. On the other hoof, we find the mother of all demand-driven secular bull markets, fueled by the expectations of bionic capabilities of an ever aging population. Typically these are the perfect ingredients to frustrate both bulls and bears, and certainly not the kind of names that appeal to me.

IMHO, the exception here is Zimmer Holdings (ZMH). You can beat your head against the wall trying to game if ASP's will be up 1% or down 1%, if Paulie is going to rally the knee caps ahead of gramma's hip, or forecast the over/under of when my knees finally give out, but I suspect that may turn out to be an exercise in futility. My guess is that at some point ZMH stock is going to start trading based on the huge free cash flow it will generate beginning this year – approximately $800M – and which will grow at 15-20% for the next several years. That's about $3.20, $4.00, and $4.80 of free cash flow for 2006, '07 and '08, leaving ZMH with a cash stash of more than $3.0b by '08 ($10-12 of net cash per share). All this free cash is the result of ZMH having paid off its LT debt over the last two years to the tune of more than $800M.

Yes, ZMH could go back on a buying binge – it's no stranger to that – or find other ways to spend the money; there's also little doubt that revenues and EPS results could jolt the stock either way; I could also argue that in the current M&A binge environment, all that projected cash flow probably has more than one LBO type salivating. But all those possibilities are even less quantifiable than all the other variables in the medical-equipment industry. The constant is likely to be the free cash flow. And that's the kind of cow Hoofy really digs.

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