Medtronic's (NYSE:MDT) June 6 analyst day was by no means light fare, as the company crammed quite a bit of information into more than seven hours. While action-oriented investors are likely disappointed that management's commentary would seem to suggest a bid for Smith & Nephew (NYSE:SNN) is not too likely, management laid out a vision of an evolving global device market where Medtronic is likely to be among the few players with the scale to really cover all of the major bases. While Medtronic shares do not appear priced for supreme near-term market outperformance, they still make sense within a diversified portfolio that tends toward the conservative.
R&D drives the bus
Comparing drug companies to device companies is tricky on multiple levels, but I think it is still significant to note that major device companies like Medtronic and Johnson & Johnson (NYSE:JNJ) have not resorted to slashing R&D to improve margins. Internal R&D still remains a key driver for leading medical device franchises like Medtronic, Johnson & Johnson, Covidien (NYSE:COV), and Stryker (NYSE:SYK), and those who are not as effective with those efforts often have to resort to M&A to fill in the gaps and stimulate future growth (St. Jude and Boston Scientific certainly come to mind).
At over $1.5 billion a year, Medtronic almost spends more on R&D than Covidien, Stryker, and St. Jude combined, while those three combined generate nearly 50% more in combined revenue. That willingness to reinvest has created a pipeline full of products including the Nuvent balloon, CoreValve for high-risk patients, Prestige LP disc, MiniMed 640G pump, and Attain Performa Quad.
Maintaining a focus on scale
At the risk of disproving my own point, I'd note that CoreValve, MiniMed, and a large part of the ENT business were are garnered through M&A. My point, though, is that even as Medtronic will use M&A to gain access to new markets, therapeutic categories, or technologies, the company has a strong record of building those platforms instead of just leveraging what they bring in from Day One.
Along those lines, Medtronic management made it pretty clear at the Analyst Day that they believe that long-term success in med-tech comes from establishing large, full-scale positions in large treatment areas and then leveraging R&D, manufacturing, and sales efforts through those channels. As Johnson & Johnson is strong in surgery, energy, and orthopedics, Covidien in surgery, energy, and endovascular, and Stryker in orthopedics, surgical equipment, and neurology, Medtronic has established very strong positions in cardiac rhythm management, spinal care, diabetes, and is on the way in heart valves.
I take this to mean that Medtronic's M&A intentions are likely to be focused much more on incremental improvements to existing targeted markets than new market entries. That would make an acquisition of Smith & Nephew fairly superfluous, as there isn't as much synergy between spine and large joint recon as you might think (about 50% of Medtronic's spine business is handled by neurosurgeons, not orthopedists). Extremities, though, could make a limited amount of sense, as could acquisitions in peripheral vascular or electrophysiology.
Is a more integrated approach on the way?
One other aspect of Medtronic's strategy that I found interesting was the company's increasing focus on integrated health solutions. In essence, Medtronic is looking to work much more closely with health care providers and payers to be more of a "solutions" provider than a seller of devices. The customer can look at this as a means of better managing workflow, inventory, and cost, while Medtronic may be exchanging some margin for greater market share and the security of long-term contracts.
It remains to be seen how this process will unfold, but it certainly seems to fit a general theme between payers and providers to focus more on results and outcomes than particular procedures, prescriptions, or devices. Should the market move in this direction in a big way (as it already seems to in orthopedics), scale will be at a premium – good for Johnson & Johnson, Covidien, Stryker, and Medtronic, but not nearly so good for the smaller rivals who may only compete in one part of one therapeutic/treatment area.
The bottom line
Medtronic's Analyst Day wasn't a deal-changer, though it may have increased the probability that long-term revenue growth could be a little higher at the expense of margins. It also, in my opinion, tamped down expectations for a bid for Smith & Nephew, though what Medtronic will do with its huge overseas cash hoard is still a large unknown. Medtronic still looks like a buy on balance, and a company built to be a long-term champion in the med-tech field.