Last year proved to be challenging for medical technology
("MedTech") stocks given the exigent economic conditions and the
precarious healthcare environment. The performance of incumbent
players was hamstrung by several macro issues, including sustained
price and procedure volume pressures.
The difficult macroeconomic backdrop, pricing headwinds, austerity
measures, reimbursement pressure, a still unstable job market and
the impact of health care reform continue to weigh on the medical
devices industry, exacerbated by Europe's sovereign debt plight.
With fewer patients going under the knife accompanied by concerns
of overuse of devices, companies in the cardiovascular and
orthopedic domain continue to grapple with tepid utilization. After
having a buoyant first half, the MedTech sector went through a
rough patch in the back half of 2011 given the weakened sector
fundamentals, sluggish key end-markets and macro pressures. Many of
the MedTech stocks lost a third of their values last year.
Although the industry is still saddled with the unfavorable macro
environment, it is expected to fare relatively better in 2012
thanks to several attractive growth opportunities and healthy
tailwinds including improving hospital spending, emerging markets
and pent-up demand.
The global medical devices industry is fairly large, intensely
competitive and highly innovative, with estimated worldwide sales
of more than $300 billion in 2011. The U.S. is the largest market,
with estimated annual revenues in excess of $100 billion.
Innovation is the quintessence in the MedTech industry, leading to
continuous advancement in treatment and delivery of health care
while driving competitiveness through differentiated and improved
The highly regulated medical devices industry is divided into
different segments including Cardiology, Oncology, Neuro,
Orthopedic and Aesthetic Devices. The U.S. medical devices industry
continues to grow at a brisk pace, backed by an aging Baby Boomer
population, high unmet medical needs and increased incidence of
lifestyle diseases (including cardiovascular diseases, diabetes,
hypertension and obesity). Neuro, orthopedic and aesthetic
represent the fastest growing categories.
The MedTech industry is plagued by several issues, including
pricing concerns, hospital admission and procedural volume
pressures, uncertainty surrounding health care reform, Medicare
reimbursement issues and regulatory overhang, which have left many
investors scratching their heads.
The beleaguered U.S. implantable defibrillator market continues to
bother cardiac devices makers, as reflected by sustained implant
volume pressures. On the other hand, companies in the orthopedic
domain remain affected by a still choppy reconstructive implant
market as they face sustained pressure across hip, knee and spine
While several catalysts for growth in 2012 exist -- such as new
product cycles, an aging population, geographic expansion, ongoing
transition towards minimally-invasive techniques and emerging
markets -- lingering issues from last year remain an overhang.
Adding to the pain is the foreign exchange headwind (stemming from
the recent strengthening of the U.S. dollar) as medical devices
companies derive a chunk of revenues from overseas markets.
Factoring in the negative currency impact, several companies have
already dialed back their forecasts for 2012. Medical devices
makers are also expected to contend with margin pressure in 2012
given the sustained pricing headwind.
The aging population nevertheless represents a major demand
catalyst for medical devices. The elderly population (65 years and
above) base in the U.S. is roughly 40 million, representing around
13% of the nation's population and accounting for a third of health
care consumption. Federal government estimates indicate that the
elderly population will catapult to 72 million by 2030, ensuring a
major boost for medical devices utilization.
Given the maturing legacy markets, medical device companies are
looking to expand into lucrative incipient markets. Expansion in
the emerging markets, especially those with double-digit annual
growth rates, represents one of the best potential avenues for
growth in 2012 and beyond.
Healthcare Reform: Tax Fear Grips MedTech
The Government-mandated health care reform in the U.S. -- the
Patient Protection & Affordable Care Act (labeled as
"ObamaCare") -- has raised a degree of uncertainty for medical
devices companies. The reform has led to a less flexible pricing
environment for these companies and may pressure pricing across the
Moreover, the highly controversial proposed tax, representing a
part of the Act, will be a drag on devices companies. When
implemented, devices makers will have to pay 2.3% excise tax on
sales of certain products beginning 2013.
The outlay is expected to throttle innovation as it will impact
investment in R&D. Moreover, it will lead to job cuts and
higher prices for customers. The federal government expects to
raise $20 billion from the tax over a ten-year period. In response,
devices makers have started to take up several initiatives
including headcount haircut and other restructuring activities to
counter costs associated with the implementation of the new tax.
Nevertheless, the Act places considerable emphasis on patient
safety and aims to reduce the number of uninsured people (from 19%
of all residents in 2010 to 8% by 2016). The new law is expected to
eventually extend health insurance coverage to an estimated 32
million Americans currently not insured.
Reimbursement Scenario: Bumps Ahead
Medical device companies are susceptible to significant
reimbursement risks as their products are reimbursed by the Center
for Medicare and Medicaid ("CMS") and commercial payers.
Third-party reimbursement programs in the U.S. and abroad, both
government-funded and commercially insured, continue to develop
different means of controlling health care costs, including
prospective reimbursement cuts with careful review of medical bills
and stringent pre-approval requirements.
An increase in the publicly insured base (resulting from health
care reform) is expected to lead to lower reimbursement obtained by
physicians, hospitals and other health care providers as public
insurance generally offers lower reimbursement vis-à-vis private
payors. Moreover, private insurance companies are increasing their
scrutiny of certain surgeries, which will continue to materially
impact utilization in 2012.
Federal budgetary pressure (given a potential reduction in U.S.
government's health care spending) has also raised reimbursement
risk as payors may more actively pursue their cost reduction
In an effort to curtail costs, the CMS, in November 2011, announced
a pilot program which directs Medicare recovery audit contractors
to perform a pre-payment audit (by means of reviewing patient
records, claims and other documents) for certain "big ticket"
cardiology and orthopedic procedures in key states, including
Florida, starting January 2012.
The goal of this move, which represents a shift from the
conventional "pay-and-chase" method, is to avoid
unnecessary/inappropriate payments and reduce Medicare payment
error rate. The procedures include pacemaker and defibrillator
implantations, joint replacements and spinal fusions which will go
under the CMS scanner before payment. The measure, which will
eventually delay payments, has goaded strong reactions from the
The 510(k) Reform - A Paradigm Shift
The U.S. Food and Drug Administration (FDA) declared, in August
2010, a set of ambitious proposals for revamping the 510(k) device
approval protocols. The 200-page report, consisting of 55 proposed
changes, was designed to serve as a blueprint for the reform,
representing FDA's vision to streamline the device review process
and make it more predictable and transparent.
As part of the listed proposals, the FDA intends to create the
"Center Science Council," which will oversee medical device
science-based decision-making. Moreover, the regulator is seeking
additional information regarding the safety and efficacy of devices
in the 510(k) submissions. The FDA also aims to form a subset of
moderately risky devices (to include devices such as infusion
pumps) under the "Class IIb" moniker that would require submission
of more clinical data and manufacturing information compared to the
existing Class II devices.
In a major move, the FDA outlined a plan in January 2011,
consisting of 25 proposals, designed to improve the regulatory
approval pathway for medical devices. The proposals, announced by
the FDA's Center for Devices and Radiological Health ("CDRH"), are
aimed at overhauling the three-and-a-half-decade-old 510(k) device
approval program by which roughly 4,000 devices have been cleared
The list includes streamlining the de novo review process for
lower-risk devices, clarifying when devices companies should submit
clinical data for a 510(k) application and establishing a new
council of senior FDA experts. President Obama emphasized that the
planned changes represent the government's efforts to keep patients
safer and accelerate the approval process of innovative and
The CDRH forwarded seven of the controversial proposals to the
Institute of Medicine ("IOM"), which provides national advice on
medical issues, for independent review. In a shocking move, in late
July 2011, the IOM recommended the FDA scrap the 510(k) process and
replace it with a new regulatory framework that integrates
pre-market clearance and better post-market surveillance. The IOM
review concluded that the 510(k) process fails to evaluate the
safety and effectiveness of Class II devices before they enter the
market. The recommendation was met with immediate industry-wide
However, the FDA noted that the IOM's recommendation is not binding
and the 510(k) process should not be eliminated. As such, the
agency continues to move ahead with its reform plans.
Among the latest developments, the FDA, on December 27, 2011,
issued a draft guidance which aims to provide detailed information
about the current review practices for 510(k) submissions. The
guidance offers greater clarity and transparency on the regulatory
framework, policies and practices underlying the agency's 510(k)
The primary aim of the guidance is to elucidate certain key points
(outlined in a decision-making flowchart) in the decision-making
process for determining substantial equivalence of devices reviewed
under the 510(k) program. Devices makers must prove that their
devices are substantially equivalent to a predicate device already
marketed to secure the FDA green signal. The FDA is currently
seeking public comments on the draft guidance and, if finalized, it
will replace the old documents which have long defined the approval
While the 510(k) overhaul is still in process, it may eventually
make device approval more complex, lengthy and burdensome.
Moreover, with the expected rise in the regulatory bar for
approvals, medical devices companies may be required to shell out
more for R&D.
For 2012, we advocate companies providing life-sustaining products
and procedures, given their healthy recurring revenue streams.
Further, investors should look for stocks with strong earnings
quality, healthy growth trajectory, and liquidity profiles as they
appear attractive considering their ability to leverage strong
balance sheet and cash flows in maximizing shareholder value in the
form of dividends and share repurchases or use them for value
acquisitions. Stocks with healthy dividend yields offer a cushion
against market volatility.
MedTech companies with vast product range/healthy pipeline and
strong infrastructure are also better poised for improved returns.
Moreover, companies focusing on more judicious R&D investment,
expansion into new markets and cost-saving through restructuring
are better placed for 2012. These companies have greater capability
of withstanding the sustained macro-level issues and increasing
Pressed by a still-soft economy, top-tier devices makers are
expected to continue their merger/acquisition binge in 2012,
especially as a means to enter new markets and diversify their
portfolio. Although this represents an important avenue for growth,
we continue to advise investors to shun companies that have grown
historically through extensive acquisitions only. These companies
face increasing challenges in integrating acquired businesses and
delivering operational synergies from them, which are considered to
be the prime reason for failures of mergers and acquisitions. We
are also cautious of dilution associated with these transactions.
At the end, we still recommend investors to eschew companies making
non-life-sustaining products and procedures (including elective
procedures such as hip and knee replacement), as they are still
engulfed by softened patient demand.
In our universe, we see growth potential in companies dealing with
cardiovascular devices, neuro and radiation oncology products.
Boston Scientific Corporation
St. Jude Medical
The above-listed companies make life-sustaining products and are
less affected by economic instability. These companies are all
leading players in their respective fields and are potential
winners in the long run. Some of these players have been successful
in weathering the storm (pricing, currency and volume headwinds) in
the cardiovascular space.
With a slew of new products, the Big Three players (Medtronic,
Boston Scientific and St. Jude) in the $6.5 billion implantable
cardioverter defibrillator ("ICD") market are well-positioned to
gain market share, despite the challenging business environment and
several other barriers to growth. These companies have a number of
levers to pull and represent a good bet for long-term investors.
Among the names above, Medtronic, the undisputed leader in the
MedTech space, has a diversified presence in cardiovascular, neuro,
spinal, diabetes and ENT and boasts of an attractive pipeline.
Despite sustained weaknesses in its key ICD and spinal implants
businesses, we like the company's efforts to augment/diversify its
product range, expand into emerging markets for growth, and
generate strong cash and healthy dividend yield. Besides, the new
MRI SureScan pacemaker and Protects ICDs should offer support to
its core CRM business.
Boston Scientific has maintained its leadership in the drug eluting
stent ("DES") market. The earlier-than-expected approval of the
next-generation DES product Promus Element coupled with a new line
of ICDs better places the company for 2012. Although Boston
Scientific's December quarter results were disappointing and its
CRM segment remains challenging, we believe that the company's
continuous focus on strategic initiatives (including new products
and cost cutting measures) to drive growth and profitability should
yield steady results moving ahead.
Boston Scientific is leaving no stone unturned to stay on course
for growth. It has undertaken a series of management changes and
restructuring initiatives that are expected to contribute to the
bottom line and margins. The company is also expanding its
footprint in the emerging markets by reinvesting the savings from
We remain intrigued by St. Jude's ability to consistently produce
positive earnings surprises and revenue growth. The company is
gaining ICD market share despite a sluggish market condition. St.
Jude is poised for incremental opportunities in CRM on the back of
strong product momentum. A surfeit of new growth drivers are
expected to offer opportunities for accelerated sales growth over
the next few years.
St. Jude recently won the U.S. approval for its Unify quadripolar
CRT-D system. The device is expected to help the company win ground
in the highly competitive U.S. defibrillator space in 2012. St.
Jude is currently the only company to offer this technology
globally. Moreover, St. Jude is well placed to leverage the solid
growth momentum in the atrial fibrillation market.
Beyond the MedTech majors, we are also optimistic about scientific
Thermo Fisher Scientific
). The leading, diversified scientific instrument maker has been
successful in expanding operating margins over the past few
quarters on the back of operational efficiency and cost discipline.
It has strong international exposure and is focusing on
acquisitions and the emerging markets for growth.
Robotic surgery is another area which appears to be better placed
for growth in 2012 and
) clearly leads the pack with its state-of-the-art technology.
Intuitive enjoys a virtual monopoly in robotic surgery and
continues to deliver forecast-topping earnings. Its sales are
growing at a torrid pace buoyed by the da Vinci surgical system.
Another good pick is Varian, the world's leading manufacturer of
integrated radiotherapy systems for treating cancer. The company is
poised to increase its market share in the radiation oncology
market. Varian is currently enjoying a healthy demand for its
RapidArc radiotherapy technology, which is meaningfully
contributing to its oncology net order growth.
Edwards Lifesciences represents another value proposition. The
company received, in November 2011, the U.S. approval for the
highly-anticipated Sapien transcatheter aortic heart valve (for
inoperable patients). With this approval, it became the first
company in the U.S. to receive approval for a transcatheter device
which allows surgeons to replace a patient's ailing aortic valve
without resorting to open-heart surgery. Banking on the launch of
the Sapien valve in U.S. and other product developments, Edwards
expects to record robust sales growth in 2012.
We also believe that cardiac assist devices maker Abiomed
represents another attractive opportunity for investors. The
company possesses a broad portfolio of products that are
life-sustaining in nature and has been able to deliver sustainable
growth in a challenging economy. Abiomed enjoys strong demand for
its Impella cardiac pumps.
We are also upbeat about the prospects of resuscitation
devices-maker ZOLL Medical. ZOLL is a leading player in the global
market for external defibrillators, which is worth more than $1
billion. The company's LifeVest wearable defibrillator business
continues to grow at a healthy quarterly run rate, benefiting from
increased awareness of the product and associated sales force
enhancements. Moreover, its significant international presence
should also push growth.
Emerging Markets: A Big Role to Play
The leading U.S. cardiovascular devices companies such as
Medtronic, Boston Scientific and St. Jude are exploring new avenues
of growth beyond the mature pacemaker and ICD markets. These
companies are increasingly seeking opportunities to expand into
fast-growing new therapy areas within or outside the cardiology
space, including markets such as atrial fibrillation and
Among the emerging cardiology markets, an encouraging prospect
represents the structural heart market with its major categories
including Patent Foramen Ovale (
) and Left Atrial Appendage (LAA) occlusion. The AGA acquisition
has provided St. Jude with devices targeted at PFO and LAA markets.
Moreover, the Transcatheter Aortic Valves (TAVI) market, an
opportunity estimated in the ballpark of $2 billion, is emerging as
a substantial new growth prospect for the top-tier MedTech
companies. St. Jude has registered the first human implant of its
next-generation TAVI product dubbed Portico. The company is
optimistic to enter the European TAVI market with its Portico valve
Medtronic's TAVI offering, CoreValve, is already approved in Europe
and is currently undergoing evaluation in a pivotal trial in the
U.S. Boston Scientific is planning to launch its Lotus valve in
EMEA in the second half of 2013. Edwards has the first-mover
advantage in the U.S. in TAVI with its Sapien valve.
Intravascular ultrasound imaging (IVUS), Optical Coherence
Tomography (OCT) and other next-generation imaging technologies are
expected to offer incremental opportunity for companies such as
), Boston Scientific and St. Jude. The OCT market has been
projected to grow at a double-digit clip over the next five years.
Another emerging prospect is renal denervation for treating
resistant hypertension. We believe that emerging markets represent
a key catalyst for growth in 2012 and beyond.
Favorable Hospital Spending Cycle
A soft hospital capital spending backdrop was challenging for
MedTech stocks in 2010. The North American and European markets
were affected by shrinking budgets for equipment purchases at the
height of the recession.
However, results in 2011 indicate a silver lining stemming from
continued recovery in hospital spending in the U.S. Spending levels
are improving as hospitals appear to have started replacing their
worn-out equipment. A healthy replacement/upgrade cycle is expected
to favorably impact results in 2012.
A Still-Clouded Orthopedic Space
We continue to advise investors to spurn companies in the
orthopedic domain. Companies in this roughly $37 billion market
continue to struggle as patients defer their elective procedures
given the lingering economic softness, exacerbated by sustained
The reconstructive market fundamentals (pricing and volume) remain
challenging with little or no clear visibility for a material
turnaround in the near future. The joint replacement market has
been hit by patient deferral of elective procedures, leading to
weak demand for hip and knee implants.
Companies that fit the bill include
Wright Medical Group
). We remain cynical about these stocks given the sustained
However, we acknowledge that companies such as Stryker and Zimmer,
with less exposure to metal-on-metal (MoM) hip products, are better
placed to gain share than their highly-exposed counterparts such as
Johnson & Johnson's
) Depuy and Wright Medical. The ongoing transition from MoM
implants to next-generation hip systems represents a tailwind for
Pricing: A Lingering Issue
Pricing compressions on hips, knees and spine products, which
impaired the performances of most of the orthopedic companies in
2011, remain a key concern, at the macro-level. The effect of
government health care cost containment efforts and continuing
pressure from local hospitals and health systems as potential
Medicare reimbursement cuts create additional reasons for hospitals
to push back pricing. This is expected to continue hurt selling
prices on a global basis.
Moreover, the advent of group purchasing organizations (GPOs),
which act as agents that negotiate vendor contracts on behalf of
their members, has also put pressure on pricing. The prevailing
economic climate has bolstered the bargaining power of GPOs. The
scenario in 2012 is expected remain challenging as hospitals
continue to push back pricing.
Spine Still Hurts
The spinal market has been worst hit by pricing/volume headwinds
and payor push back as manifested by a moribund quarterly growth
trend. Leading companies in the orthopedic space such as Stryker
and Zimmer continue to experience price and volume pressure,
evident in 2011 results.
Pricing pressure and reimbursement uncertainties coupled with
austerity measures in Europe are expected continue to weigh on this
market in 2012. Moreover, private payors are delaying spine
surgeries by requiring more documentation before approving such
procedures, thereby contributing to the slowdown in this market.
Volume: Still a Headwind
The $12 billion replacement hips and knees markets have been
affected by lingering economic softness, as reflected in procedure
volume pressure. Cash-strapped patients continue to defer surgeries
given the weak economy and reimbursement-related pushback.
Procedural volumes in the U.S. have been negatively impacted as a
result of a high unemployment rate, which has resulted in the
expiry of health insurance as well as a decline in enrollment in
private health plans.
As per the demographic analysis, these trends had a significant
impact on the potential patient base for joint replacement
procedures, those between 45 and 65 years of age and without any
Medicare coverage. On the other hand, austerity measures are
contributing to the reduction in procedure volumes in Europe.
Governments across several European countries have taken up
measures to curb spending on drug and devices, which is expected to
thwart utilization this year.
The hip/knee market in Europe is expected to remain challenged in
2012. Volume headwind is likely to sustain this year as
unemployment continues to influence procedure deferrals.
Companies such as Stryker and Zimmer derive a chunk of their
revenues from replacement hips and knees. Most of the leading
players in the orthopedic space reported weak knee sales in the
most recent quarter, echoing a general softness in the market.
December quarter trends indicate sustained lumpiness in procedure
volume growth across hip and knee markets (although manifesting
signs of stabilization) and a substantial recovery is not likely,
at least in the near term. In fact, it is still hard to pin down
the timing of the rebound in procedure volume to pre-recession
level. As such, we continue to recommend investors to steer clear
of the above-mentioned orthopedic stocks until the pricing/volume
ABIOMED INC (
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BOSTON SCIENTIF (
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CONMED CORP (
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EDWARDS LIFESCI (
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INTUITIVE SURG (ISRG): Free Stock Analysis
MEDTRONIC (MDT): Free Stock Analysis Report
SYMMETRY MEDICL (SMA): Free Stock Analysis
ST JUDE MEDICAL (STJ): Free Stock Analysis
STRYKER CORP (SYK): Free Stock Analysis Report
THERMO FISHER (TMO): Free Stock Analysis Report
VARIAN MEDICAL (VAR): Free Stock Analysis
VOLCANO CORP (VOLC): Free Stock Analysis Report
WRIGHT MEDICAL (WMGI): Free Stock Analysis
ZIMMER HOLDINGS (ZMH): Free Stock Analysis
ZOLL MEDICAL CO (ZOLL): Free Stock Analysis
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