We are in the midst of the fourth quarter earnings season and it
is once again time to review the players in the worldwide medical
devices market. The US still holds the leading position with almost
one-third of the market share. However, emerging economies like
Brazil, Russia, India and China - collectively known as the BRICs -
are fast coming up in the medical devices space and are attracting
a lot of attention.
These emerging economies are seeing an increasing uptake of medical
devices due largely to growing medical awareness and economic
prosperity. Expansion in emerging markets, especially those
with double-digit annual growth rates, represents one of the best
potential avenues for growth in 2013 and beyond.
On the flip side, the MedTech industry is currently plagued
by several issues including the 2.3% medical device excise tax,
pricing concerns, hospital admission and procedural volume
pressures, Medicare reimbursement issues and regulatory overhang.
Percutaneous intervention (angioplasty) volumes continue to be
relatively flat in the US, Japan and Europe, with improvement not
expected anytime soon.
In spite of several uncertainties resulting in constrained capital
spending, the past year also witnessed significant M&A deals
including acquisitions of Switzerland-based Synthes Inc. by
Johnson & Johnson
) for a whopping $19.7 billion, Gen-Probe Inc. by
) for $3.8 billion and
) acquisition of Danish cancer diagnostics company Dako for $2.2
Another trend that we have been observing of late is the divestment
of non-core business segments. For example, in early January,
) separated its research-based pharmaceuticals business by creating
a new company,
), to allow the two separate entities to perform in a more focused
In January, diagnostic testing company
) divested its OralDNA Labs salivary-diagnostics business to Access
Genetics. The sale of the company's HemoCue diagnostic products
business is also in the works. This would enable the company to
refocus its attention on its core diagnostic information services.
Moreover, Johnson & Johnson is currently looking for
opportunities to sell or spin off its Ortho Clinical Diagnostics
In November last year,
Becton, Dickinson and Company
) divested its Discovery Labware sub-segment (excluding Advanced
Bioprocessing capability) to
) for $730 million. In May,
Smith & Nephew
), through an agreement with Essex Woodlands, completed the
disposal of its Clinical Therapies business, to the newly formed
Bioventus LLC, in which it will retain a 49% investment. Healthcare
) is on track to spin off its pharmaceuticals business into a
standalone public company by mid-2013.
Before getting into the core discussion, let us brief some of the
significant earnings releases so far. Johnson & Johnson's
fourth quarter 2012 earnings came ahead of expectations, though
revenues were just shy of the Zacks Consensus Estimate.
Another medical device major
St. Jude Medical's
) fourth-quarter earnings and revenue came ahead of expectations.
The still-choppy U.S. defibrillator market remains an overhang on
St. Jude and we expect the same to affect the performance of its
), though Boston Scientific's results earlier today came inline
Other major earnings reports by industry players include the
earnings and revenue beats by
) and positive earnings surprise but a revenue miss from Quest
Diagnostics. We believe that the overall soft industry trends
leading to low volume growth was a dampener for Quest. We expect
this challenging scenario to adversely affect Quest Diagnostics'
Laboratory Corporation of America
) as well, which is scheduled to release its fourth-quarter and
fiscal 2012 results on Feb 8, 2013.
A look at the Zacks Earnings ESP (Expected Surprise Prediction -
Zacks Earnings ESP: A Better Method
) in the table below shows that companies like Becton Dickinson and
Hologic are likely to beat the Zacks Consensus Estimate this
Wary of an uncertain economy, MedTech companies have resorted to
the acquisition route to harness their strength and diversify their
Apart from the massive takeovers by Johnson & Johnson, the
other major deals inked in recent times in the MedTech space
include six successive acquisitions by Covidien exceeding $1.2
billion. In late December the company again entered into a
definitive agreement to acquire Fremont, California-based medical
device company, CV Ingenuity.
After strengthening its Cardiac Rhythm Management (CRM) portfolio
with the acquisition of Cameron Health, Boston Scientific recently
purchased Rhythmia Medical in Massachusetts and Minnesota-based
BridgePoint Medical (in October). While the former strengthens the
company's foothold in the rapidly growing electrophysiology
ablation business, the latter brings in a catheter-based system to
treat coronary chronic total occlusion. Moreover, the company
currently plans to acquire Vessix Vascular, which has developed the
percutaneous radiofrequency balloon catheter technology for the
treatment of hypertension.
) continues to expand its base on the back of acquisitions and
strategic alliances. The latest in its kitty, the Navilyst
acquisition will effectively double the company's existing market
share in the vascular access market.
In Nov 2012, the neurovascular division of Stryker acquired Surpass
Medical (for $135 million) to expand its Complete Stroke Care
portfolio. Surpass' mainstay, the CE-Marked NeuroEndoGraft family
of flow diverters is an attractive addition to the company's
In order to expand into the large and lucrative market for
) purchased Lutonix Inc. in December. The worldwide peripheral
vascular market for drug-coated balloons is forecast to hit roughly
$1 billion annually over the next ten years. Further, the
acquisition of Neomend will allow Bard to expand into another $1
billion market for surgical specialties offerings.
Low global penetration and demand outstripping supply provide a
positive long-term thesis for investing in the blood processing and
supply chain management industry. With the acquisition of the
transfusion medicine business of
) has entered the $1.2 billion whole blood collection market.
Haemonetics is also in the process of acquiring Hemerus Medical
that develops technologies for the collection of whole blood, and
processing and storage of blood components. The acquisition is
expected to close in 2014.
Also noteworthy is women's health giant Hologic's acquisition of
Gen-Probe in August. In addition,
), a global medical products player acquired Denmark-based Origio
to beef up its women's health franchise.
Trends over the recent past reflect focus on the diagnostics space.
A prime example is that of Agilent Technologies entering into the
Diagnostics and Genomics space through the acquisition of cancer
diagnostic company Dako. The acquisition is intended to augment
Agilent's portfolio and build a global market share to better fight
its major peers, especially
Thermo Fisher Scientific, Inc.
) in this space.
In November, Danaher acquired IRIS International, a leading
manufacturer of automated in-vitro diagnostics systems and
consumables and a provider of high-value personalized medicine
While Thermo Fisher Scientific strengthened its Specialty
Diagnostics business with the acquisition of One Lambda, a leading
player in the field of transplant diagnostics,
) three recent tuck-in acquisitions -- Compendia Bioscience,
Navigenics and Pinpoint Genomics -- will bolster its diagnostics
franchise. Moreover, Life Technologies has several agreements with
pharmaceutical players such as
) to shore up its companion diagnostics franchise.
In the light of the discussion above, 2012 has thus been a big year
for mergers and acquisitions in the MedTech space. According to the
American Council for Capital Formation's (ACCF) report, effective
Jan 2013, capital gains tax rate increased to 20% from 15% earlier.
The MedTech giants, being fully aware of this expected increase,
accelerated their acquisition strategy in 2012.
Despite the bleak prognosis, we do not expect the M&A trend to
slacken going forward. We expect a significant pickup in
in-licensing activities and collaborations for the development of
pipeline candidates. Several MedTech majors struggling in their
core businesses are looking to explore potential emerging therapies
through collaborations and alliances.
Another avenue of growth for the MedTechs is the huge untapped
potential of the emerging markets. An aging population, rise in
wealth, government focus on healthcare infrastructure and expansion
of medical insurance coverage make these markets a happy hunting
ground for global medical device players.
The focus on emerging markets is all the more significant given the
saturation and uncertain growth in the developed markets of US,
Europe and Japan. Companies like Medtronic, Boston Scientific,
Thermo Fisher Scientific and Life Technologies are all vying to
expand their presence in the BRICs and other emerging markets.
These companies are also looking to establish their manufacturing
According to a recent McKinsey & Co. report, health-care
spending in China has more than doubled from $156 billion in 2006
to $357 billion in 2011. It is expected to grow to $1 trillion by
2020. China is also setting up proper health insurance coverage
that should boost the healthcare sector. It is expected that within
the next decade, China will be the biggest healthcare market in the
world, outpacing the US.
Among the other BRIC members, Brazil is currently the largest
health care market in Latin America, covering almost one-fourth of
the population. Though India has one of the largest and fastest
growing health-care markets in the world, it is considered to have
the least developed health-care infrastructure and spends
relatively little on health care. In order to reverse the trend,
during the 12th Plan (2012-2017), the Indian government planned to
spend 2.5% of its GDP (up from 1.2% earlier) on healthcare and
raise it to at least 3% by 2022.
Given the huge potential in these regions, Johnson & Johnson
has set up manufacturing and R&D centers in Brazil, China and
India. While it has been doing business in China for more than 25
years, it established a new innovation center in the country in
2011. The Guangzhou Bioseal Biotech deal marked the company's first
MedTech acquisition in China. The company is expected to expand
further in China on the back of the Synthes acquisition.
Medtronic, on the other hand, is targeting 20% of its revenues from
emerging markets by fiscal 2015−16. After setting up its Innovation
Center in Shanghai, the first outside the US and Europe, last
September, the company decided to acquire China Kanghui Holdings
for $816 million. The acquisition would strengthen its orthopedic
franchise in the country.
Boston Scientific is aiming to increase its below-average market
share in the $700 million combined drug-eluting stent market in
China and India, which is growing sharply at 20%. The company plans
to invest $150 million in China over the next 5 years to build a
local manufacturing operation.
Life Technologies expects emerging markets to contribute $1.6
billion to revenues in 2015, up from just $188 million in 2007,
representing a CAGR of 30%. In the third quarter of 2012, the
company acquired Genewindows, a distributor covering the Invitrogen
brand reagent portfolio. In October 2012, the company entered into
a strategic partnership with Sino Biological, a Chinese
biotechnology company and a license and supply agreement with
Singapore based VelaDx.
Thermo Fisher is also expanding its presence in emerging markets.
It expects to garner 25% of total revenues from the high-growth
Asia-Pacific region and emerging markets by 2016, up from 19% in
2011 and 10% in 2006.
Healthcare Reform: MedTech Tax Woes
The Government-mandated health care reform in the US - the Patient
Protection & Affordable Care Act (aka "ObamaCare") - has
already started impacting the financial results of medical device
companies. The reform has led to a less flexible pricing
environment for these companies and has increased pricing pressure
across the board. As per the mandate, beginning 2013, device makers
will have to pay this tax on sales of certain products.
With the first tax installment due by the end of this month, many
of the nation's medical devices players are bracing themselves for
the impact of this tax. The companies are either trying to relocate
outside the US or reduce operations in order to weather the 2.3%
tax burden. They are undertaking various restructuring initiatives
to counter costs associated with the implementation of the new tax.
Earlier this month, the Medical Device Manufacturers Association
(MDMA) released a statement expressing its disappointment with the
failure to repeal the medical device tax in the fiscal cliff deal.
According to the MDMA, the outlay has already been felt across the
country in the form of an adverse impact on R&D investment, job
cuts and higher prices for customers impacting the overall quality
of patient care.
We continue to have a Neutral outlook on large-cap medical device
stocks. While the companies will keep facing challenges like
pricing pressures, declines in procedural volume from economic
uncertainties and sluggish growth in the CRM business, increased
M&A activities, focus on emerging markets and product approvals
in latent areas could help reduce the impact. Better pipeline
visibility and appropriate utilization of cash should increase
confidence in the medical device sector.
Zacks Rank #2 (Buy) stocks in the MedTech sector include
Johnson & Johnson
) among others. In our universe, we see growth potential in
companies dealing with promising technologies. In this respect,
both these companies represent a value proposition.
In spite of several core market challenges, the big three medical
device players -- Medtronic, Boston Scientific and
St. Jude Medical
) -- are striving to gain share in the ICD market through several
new product launches. The big three are also exploring new avenues
of growth beyond the mature pacemaker and ICD markets. With gradual
stability in the ICD market, they should be able to revive their
Beyond the MedTech majors, we are optimistic about the Zacks #2
Ranked orthopedic devices player
Zimmer Holdings Inc.
). The percentage of the population over age 65 in the US, Europe,
Japan and other regions is expected to nearly double by the year
In the US, the oldest baby boomers are now approaching retirement
age. We believe the orthopedic giants will stand to benefit from
this aging demography.
Among the scientific instrument makers,
Thermo Fisher Scientific
), a Zacks Rank #2 stock, has been successfully expanding operating
margins over the past few quarters on the back of operational
efficiency. Its rival
) has the same rank based on its strong position in the life
sciences market and momentum of its Ion Torrent franchise.
We are also positive on
), another Zacks Rank #2 stock, based on factors such as margin
expansion, acquisitions, product line expansion and geographical
reach as well as share buybacks.
CHALLENGES AND WEAKNESSES
Apart from the medical devices excise tax discussed earlier, the US
medical device industry is facing several challenges in the form of
depressed volumes, pricing pressure, currency headwinds and a
complicated regulatory system.
While the debt crisis in Europe remains unresolved, economies
throughout the world are trying to come to terms with myriad
challenges. Consequently, procedural volumes in the US have been
hit by a high unemployment rate, which has resulted in the expiry
of health insurance as well as a decline in enrollment in private
Governments across several European countries have taken up
measures to curb spending on devices, which is taking a toll on
utilization. Volume headwind is likely to linger as unemployment
continues to influence procedure deferrals.
Players in the medical device space are also experiencing pricing
pressure of varying degrees. Companies are witnessing global
pricing pressure in the CRM business and in some cases in stents.
Adding to the risk is the foreign exchange headwind (stemming from
the strengthening of the US dollar) as medical device companies
derive a chunk of revenues from overseas markets. Medical device
makers are also expected to contend with margin pressure given the
sustained pricing headwind.
Last but not least, the highly regulated US medical device industry
is hampered by stringent and complex procedures leading to approval
delays. This sometimes demotivates companies, deterring them from
investing in product development. In fact, according to a report
based on a survey of over 200 medical technology companies, the US
FDA takes a significantly high time to review compared to its
Coming to the weakest link in the MedTech sector, we recommend
avoiding names that offer little growth/opportunity over the near
term. These include companies for which estimate revision trends
for 2012 and 2013 reflect a bearish sentiment. These are
Patterson Companies Inc.
), a distributor of dental, companion-pet veterinarian, and
MGC Diagnostics Corporation
), a provider of non-invasive cardio respiratory diagnostic systems
), which provides medical equipment and supplies for non-acute care
environment. All these companies carry a Zacks Rank #5 (Strong
Sell). Also, cloud-based services provider
) currently retains a Zacks Rank #5 as doubts linger around its
proposed acquisition of
Further, pricing compressions on hips, knees and spine products,
which impaired the performances of several orthopedic companies,
remain a key concern, at the macro level. We remain skeptical about
Wright Medical Group
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