Here Comes the Medical Device Tax

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Ka-ching! That's the sound of the government's cash register after the first tax bill from the Affordable Care Act's medical device tax hit the industry for $97 million this week, according to trade groups.

Medical device companies are grumbling, but investors have yet to feel the hit. It could only be a matter of time, however -- and this earnings season has already given us a glimpse of what companies are doing to adapt.

Taxes, job cuts, and an industry in transition
Industry groups estimate the tax -- put in place in order to help pay for the sweeping reforms of the Affordable Care Act -- will drain $194 million per month from the industry en route to coughing up around $29 billion over the next 10 years. That's chump change for the biggest players in the business, but for the smaller or financially challenged companies in the industry struggling to compete, the 2.3% hit on sales has already forced some changes.

Boston Scientific (NYSE: BSX  ) is unloading a new round of layoffs despite recording a better-than-expected fourth quarter. Company CEO Michael Mahoney announced up to 1,000 job cuts after the earnings release, citing the tax's hit -- along with slow growth in some of the company's units -- as a factor in the move.

With Mahoney predicting a tax blow of $75 million to Boston Sci, layoffs are the least he can do to keep the company's finances afloat, particularly with the cardiac rhythm management and interventional cardiology units -- Boston Scientific's two largest divisions -- continuing to see sales fall.

A turn for the worse
Suffice to say, I don't think the government had these sorts of job cuts in mind when it announced the tax. Zimmer Holdings (UNKNOWN: ZMH.DL  ) already beat Boston Sci to the punch, cutting 450 jobs last year partly because of fear over the tax's hit. Zimmer's flat sales and slight drop in profit in its recent quarterly report have pushed the company to announce that it will continue to streamline operations, so more job cuts could be coming.

Medtronic's (NYSE: MDT  ) also in the midst of a job-cutting program, with 500 positions slashed and another 500 to come as the company predicts losses of up to $175 million annually.

So, what can you expect going forward? Job cuts and other operational changes should continue to hit smaller or less prominent companies, such as Boston Sci and Zimmer. Even large companies could be forced to change their plans, particularly those with lower growth projections – such as the new Abbott Labs (NYSE: ABT  ) , which finds itself much more exposed to the medical device industry after its spinoff. The company's already promised job cuts due to the tax, and more operational maneuvering wouldn't be surprising. Abbott's better positioned than most, with a portfolio that stretches well beyond the United States and into generic drugs and other products, but don't expect the company to come away without a scratch from the tax.

On the other hand, the well-diversified (both product-wise and geographically) industry giants such as Johnson & Johnson should be fairly insulated, as should higher-growth companies that are managing to make strong profits already. Intuitive Surgical (NASDAQ: ISRG  ) comes to mind: Although the medical robotics leader will feel a punch from the tax, its string of earnings beats and strong margins should make it a portfolio winner despite the tax.

A good time to check your stocks
The tax bill's only $97 million now, but it's going to grow into a monster in the medical device industry before long. You shouldn't abandon great stocks just because of the hit, but the tax should force you to take a closer look at just how well companies you've invested in will handle this latest hurdle. The small players in the medical device industry could face a serious financial blow in the near future -- and more layoffs across the sector could be an unfortunate, but necessary, solution to keep profits steady.

Intuitive Surgical, fortunately, should be one of the better-positioned players in the industry to shoulder the tax. If you want members-only analysis of Intuitive Surgical, be sure to check out our brand-new premium report. A recent bearish research report has investors questioning the company's future, and analyst Karl Thiel has released his exclusive take on the news. As one of the key minds behind our Rule Breakers recommendation of the stock in 2005 (before it went on to gain more than 1,000%), Thiel knows the Intuitive Surgical story inside and out. The report is a must-read for any current or prospective investor, and it comes with a full year of analyst updates. Be sure to claim your copy today by clicking here now.

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  • Report this Comment On February 04, 2013, at 5:32 PM, Sutures wrote:

    The direct job losses from the medical device tax will be very substantial and ongoing for a couple years. CEO's of these companies need to speak up and let the American people know exactly what is happening. Too often, politicians make very poor decisions and get let off the hook because it isn't politically correct to challenge a popular president. The other side of the coin is that these medical device companies will start to do more manufacturing overseas. Sure, they will still pay the 2.3% medical device tax, but the savings from manufacturing overseas will help in alleviating some of the Obama med device tax pain. This tax will cost tens of thousands of good paying jobs.

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