Lost in all of this spring's hand-wringing about the potentially
negative impacts from President Obama's health care overhaul,
investors seemed to overlook two more powerful forces that could
severely impact the health care industry. Consumers' financial
distress is leading to a sharp slowdown in elective medical
procedures (as my colleague Andy Obermueller recently noted), while
hospitals and insurers are pressing medical device makers to cut
prices if they are to see continued use of their products.
As Fewer Go to the Doctor, This Winning Health-Care
Company Bucks the Trend
Those factors led
, a leading supplier of spinal products and defibrillators, to post
weak fiscal first quarter results, pushing shares down -10% in
Tuesday trading. Shares are now at their lowest level in more than
10 years (with the exception of the market swoon in early 2009),
and prospects are very dim for a rebound. As Chairman and CEO Bill
Hawkins noted in a call with investors, industry conditions are
unlikely to improve any time soon.
These industry pressures appear inevitable. Health care costs had
been rising faster than
for quite some time: U.S. spending on health care surpassed $2.3
trillion in 2008, more than three times the $714 billion spent in
1990 and more than eight times the $253 billion spent in 1980,
according to the Kaiser Family Foundation. Most agree that this
burdensome trend must come to an end.
It's easy to blame our aging and increasingly obese population for
ever-rising health care spending.
Yet as the Congressional Budget Office notes
, "about half of all growth in health care spending in the past
several decades was associated with changes in medical care made
possible by advances in technology." And that's where companies
like Medtronic and
Boston Scientific (
come in. These companies have consistently sought out acquisitions
of smaller medical device players that offered novel but pricey
applications to cure what ails us. Growth is slowing for these big
companies precisely in the areas in which they made a lot of
acquisitions. In a nutshell, it's been a great era to invest in
smaller medical device companies that have ultimately been bought
out. Just this year, Medtronic agreed to acquire ATS Medical and
Osteotech (Nasdaq: OSTE)
. In both cases, Medtronic paid greater than a +50% premium to
acquire these firms. Yet these firms are seeing increasingly
restrictive reimbursement environments themselves.
In a box
At this point, large players like Medtronic and Boston Scientific
are in a box. They have to assume that consumer spending on
elective healthcare will stay downbeat for some time to come. It's
easier to deal with a bad back on your own than come up with major
out-of-pocket funds if you need an un-reimbursable elective
procedure. And changes at the federal level won't be of much help.
As parts of the health care overhaul, tests are underway to
identify the cost-effectiveness of a wide range of medical
procedures. Any procedures that fail to materially improve patient
outcomes are likely to see reimbursement levels slashed in the next
In a best case scenario, these firms will be able to boost sales at
a small pace, largely thanks to acquisitions. More than likely,
organic growth is likely to be flat to negative. So to boost
profits, these firms can cut costs (Medtronic has already cut a lot
of fat and likely has little left to cut) or buy back stock
(Medtronic recently completed a $500 million buyback).
In light of all of these pressures, there is simply no way to
justify purchase of Medtronic shares, even as they languish at
lows. Management has already conceded that business will remain
lousy for at least several more quarters, although sales are
unlikely to rebound in the next few years either.
Action to Take -->
Shares of Medtronic and Boston Scientific are too cheap to short.
Instead, investors should stick to smaller medical device makers
that either have robust growth prospects or might eventually find
an acquirer. For further research, you can investigate names such
Given Imaging (Nasdaq: GIVN)
Nuvasive (Nasdaq: NUVA)
Varian Medical (
-- David Sterman
David Sterman started his career in equity research at Smith
Barney, culminating in a position as Senior Analyst covering
European banks. David has also served as Director of Research at
Individual Investor and a Managing Editor at TheStreet.com. Read
Disclosure: Neither David Sterman nor StreetAuthority, LLC hold
positions in any securities mentioned in this article.