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 (JNJ) for a whopping $19.7
billion, Gen-Probe Inc. by Hologic (HOLX) for $3.8
billion and Agilent Technologies’ (A) acquisition
of Danish cancer diagnostics company Dako for $2.2 billion.
Another trend that we have been observing of late is the
divestment of non-core business segments. For example, in early
January, Abbott Laboratories (ABT) separated its
research-based pharmaceuticals business by creating a new company,
AbbVie (ABBV), to allow the two separate entities
to perform in a more focused manner.
In January, diagnostic testing company Quest
Diagnostics (DGX) 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 business.
In November last year, Becton, Dickinson and
Company (BDX) divested its Discovery Labware sub-segment
(excluding Advanced Bioprocessing capability) to
Corning (GLW) for $730 million. In May,
Smith & Nephew (SNN), 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 products maker
Covidien (COV) is on track to spin off its
pharmaceuticals business into a standalone public company by
mid-2013.
Earnings Numbers
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
(STJ) 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 peers Boston Scientific (BSX)
and Medtronic (MDT), though Boston Scientific’s
results earlier today came inline with expectations.
Other major earnings reports by industry players include the
earnings and revenue beats by Stryker Corporation
(SYK) 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’
peer Laboratory Corporation of America (LH) 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 –
read: 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 quarter.
M&A Activity
Wary of an uncertain economy, MedTech companies have resorted to
the acquisition route to harness their strength and diversify their
offerings.
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.
AngioDynamics (ANGO) 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
product line.
In order to expand into the large and lucrative market for
drug-coated balloons, C.R. Bard (BCR) 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 Pall Corporation
(PLL), Haemonetics (HAE) 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, Cooper Companies
(COO), 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 Teradyne
(TER), Thermo Fisher Scientific, Inc. (TMO) and
Danaher Corp. (DHR) 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
solutions.
While Thermo Fisher Scientific strengthened its Specialty
Diagnostics business with the acquisition of One Lambda, a leading
player in the field of transplant diagnostics, Life
Technologies’ (LIFE) 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
Bristol-Myers Squibb (BMY) 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.
Emerging Markets
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
facilities abroad.
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.
OPPORTUNITIES
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 (JNJ) and Edwards
Lifesciences (EW) 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 (STJ) -- 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 top line.
Beyond the MedTech majors, we are optimistic about the Zacks #2
Ranked orthopedic devices player Zimmer Holdings
Inc. (ZMH). The percentage of the population over age 65
in the US, Europe, Japan and other regions is expected to nearly
double by the year 2030.
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 (TMO), a Zacks Rank #2 stock, has been
successfully expanding operating margins over the past few quarters
on the back of operational efficiency. Its rival Life
Technologies (LIFE) 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 Cooper Companies (COO),
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
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.
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 European counterpart.
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
Abbott Laboratories (ABT), Patterson
Companies Inc. (PDCO), a distributor of dental,
companion-pet veterinarian, and rehabilitation supplies,
MGC Diagnostics Corporation (MGCD), a provider of
non-invasive cardio respiratory diagnostic systems and
Invacare Corporation (IVC), 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 athenahealth Inc. (ATHN)
currently retains a Zacks Rank #5 as doubts linger around its
proposed acquisition of Epocrates Inc. (EPOC).
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
companies including Wright Medical Group
(WMGI).
ABBOTT LABS (ABT): Free Stock Analysis Report
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