Omar Ishrak, Chairman and CEO
Gary L. Ellis, Exec. VP and Chief Financial Officer
Geoffrey S. Martha, Sr. VP of Strategy and Business Development
Bradley E. Lerman, Sr. VP, General Counsel and Corporate Secretary
Robert ten Hoedt, Exec. VP and President, EMEAC
Michael J. Coyle, Exec. VP and Group President, Cardiac and Vascular Group
Hooman C. Hakami, Exec. VP and Group President, Diabetes Group
Bryan C. Hanson, Exec. VP and Group President, Minimally Invasive Therapies Group
Christopher J. O’Connell, Exec. VP and Group President, Restorative Therapies Group
NUMBER OF EMPLOYEES: 92,500
GLOBAL HEADQUARTERS: Dublin, Ireland
It’s going to be difficult, if not downright impossible, for Medtronic plc to top its 2015 fiscal year.
During that historic 12-month period, the company purchased Covidien plc for a record $50 billion, creating the world’s second-largest medical device company (Johnson & Johnson still leads, even with slumping device revenue) and sparking a national debate over the deal’s structure. Under terms of the all cash-and-stock purchase, Medtronic redomiciled overseas, reducing its corporate tax rate in a controversial practice known as an inversion. The move was among a slew of inverted deals that eventually prompted the U.S. Treasury Department to impose limits on re-incorporations and restrict related-party debt for American subsidiaries.
Besides trimming its tax rate, the blockbuster merger enabled Medtronic to increase its fiscal year revenue by 19 percent and helped the company become more diversified and balanced, given Covidien’s focus on surgical tools and hospital-based technologies. It also expanded Medtronic’s exposure to smaller cities in emerging markets, which currently constitute 12.7 percent of total revenue, up slightly from 12.3 percent in FY14. And it better positions the company to lead the push toward value-based healthcare by integrating patient care services that balance cost and access challenges.
“Ishrak changed the ethos of the company, expanding it from a device maker into one that also offers services and partners with healthcare providers,” Raj Denhoy, a medical technology research analyst at Jefferies LLC told Barron’s last fall. “It was a bold move.”
And a necessary one as well. With the U.S. healthcare industry favoring risk- and value-based business models over traditional fee-for-service systems (thanks to Obamacare), medtech companies are increasingly reducing their dependence solely on medical devices to sustain growth. At Medtronic, that newfound freedom has inspired collaborations with hospital systems, payers, governments, and companies to develop integrated health solutions that complement and enhance product value through traditional wraparound services and solutions.
In FY15, those solutions targeted diabetes and patient home monitoring. Medtronic partnered with both Sanofi S.A. and IBM on diabetes treatment and management, leveraging its devices and care management products with its cohorts’ existing solutions to improve patient outcomes. The company is matching its insulin pumps and glucose monitoring technology with Sanofi’s insulin products to ameliorate type 2 diabetes management, particularly for patients having trouble controlling their blood sugar levels. The pair has been battling type 1 diabetes with a similar agreement, offering an implantable insulin delivery system to European patients.
Medtronic and Sanofi are also working together on care management services, developing an education plan for type 2 diabetics who cannot control their glucose levels through medication. The program will guide these patients through the initial phase of insulin treatment. “One of the priorities of the alliance will be to deliver novel drug-device combinations, including new form factors that are affordable, convenient, and easy to use to increase therapy adherence and deliver better outcomes,” the two companies said in a June 2014 joint statement.
Medtronic’s hookup with IBM aims to improve outcomes as well, albeit via personalized care plans that provide decision support for healthcare providers and patients. The companies are also exploring ways to leverage IBM’s Watson Health Cloud platform to improve Medtronic and other partners’ closed loop algorithms, which attempt to mimic the functions of a healthy pancreas.
In keeping with its mission to create new, value-based solutions, Medtronic subsidiary Cardiocom agreed last year to provide a telehealth platform for the LHC Group, a Lafayette, La.-based provider of healthcare services for home health, hospice, and post-acute care. The partnership integrates Cardiocom’s Commander Flex remote patient monitoring system with LHC’s T3 (Transitions, Training, and Triage) care management program. The T3 plan—designed to reduce avoidable medical issues and emergency room visits—targets patients with complex conditions such as heart failure, hypertension, chronic obstructive pulmonary disease, and diabetes through daily monitoring of vital signs and communication.
The LHC Group alliance gives Cardiocom telehealth partnerships with four of the five largest U.S. home healthcare companies. Medtronic acquired Cardiocom in 2013 for $200 million to form its Hospital Solutions business, an enterprise that has served more than 80,000 patients through a series of long-term contracts.
The Hospital Solutions business gained a managed services arm in August 2014 with Medtronic’s $350 million purchase of NGC Medical, a manager of cardiovascular suites, operating rooms, and intensive care units at 30 hospitals in Italy and throughout Europe. Medtronic previously held a 30 percent stake in NGC Medical.
The LHC-Cardiocom partnership gives Medtronic more than 40 agreements with hospital systems, including 21 pacts from the NGC merger. The agreements, according to executives, represent more than $900 million in committed revenue over the five- to six-year average contract period.
“As more health systems and Accountable Care Organizations look toward maximizing value and population health models, post-acute care providers are playing a critical role in ensuring patients remain healthy through the transition from the hospital to their homes,” Daniel Cosentino, Cardiocom vice president and general manager, said in a statement.
While certainly a sound investment, partnerships like those between Cardiocom and LHC are most likely to increase as Medtronic embraces emerging bundle payment and risk-sharing business models, and distances itself from product-only growth strategies. “Of all the healthcare industries, medical devices faces the biggest challenge from the shift to a fee-for-outcome system. Hospitals are gaining clout when it comes to deciding if a medical device gets used by doctors and the price they pay,” Jean Hynes, manager of the Vanguard Health Care Fund (a Medtronic shareowner), explained to Barrons. “Omar (Ishrak) is way ahead of the curve in figuring out this new world in terms of how to compete.”
Indeed, Medtronic Chairman and CEO Omar Ishrak’s ingenuity has yielded significant financial gains for his company. In fiscal 2015 (year ended April 24, 2015), revenue jumped 19 percent to $20.2 billion—due largely to the Covidien acquisition—and the company’s stock appreciated 33 percent, or 20 percentage points better than the S&P 500’s overall performance. In addition, operating margin improved by roughly 60 basis points, which corresponded to about 200 basis points of operating leverage.
Operating profit, however, slipped 1.2 percent to $3.76 billion and net income fell 12.7 percent to $2.67 billion as volatile currency rates undercut earnings by $666 million.
That instability had a negligible effect on foreign sales, though. Non-U.S. developed markets revenue ballooned 13 percent to $6.37 billion, and emerging market proceeds surged 23 percent to $2.58 billion, according to Medtronic’s fiscal 2015 annual report. Executives attributed the rise in foreign sales to the fourth-quarter creation of the Minimally Invasive Therapies Group, solid gains in the company’s three other business segments, significant new product growth in the Australia-New Zealand region, and steady sales in Western Europe of catheter lab managed services. Similarly, broad-based procedural growth and new product launches bolstered U.S. sales 22 percent to $11.3 billion.
“We delivered solid results in FY15,” Ishrak wrote in his annual letter to shareholders. “The most important event of our fiscal year was the Covidien transaction. The combination of Medtronic and Covidien positions us as a clear industry leader and has set the stage for us to lead the transformation of healthcare. In many ways, this acquisition has initiated a new era for Medtronic.”
The company’s new era began quite auspiciously, with solid gains reported in all business segments. The Cardiac and Vascular Group (CVG) posted the highest sales growth in five years, driven by several new product launches, organic R&D, and steady earnings from old favorites like the Reveal LINQ Insertable Cardiac Monitor System, which is used to identify a diagnosis from unexplained syncope, atrial fibrillation, and cryptogenic stroke. The Group increased revenue 6 percent to $9.36 billion on the strength of its three internal divisions—Cardiac Rhythm & Heart Failure, Coronary & Structural Heart, and Aortic & Peripheral Vascular.
Cardiac Rhythm & Heart Failure proceeds rose 5 percent to $5.24 billion due to robust Reveal LINQ sales as well as the U.S. launch of the Viva XT CRT-D with Attain Performa quadripolar CRT-D lead system (September 2014) and Japanese debut of the Evera MRI SureScan ICD (November 2014). The Viva Quad XT device, equipped with a proprietary AdaptivCRT feature, preserves normal heart rhythms and automatically adjusts to patients’ needs to customize therapy. The system includes VectorExpress technology, which reduces lead programming time by providing doctors with clinically actionable data to help them select optimal pacing configurations for each patient.
Medtronic claims its Evera MRI system gives patients “the most unrestricted access” to magnetic resonance imaging scans. The device, available in single and dual chamber implantable cardioverter defibrillators, reduces skin pressure by 30 percent. It is paired with the Sprint Quattro Secure family of ICD leads.
Cardiac Rhythm & Heart Failure division sales also were buoyed by global demand for the Arctic Front Advance Cardiac CryoAblation Catheter, and steady sales from the catheter lab managed services subsidiary.
Coronary & Structural Heart proceeds climbed 3 percent to $3 billion, though the division’s performance was partially offset by fluctuating currency rates and pricing pressures in the United States, Japan, India, and Western Europe. Nevertheless, sales inched higher due to U.S. growth in CoreValve transcatheter aortic heart valve revenue, and the international introductions of both the CoreValve Evolut R recapturable system and Resolute Onyx drug-eluting stent. The latter product is the first to contain CoreWire technology, an advancement that wraps a dense core metal in a cobalt alloy outer layer, which helps increase radiopacity (i.e., procedural visibility). The stent also features thinner struts to improve deliverability without compromising radial and longitudinal strength.
The Aortic & Peripheral Vascular division delivered the best CVG performance, growing net sales 20 percent to $1 billion. Covidien’s peripheral business—specifically, its chronic venous insufficiency products—contributed to the increase, as did demand for IN.PACT Admiral drug-coated balloons. Other growth drivers included the Valiant Captivia Thoracic Stent Graft System and Endurant 2S Abdominal Aortic Aneurysm Stent Graft System.
Like its CVG kin, Medtronic’s Restorative Therapies Group posted its best gains in five years, but the final numbers were still below management’s expectations. Growth in Surgical Technologies proceeds was partially offset by sagging spine sales and a $127 million loss to foreign currency volatility. Even so, Restorative Therapies still achieved an overall 4 percent increase compared to FY14, generating $6.75 billion in sales. The Group’s overall health was driven by the birth of the Neurovascular division (formerly part of Covidien), and solid growth in both the Surgical Technologies and Neuromodulation divisions.
Surgical Technologies generated the Group’s highest overall sales hike, expanding revenue 7 percent to $1.67 billion. Contributing to the growth were power systems, Aquamantys Transcollation, and PEAK PlasmaBlade technologies, as well as Midas Rex products, monitoring, and O-arm imaging systems. Sales also received a lift from the second-quarter launch of NuVent sinus balloons and the $105 million purchase of Houston, Texas-based Visualase Inc., a startup that developed a U.S. Food and Drug Administration-approved MRI-guided laser and image guided system for minimally invasive neurosurgeries, including surgical thermal ablation. The system uses tiny drill holes to destroy tissue that otherwise would be removed through invasive craniotomies. Gains from the Visualase acquisition and NuVent launch, however, were partially offset by Medtronic’s divestiture of its MicroFrance surgical tool line and French manufacturing facility. The divested portfolio consisted of hand-held reusable instruments used in ear, nose, and throat surgeries, and laparoscopic procedures.
Acquisitions figured prominently into Neuromodulation’s 2015 fiscal year as well but did not impact net sales. Proceeds rose 4 percent over FY14 to $1.97 billion on the strength of Medtronic’s gastro/urology products and deep brain/pain stimulation technology, particularly the RestoreSensor SureScan MRI system, an implantable pain-relieving device for the spinal cord.
The sales drivers likely inspired Medtronic’s August 2014 purchase of Sapiens Steering Brain Stimulation and its December 2014 merger with Advanced Uro-Solutions.
The $200 million Sapiens acquisition gives Medtronic an R&D hub in The Netherlands and a revolutionary technology to treat patients with neuro-degenerative diseases. Sapiens currently is finalizing the development of a new device that potentially could offer more precise deep brain stimulation treatment by using a 40-point electric stimulation system to interact with the brain. Medtronic’s three U.S.-approved device leads use just four electrodes.
“This acquisition broadens our neuroscience position with innovative brain modulation technology that, along with our portfolio of DBS solutions, may one day transform the way physicians are able to treat patients with neurodegenerative diseases like Parkinson’s disease and essential tremor,” Lothar Krinke, Ph.D., vice president and general manager of Medtronic’s brain modulation business, said when the Q2 deal was announced.
The purchase of Elizabethton, Tenn.-based Advanced Uro-Solutions, creator of the NURO system, boosts Medtronic’s offerings in overactive bladder treatment and pits the company directly against Cogentix Medical Inc. for market share. Cogentix (a Uroplasty Inc.-Vision Sciences Inc. amalgam) has been marketing its Urgent PC neurostimulator for several years; the device sends a signal to the sacral nerve through the tibial nerve to regulate urinary function. Uro-Solutions’ NURO system, on the other hand, uses electrical pulses to stimulate the nerves controlling bladder function.
Neurovascular net sales totaled $132 million in fiscal 2015. The division, formerly part of Covidien, generated revenue from sales of its coils, stents, flow diversion equipment, and access product lines, as well as the U.S. launch of the Pipeline Flex, an embolization device designed for minimally invasive large and giant brain aneurysm treatment. The product diverts blood flow away from an aneurysm, reconstructing the parent vessel’s diseased section.
Spine spoiled Medtronic’s near-perfect financial report card, posting FY15’s only loss. Division sales slipped 2 percent to $2.97 billion as Interventional spine proceeds fell victim to weak demand in Europe, pricing pressures in Germany, and overall foreign currency volatility. Neither modest U.S. procedural growth nor new product launches—the Prestige LP Cervical Disc and Pure Titanium Coated interbody fusion devices—could overcome domestic pricing pressures and lingering stagnation in the bone morphogenetic protein market.
Diabetes Group sales neutralized the losses in Spinal, rising 6 percent to $1.76 billion. Growth drivers included the MiniMed 530G System with Enlite Sensor and MiniMed 640G System with the Enhanced Enlite CGM sensor. The latter product is designed to help prevent hypoglycemia by automatically suspending insulin delivery when glucose levels are expected to fall below a set baseline, and then resuming delivery upon level recovery. The pump features a simple user interface, full-color screen, waterproofing, and remote bolus.
Medtronic’s Minimally Invasive Therapies Group was a revenue dynamo, generating $2.38 billion in sales in only three months (from Jan. 26, 2015, through April 24, 2015). An inheritance of the Covidien purchase, the Group contains most of the merged firm’s former operations, split among Surgical Solutions and Patient Monitoring & Recovery divisions. The Groups products include those for advanced and general surgical care such as stapling, vessel sealing, and other surgical instruments; sutures; electrosurgery products; hernia mechanical devices; mesh implants; gastrointestinal, interventional lung, and advanced ablation solutions; products for patient monitoring and recovery such as ventilators, capnography, and other airway devices; sensors; monitors; compression and dialysis products; enteral feeding; wound care; and medical surgical products including operating room supplies, electrodes, needles, syringes, and sharps disposals.
Oximetry sales drove Patient Monitoring & Recovery revenue, while strong demand for stapling and energy products bolstered Surgical Solutions proceeds.
Omar Ishrak timed it perfectly.
The Medtronic chairman and CEO caught Uncle Sam a bit off-guard with his tax-inverted deal for Covidien plc two years ago. The $50 billion acquisition—the largest in medtech history—was among more than a dozen in 2014 that involved overseas redomiciling to countries with lower tax rates (Ireland, Britain, The Netherlands). The group of bargain-hunters included Mylan, Theravance Biopharma, Horizon Pharma, and AbbVie, the latter of which had proposed the largest-ever inversion deal: Its $137 billion post-merger market value would have topped the net worth of Boeing, McDonald’s, and Cisco.
Inversions, of course, have existed for decades, dating as far back as 1983. But they’ve become considerably more common over the last decade, likely due to the 2008 financial crisis and the business world’s dwindling profit margins. Over 47 U.S. companies have redomiciled overseas through corporate inversions since 2004—nearly two-thirds of the more than 75 firms that have reincorporated abroad since 1994, according to Congressional Research Service data.
That onslaught of corporate relocations—along with those proposed by AbbVie, Medtronic, and others—prompted a significant counterattack from the U.S. government. Three months after Medtronic’s mid-June (2014) announcement, the U.S. Treasury Department implemented new inversion rules.
The regulations eliminated “hopscotch” loans that give firms access to foreign cash without paying U.S. taxes, and limited the actions companies can use to make inversion deals qualify for favorable tax treatment. The crackdown claimed several victims, including AbbVie’s $54 billion takeover of Shire, but it failed to discourage Medtronic from redomiciling in Ireland, where corporate taxes are 12.5 percent—nearly one-third of America’s 35 percent rate. The Treasury’s new rules did add one minor wrinkle to the process, though: It made the Covidien deal more expensive, forcing Medtronic to finance the purchase through a loan rather than with overseas cash.
While Medtronic executives characterized the merger as a “strategic initiative” they acknowledged its various financial benefits—namely, a reduced tax rate and improved free cash flow. Ishrak, however, claimed the deal’s overall rationale helped spare it from government scrutiny.
“We just followed the rules and the deal was done based on strategic merits,” he told the London-based Financial Times last winter. “So that’s why it’s more resilient to some of the obvious things the Treasury did.”
Maybe so, but Medtronic’s inversion was also well-timed. Since November last year, the U.S. Treasury has issued two additional rounds of inversion rule changes. The first batch reduces the tax benefits of inversions by limiting the ability of an inverted company to transfer its foreign operations to its new corporate parent without paying U.S. tax. This rule applies to any transactions completed on or after Sept. 22, 2014.
In addition, the Treasury is restricting U.S. firms from inflating the size of their foreign overlord, thereby preventing the circumvention of a current law that requires the former owners of the U.S. firm to own less than 80 percent of the newly combined entity. Also, the government strengthened an existing statute that allows inversions if, after the transaction, at least 25 percent of the combined entity’s business activity occurs in the country where the company has tax residency. The change blocks inversions unless the new foreign parent is a tax resident of the overseas country in which it was created or organized.
“...It’s Treasury’s responsibility to protect the U.S. tax base, and we’ve repeatedly stated that we will use all of our existing administrative authority to address inversions,” U.S. Treasury Secretary Jacob Lew said after releasing the government’s second set of anti-inversion rules last year.
Lew issued a third set of regulations in April that are more expansive than his earlier volleys, tackling such issues as multistep acquisitions and earnings-stripping. The newest guidance also revises and completes the rules the Treasury issued since 2014.
Earnings stripping, a practice commonly associated with inversions, is designed to shrink the taxable U.S. profits of multinational companies. A common tactic involves loading up the U.S. unit of a redomiciled foreign company with debt and then shifting U.S. profits to the new lower-tax jurisdiction through interest payments. The Treasury’s latest rules, however, restrict related-party debt for U.S. subsidiaries in dealings that do not finance new U.S. investment. As part of the proposed regulations, the Internal Revenue Service would be given the ability to divide debt instruments into part debt and part equity, according to the guidelines.
The Treasury’s most recent effort also attempts to prevent companies from flouting existing curbs on inversions. Under current law, any shareholder of an acquired U.S. firm must own a certain percentage of the merged company. But some foreign firms have grown by purchasing several smaller U.S. firms in a short period of time, which makes it easier to buy a much larger American company without violating the ownership thresholds.
The new rules will make such “serial inversions” less attractive because the Treasury will calculate the ownership percentage of the foreign company by excluding stock attributable to smaller purchases made within the past three years.
“It’s going to be a major impediment. They’re pretty much taking all of the juice out of inversions,” Robert Willens, a New York-based tax analyst, told The Wall Street Journal upon release of the third round of regulations. “They’ve addressed literally every benefit that one attempted to gain from an inversion and shut them all down systematically.”
Most all of them, anyway. — M.B.