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Published: August 24, 2010
Lost in all of this spring's hand-wringing about the
potentially negative impacts from President Obama's health care
overhaul, investors seemed to overlook two more powerful forces
that could severely impact the health care industry. Consumers'
financial distress is leading to a sharp slowdown in elective
medical procedures, while hospitals and insurers are pressing
medical device makers to cut prices if they are to see continued
use of their products.
Those factors led Medtronic (NYSE: MDT), a leading
supplier of spinal products and defibrillators, to post weak
fiscal first quarter results, pushing shares down -10% in
Tuesday trading. Shares are now at their lowest level in more
than 10 years (with the exception of the market swoon in early
2009), and prospects are very dim for a rebound. As Chairman and
CEO Bill Hawkins noted in a call with investors, industry
conditions are unlikely to improve any time soon.
These industry pressures appear inevitable. Health care costs
had been rising faster than inflation for quite some time: U.S.
spending on health care surpassed $2.3 trillion in 2008, more
than three times the $714 billion spent in 1990 and more than
eight times the $253 billion spent in 1980, according to the
Kaiser Family Foundation. Most agree that this burdensome trend
must come to an end.
It's easy to blame our aging and increasingly obese population
for ever-rising health care spending.
Yet as the Congressional Budget Office notes, "about half of
all growth in health care spending in the past several decades
was associated with changes in medical care made possible by
advances in technology." And that's where companies like
Medtronic and Boston Scientific (NYSE: BSX) come in.
These companies have consistently sought out acquisitions of
smaller medical device players that offered novel but pricey
applications to cure what ails us. Growth is slowing for these
big companies precisely in the areas in which they made a lot of
acquisitions. In a nutshell, it's been a great era to invest in
smaller medical device companies that have ultimately been
bought out. Just this year, Medtronic agreed to acquire ATS
Medical and Osteotech (Nasdaq: OSTE). In both cases,
Medtronic paid greater than a +50% premium to acquire these
firms. Yet these firms are seeing increasingly restrictive
reimbursement environments themselves.
In a box
At this point, large players like Medtronic and Boston
Scientific are in a box. They have to assume that consumer
spending on elective healthcare will stay downbeat for some time
to come. It's easier to deal with a bad back on your own than
come up with major out-of-pocket funds if you need an
un-reimbursable elective procedure. And changes at the federal
level won't be of much help. As parts of the health care
overhaul, tests are underway to identify the cost-effectiveness
of a wide range of medical procedures. Any procedures that fail
to materially improve patient outcomes are likely to see
reimbursement levels slashed in the next few years.
In a best case scenario, these firms will be able to boost sales
at a small pace, largely thanks to acquisitions. More than
likely, organic growth is likely to be flat to negative. So to
boost profits, these firms can cut costs (Medtronic has already
taken cut a lot of fat and likely has little left to cut) or buy
back stock (Medtronic recently completed a $500 million
buyback).
In light of all of these pressures, there is simply no way to
justify purchase of Medtronic shares, even as they languish at
lows. Management has already conceded that business will remain
lousy for at least several more quarters, although sales are
unlikely to rebound in the next few years either.
Action to Take --> Shares of
Medtronic and Boston Scientific are too cheap to short. Instead,
investors should stick to smaller medical device makers that
either have robust growth prospects or might eventually find an
acquirer. For further research, you can investigate names such
as Given Imaging (Nasdaq: GIVN), Nuvasive (Nasdaq:
NUVA) or Varian Medical (NYSE: VAR).
-- David Sterman
Staff Writer
StreetAuthority |
