Earl Bakken can’t be happy with what he reads about the mighty Medtronic Inc. (NYSE:MDT) he and his brother-in-law, Palmer Hermundslie, founded in his garage in 1949, primarily working with the University of Minnesota hospital.
We have followed Medtronic since 1979 and from time to time have seen the company suffer problems much like any other medical device company. In those days there were problems with rapid battery depletion in pacemakers, faulty connections and lead fractures, all part and parcel of an evolving technology. But it seems to us that lately, Medtronic has experienced some miscues of its own making that call into question management’s attention to detail, its overall philosophy on product development and its dealings with the medical community.
Recently Medtronic has found itself in the vortex of two debacles: the off-label use of its bone morphogenetic protein (BMP) product InFuse and its apparently exorbitant payment of consulting fees to physicians involved in the development and use of new spine surgery devices. In our opinion these issues reflect poorly on management, obscure the positive scientific and medical accomplishments of the company and cause some investors to avoid being interested in the company or its stock. Since Medtronic’s stock hit its 2008 high on August 22nd of $56.97, it has declined 42.6% to $32.72, a reflection of its own self-inflicted circumstances.
Consider the following:
- Medtronic is finally reporting the death of a patient (Shirley Nisbet) that died more than three months ago after falling into a coma in August after being treated with its InFuse bone graft in cervical spine, an indication that is not approved by the FDA. InFuse is approved for use in the lumbar spine and to its credit, Medtronic did report the adverse reaction to the FDA two days before her death on August 30th. But the company was unaware of her death until it was served a lawsuit by the patent’s family. InFuse has been and can be used off label at the discretion of the implanting surgeon but has had enough adverse reactions to be the subject of an FDA safety alert in July and is now the subject of both a Department of Justice and Senate investigations.
On December 3, 2008, Medtronic issued a statement that said:
Its technical consultant in this case denies that he recommended the off-label use of the company’s InFuse Bone Graft product. FDA approved drugs and medial device products can be used by physicians in any way they deem proper, but companies are not allowed to promote off label applications or to induce physicians to do so. The physician who performed the procedure in question, (identified by the Wall Street Journal as Johannes Bernbeck, of the Baldwin Park Medical Center in Baldwin Park, CA) has also said, “The decision to use InFuse during surgery was a clinical decision based on my personal experience with the product and evidence presented at our professional medical society meetings, and had nothing to do with the Medtronic technical expert."
Medtronic goes on to say in its statement that, “Medtronic does not promote off label use of products, and physicians decide how medical products are ultimately used to the benefit of patients.” While we do not doubt this, the real question remains, how safe is InFuse and has the company done enough to discourage its off label use in cervical spine procedures?
The FDA has received 280 reports of side effects in using InFuse, about 75% of which were used off label. The agency has received 38 reports of complications from the use of InFuse in cervical spine applications. The complications range from difficulty in swallowing to problems in breathing and speaking. Some have resulted in the use of a tracheotomy to relieve the situation. Medtronic claims these are small numbers as compared to the more than 630,000 units of InFuse which have been administered.
Dr. Todd S. Jarosz, a spine surgeon from North Carolina, along with a group of surgeons, recently reported a study of 76 patients in whom InFuse was used, produced complications in 59% of cervical spine procedures in which InFuse was used, as compared a complication rate of 21% in conventional cervical fusions which used bone graft or collagen. The study identified a range of side effects the most serious of which were inflammation that required the installation of a feeding tube, and severe breathing problems that required a tracheotomy, which involves an incision and insertion of a tube into the airway. Despite such findings, Dr. Jarosz said InFuse continues to be used by many surgeons in the cervical spine.
So what is the significance of all of this? In Medtronic’s second fiscal quarter, reported on November 18, 2008, the company reported InFuse sales were flat at $198 million as compared to an anticipated increase of 14%. Since it was approved in 2002, InFuse has generated revenues of over $3 billion. Clearly the negative news on InFuse is having a dampening effect on its use.
- Dovetailing with the challenges facing InFuse, Medtronic is the subject of an investigation by Senator Chuck Grassley (R-Iowa) into the exorbitant and excessive consulting and royalty payments being made by medical device companies, Medtronic specifically, to physicians for the development of new products and as a possible inducement to prescribe these and other products for their patients. (Click to Download Grassley's Letter)
Senator Grassley’s investigation reveals that Medtronic paid Dr. Thomas Zdeblick, Professor and Chairman, Department of Orthopedics & Rehabilitation at the University of Wisconsin, $19 million in royalties between 2003 and 2007 and that these amounts were far in excess of what was reported to the university or disclosed by the university in public records. For example, in 2007, Dr. Zdeblick reported receiving greater than $20,000 from Medtronic in consulting and royalties. Medtronic reported to Senator Grassley that the actual payments for consulting were $31,500 and the payments for royalties were $2.64 million.
Statements made by Dr. Zdeblick include:
The individual decision to perform surgery on a patient, and which implant to place in that patient, should not personally profit the surgeon. This means that the surgeon should not receive any royalty for that implant, should have no increase in his or her consulting fee based on the placement of that implant, and should not have substantial (≥5%) ownership interest in the implant company.
Dr. Zdeblick also wrote, “Under an appropriate conflict-of-interest plan, any investigator who has substantial financial ties to an industrial sponsor must disclose those ties to individual patients”. In light of these statements, Senator Grassley is investigating whether or not Dr. Zdeblick has violated these covenants. Ironically, InFuse is a product a product for which Dr. Zdeblick receives a royalty.
In 2006, Medtronic settled two whistle blower lawsuits with the Federal government for $40 million. The lawsuits alleged that Medtronic engaged in kickbacks to physicians for sham consulting and royalty agreements and expensive trips. One of the lawsuits was filed by a former Medtronic legal counsel and included the revelation that Dr. Zdeblick had a 10-year consulting contract with Medtronic in which he agreed to do two days of consulting work per quarter over 10 years for $400,000 a year ($50,000 per day). Dr. Zdeblick said the consulting contract was legitimate, and not a sham as alleged, and that he stopped the bulk of his consulting work for Medtronic in 2004. According to the following table supplied by Senator Grassley, that is not true.
Selected Disclosures by Dr. Zdeblick (University of Wisconsin) and Related Information Reported by Device Manufacturers
Whether or not these contracts are legal, the strong perception is that they are improper and present inappropriate incentives to develop and prescribe products. In our opinion, it would appear that Medtronic did not learn its lesson in 2006 but then again, what’s $40 million to a company generating $3 billion for a single product in question?
We believe all of this taints Medtronic’s reputation and has a negative effect on the P/E multiple investors are willing to apply to the company’s earnings, resulting in a lower stock price than should or could be the case.
Disclosure: No position.