As expected, the Patient Protection and Affordable Care Act
(PPACA), particularly the medical device excise tax, has taken a
heavy toll on the MedTech sector, hurting pricing decisions of the
companies and subjecting them to tremendous margin pressure.
The small and the medium-sized players in the sector (comprising
about 80% of the industry) are the worst hit by this public policy.
The 2.3% excise tax (effective Jan 2013), which is imposed on the
sale price instead of net profit, amounts to a material burden,
wiping out almost a quarter's profit at many industry players.
On the other hand, the big players are trying every means to change
their business models and cost structures to accommodate the excise
tax. They are undertaking various restructuring initiatives to
counter costs associated with the implementation of the new
Restructuring, especially to offset the effect of tax, has
already been adopted by key players such as
St. Jude Medical, Inc.
). The companies are also trying to focus on strategic mergers and
acquisitions (M&A), emerging market expansion or are reducing
operations in order to weather the tax burden.
As mentioned above, MedTech M&A has continued unabated so far
in 2013. Wary of an uncertain economy, MedTech giants have resorted
to the acquisition route to harness their strength and diversify
The most noteworthy move is observed in MedTech giant
) strategic shift from being a device manufacturer to a provider of
broader healthcare services and solutions with meaningful clinical
and economic value for hospitals, physicians, patients and payers.
As an opening move, on Aug 12, 2013, the company acquired privately
held Cardiocom, a provider of integrated telehealth and patient
services for chronic disease management for a total consideration
of $200 million.
Also worth mentioning is the mega $13.6 billion takeover agreement
Thermo Fisher Scientific
) to acquire its major peer
Life Technologies Corporation
). This is the biggest ever deal for Thermo Fisher which will
inevitably strengthen the company's global foothold and commercial
reach. With the recent overwhelming approval of LIFE's stockholders
in favor of the deal, the acquisition is expected to close in early
Medical device M&As are not stopping here. In an effort to
expand its atrial fibrillation portfolio in the $900 million global
cardiac ablation catheter market, in August, St. Jude Medical
acquired Geneva, Switzerland-based Endosense SA for $170 million.
St. Jude plans to pay an additional $161 million in cash on the
achievement of a regulatory milestone.
About the same time,
) completed two significant purchases. These include privately-held
IDEV Technologies for $310 million and OptiMedica Corporation for
$250 million, both in cash. While the former would strengthen
Abbott Lab's vascular business the latter would boost its cataract
surgery business which accounted for 60% of total vision care
We also make a note of MedTech giant
Johnson & Johnson's
) $1 billion acquisition of privately-held, pharmaceutical
discovery and development company, Aragon Pharmaceuticals, Inc.
C. R. Bard, Inc.
) entered into a $200 million definitive acquisition deal to
purchase a leading developer and supplier of plant based hemostatic
agents, Medafor, Inc. The acquisition will help Bard gain access to
a proprietary technology platform and expand its global footprint.
It will boost the company's surgical specialties portfolio
(particularly surgical hemostats) in its Davol subsidiary.
In June, to strengthen its contraceptive portfolio, drug and
) acquired contraceptive device maker
) for approximately $1.1 billion in cash. This acquisition has
added the Essure permanent (non-surgical) birth control system to
Bayer's product portfolio.
Apart from the above mentioned takeovers and/or acquisitions, at
the end of last year,
) entered into a $4 billion deal to acquire Gambro AB, a
Sweden-based privately-owned renal products company. The deal,
which is expected to close shortly, will strengthen the company's
role in the hemodialysis market.
Also, Quest Diagnostics' acquisition of the lab-related clinical
outreach service operations of California-based Dignity Health in
Jun 2013 is in sync with its goal to create the planned "lab of the
future." This acquisition is the third laboratory business acquired
by the company in 2013.
In May, the company acquired the toxicology and clinical
laboratory business from Concentra, a subsidiary of
). Earlier, in January, the company had acquired the clinical and
anatomic-pathology outreach laboratory businesses of
Massachusetts-based UMass Memorial Medical Center. According to the
company, this will help boost its long-term growth opportunities in
the faster-growing esoteric markets.
In Mar 2013,
Becton, Dickinson and Company
) acquired Austria-based Cato Software Solutions, the manufacturer
of a suite of comprehensive medication safety solutions for
pharmacy intravenous medication preparation, physician therapy
planning and nurse bedside documentation. In the same month, the
leading vendor of cloud-based services for physician practices
) took over Epocrates, a pioneer of mobile health workflows and POC
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
) entered the $1.2 billion whole blood collection market. Moreover,
in May 2013, Haemonetics acquired Hemerus Medical that develops
technologies for the collection of whole blood, and processing and
storage of blood components.
The year 2012 had also witnessed significant M&A deals
including the acquisition of Switzerland-based Synthes Inc. by
Johnson & Johnson for a whopping $19.7 billion and Gen-Probe
) for $3.8 billion. Moreover,
) entered the Diagnostics and Genomics space through the $2.2
billion acquisition of cancer diagnostic company Dako.
In the light of the discussion above, the second half of 2013 is
going to be dense with M&A deals in the MedTech space. We also
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
Another trend that we have been observing of late is the divestment
of non-core business segments. For example, to streamline its
business, in July CR Bard agreed to divest certain assets of its
Electrophysiology (EP) division to Boston Scientific. Management
believes that the divestment will help the company to focus on
other high-growth businesses, which in turn should boost its top
In Jun 2013, to focus on its high-margin Medical Devices and
Medical Supplies businesses, healthcare products maker
) divested its pharmaceuticals business
Quest Diagnostics has also been focusing on areas with high
potential such as gene-based esoteric testing for cancer,
cardiovascular disease, infectious disease and neurological
disorders. As a part of this strategy, in Apr 2013, the company
completed the divestiture of the HemoCue diagnostics products
Earlier, in Dec 2012, the company divested its OralDNA Labs
salivary-diagnostics business in order to redirect its resources to
core diagnostic information services. Johnson & Johnson is also
currently looking for opportunities to sell or spin off its Ortho
Clinical Diagnostics business.
In early January, Abbott Laboratories separated its research-based
pharmaceuticals business by creating a new company,
), to allow the two separate entities to focus on their core areas
of expertise. In November last year, Becton, Dickinson and Company
divested its Discovery Labware sub-segment (excluding Advanced
Bioprocessing capability) to
Although the U.S. still holds the leading position with almost
one-third of the global market share, a gradual slowing down of the
established markets due to several prevailing headwinds are forcing
MedTech companies to move beyond their comfort zone. Accordingly,
emerging economies like Brazil, Russia, India and China --
collectively known as the BRICs -- as well as Turkey, Mexico,
Malaysia, South Africa, South Korea and the Czech Republic are fast
coming up in the medical devices space.
These emerging economies are seeing an increasing uptake of medical
devices due largely to growing medical awareness and economic
prosperity. An aging population, increasing wealth, government
focus on healthcare infrastructure and expansion of medical
insurance coverage make these markets a happy hunting ground for
global medical device players. 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.
The focus on emerging markets is all the more significant given the
saturation and uncertain growth in the developed markets of the
U.S., Europe and Japan. Companies like Medtronic, Boston
), Thermo Fisher Scientific, Life Technologies,
Smith and Nephew
) and many more are all vying to expand their presence in BRIC and
other emerging markets. These companies are also looking to
establish their manufacturing facilities abroad.
According to a McKinsey & Co. report (Sep 2012), healthcare
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, even outpacing the U.S.
Among the BRIC members, Brazil is currently the largest healthcare
market in Latin America, covering almost one-fourth of the
population. Though India has one of the largest and fastest growing
healthcare markets in the world, it is considered to have the least
developed healthcare infrastructure and spends relatively little in
this area. 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
Given the possibilities rife in the emerging markets, in the last
few months Life Technologies has undertaken several bolstering
initiatives. In Aug 2013 the company opened an advanced DNA
forensics laboratory in Gurgaon, India.
In June, the company acquired a South Korea-based distributor,
Life Science Korea, which is in line with its 'go direct' strategy
in this country. In April, as a part of this strategy, Life
Technologies acquired KDR Biotech Co., a reagents distributor based
in Seoul, Korea. In China, on the other hand, the company came up
with a licensing agreement with Suzhou Ribo Life Sciences Co. Ltd.
in Jun 2013.
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. According to the company, China with its
rapid industrialization, increasing focus on healthcare, new
BioPharma R&D centers and government sponsored research has
robust growth potential.
On the other hand, key growth drivers in India include
outsourcing of clinical packaging and logistics by Pharma and
Biotech companies, growing Biotech and food & beverage
industries, and introduction of environmental regulations to
address air quality issues in the wake of rapid industrialization.
Medtronic continues to record 20% growth in emerging markets,
accounting for half of its overall growth. The adoption of its
implantable cardioverter-defibrillators (ICDs) and pacers in
emerging markets continues to improve. Moreover, commercialization
of new products should accelerate sales growth in emerging
After acquiring China Kanghui Holdings, which added strength to
its orthopedic franchise in that country, Medtronic is keeping an
eye on other accretive buyouts in the region. According to the
company, the premium segments in China and India alone include a
population of more than 380 million, leading to $5 billion of
annual sales opportunity for Medtronic.
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 five years to build a
local manufacturing operation.
Smith & Nephew on its part entered into two definitive
agreements to expand in the BRIC countries. In Apr 2013, it
contracted to purchase its Brazilian distributor, Pró Cirurgia
PCE has been associated with the company for the last 30 years and
has distributed its sports medicine, orthopedic reconstruction and
trauma offerings in Brazil. In May 2013, the company announced
another agreement to take over Adler Mediequip Private Limited and
with it, the brands and assets of Sushrut Surgicals Private
Limited, a leader in mid-tier, orthopedic trauma products for the
Johnson & Johnson has already set up manufacturing and R&D
centers in Brazil, China and India. 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
Other Issues at Work
Apart from the medical device excise tax, the MedTech industry is
currently plagued by several issues, including pricing concerns,
hospital admission and procedural volume pressure, Medicare
reimbursement issues and regulatory overhang. 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 U.S. 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 health plans.
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.
Last but not least, the highly regulated U.S. medical device
industry is constrained by stringent and complex procedures,
leading to approval delays. This sometimes demotivates companies,
deterring them from investing in product development. According to
a report based on a survey of over 200 medical technology companies
(FDA Impact on U.S. Medical Technology Innovation), the U.S. FDA
takes a significantly longer time to review compared to its
Zacks Industry Rank
Within the Zacks Industry classification, MedTech is broadly
grouped into the Medical sector (one of 16 Zacks sectors) and
further sub-divided into four industries at the expanded level: med
instruments, med products, med/dental-supp and medical info
We rank all the 260-plus industries in the 16 Zacks sectors based
on the earnings outlook and fundamental strength of the constituent
companies in each industry. To learn more visit: About Zacks
As a guideline, the outlook for industries with Zacks Industry Rank
of #88 and lower is 'Positive,' between #89 and #176 is 'Neutral'
and #177 and higher is 'Negative.'
The Zacks Industry Rank for med instruments is #189, med products
is #104, med/dental-supp is #118, while the medical info systems is
#162. Analyzing the Zacks Industry Rank for different MedTech
segments, it is obvious that while the outlook for med instruments
stocks is negative, that for med products, med/dental-supp and
medical info systems is neutral.
Earnings Trend of the Sector
So far, 100% of the Medical sector participants have reported
second-quarter results, which have been fairly good with respect to
beat ratios (percentage of companies coming out with positive
surprises). However, the results were not impressive in terms of
The earnings "beat ratio" was 70.0%, while the revenue "beat ratio"
was 48.0% in the second quarter. Total earnings for the companies
in this sector declined 1.1% year over year despite marginal
revenue growth of 2.4%. In fact, earnings and revenues showed a
sharp decline from the first quarter 2013 growth of 4.5% and 8.1%
The earnings is expected to decline by 4.3% in the third quarter
2013 although it will increase by 1.1% in the subsequent quarter.
However, the sector is expected to register a nominal growth of
0.5% for the full-year 2013. In terms of revenue expectation, the
sector is expected to register 4.1% and 2.4% year-over-year growth
in the third and fourth quarters of the year respectively,
resulting in an annual growth rate of 2.8%.
Medical device majors like Boston Scientific and St. Jude Medical
are confronted with challenging economic conditions, a competitive
environment, pressure on core segments and a larger-than-expected
currency headwind. Although they managed to stay ahead of the Zacks
Consensus Estimate for earnings and revenues in the second quarter,
challenges continue to remain in the core stent and defibrillators
On the other hand, Medtronic barley managed to stay in line with
the Zacks Consensus Estimate for earnings. While we are to some
extent relieved with the signs of stability in Medtronic's core
CRDM and pacing segments, challenges still remain in the Spine
business, which is expected to remain sluggish, thereby affecting
the company's overall performance.
Other adverse earnings reports from major industry players include
the second quarter earnings miss of
) due to a stiff capital spending environment and sluggish benign
gynecologic procedures in the U.S. We witnessed a negative earnings
surprise from Quest Diagnostics. We believe that the overall soft
industry trends leading to a challenging volume environment for
testing laboratories and utilization weaknesses are looming
headwinds for Quest.
On the positive, earnings beat from big names like Johnson &
Laboratory Corporation of America Holdings
), Zimmer Holdings, Thermo Fisher, Life Technologies, Edwards
Lifescience and Abbott Labs kept the hope alive.
In spite of several core market challenges, the big two medical
device players -- Medtronic and Boston Scientific -- are striving
to gain share in the ICD market through several new product
launches. They 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 top line. Also, better
pipeline visibility and appropriate utilization of cash should
increase confidence in the medical device sector.
Microarray product maker
) was languishing with its flagship GeneChip Expression products
until management found a strategy to expand into high-growth
markets for translational medicine, molecular diagnostics and
applied markets. Consequently the shares of Affymetrix hit a
52-week high accompanied by a bullish Zacks Rank #1 (Strong Buy).
Zacks Rank #2 (Buy) stocks in the MedTech sector include
The Cooper Companies Inc.
) and Boston Scientific among others. Cooper represents a value
proposition based on factors such as margin expansion,
acquisitions, product line expansion and geographical reach as well
as share buybacks. On the other hand, we are positive about
multiple initiatives taken by Boston Scientific to expand
electrophysiology (EP) division.
Zacks Ranked #3 St. Jude is also doing well with its growing Atrial
Fibrillation products portfolio that witnessed a major boost with
the acquisition of Endosense and regulatory approval for its
Beyond the MedTech majors, we are also optimistic about the Zacks
Ranked #3 orthopedic device players, Zimmer Holdings and Stryker
Corporation. The percentage of population over 65 in the U.S.,
Europe, Japan and other regions is expected to nearly double by the
year 2030. In the U.S., the oldest baby boomers are now approaching
retirement age. We believe the orthopedic giants stand to benefit
from this aging demography.
Among scientific instrument makers, Thermo Fisher Scientific has
been successfully expanding operating margins over the past few
quarters on the back of operational efficiency. Thermo Fisher's
market leading portfolio of analytical technologies and specialty
diagnostic will be complemented by the upcoming buyout of Life
Technologies. The latter has an expansive line of consumables for
genomic, molecular and cell biology.
Among mid-cap MedTech stocks,
) carrying a Zacks Rank #2 (Buy) look attractive.
CHALLENGES AND WEAKNESSES
Coming to the weakest link in the MedTech sector, we advise
investors against names that offer little growth/opportunity over
the near term. These include companies for which estimate revision
trends for 2013 and 2014 reflect a bearish sentiment.
After posting dismal second quarter results and lowering its fiscal
) currently retains a Zacks Rank #4 (Sell). Other Zacks Rank #4
(Sell) stocks which do not look inspiring are
Allscripts Healthcare Solutions, Inc.
Symmetry Medical, Inc.
Merge Healthcare Inc.
Pricing compression on hips, knees and spine products, which
impaired the performances of several orthopedic companies, remains
a key concern, at the macro level. We remain skeptical about
Wright Medical Group
), which currently carries a Zacks Rank #4 (Sell).
ABBOTT LABS (ABT): Free Stock Analysis Report
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