Seeking Alpha
Research analyst, long/short equity, tech
Profile| Send Message|
( followers)  

Medtronic’s (NYSE:MDT) stock has appreciated almost 15% this year amidst share purchases of medical device makers and has exceeded our $46 price estimate. Boston Scientific’s (NYSE:BSX) earnings fueled positive sentiment regarding the overall business environment and has contributed to this performance. (Read Boston Scientific Revised To $8 On Acquisitions, New Products & Cost Cutting Efforts) The company will release its fiscal Q3 earnings next Tuesday, and we will update our price estimate after the release.

However, with the stock passing our price estimate, we find it prudent to discuss Medtronic’s business model and see what factors in our model could add upside to our current price estimate. One area in particular is if it can maintain or limit the decline in its market share for the cardiac rhythm management and spinal segments, which could add another 15% to our price estimate.

See our complete analysis of Medtronic

1. Market share in Cardiac Rhythm Management: This represents Medtronic’s revenues from the cardiac rhythm disease management division as a percentage of the total cardiac rhythm disease management market. Cardiac rhythm management equipment helps in treating abnormal heart conditions with the use of pacemakers and implantable cardioverter defibrillators (ICDs).

2. Market share in Spinal: This represents Medtronic’s revenues from its spinal division as a percentage of the total spinal market. This division sells self-manufactured devices and implants for conditions relating to the spine and musculoskeletal system. Additionally, it includes biologic solutions for the dental and orthopedic markets.

15-20% Upside Scenario | $52-55 Trefis Price Estimate

1. Lower Decline in Cardiac Rhythm Management Division Market Share (+10%):

Medtronic’s market share declined from 56% in 2008 to 30% in 2011 as revenues declined due to stiff competition and certain negative reports regarding the use of implantable cardioverter defibrillators (ICDs). In January 2011, the Journal of the American Medical Association reported that evidence-based guidelines were not met by approximately 20% of the recipients of implantable cardioverter defibrillators (NYSE:ICD), resulting in higher exposure to risk of death in hospitals compared to people who met the guidelines. Estimating that the negative impact of the report and intense competition will continue to weigh, we expect further declines in Medtronic’s market share, reaching close to 20% by the end of our forecast period.

Medtronic, however, could benefit from fresh troubles for one of its largest competitors, St. Jude Medical. The FDA had raised serious concerns about the latter’s “Durata” leads last November. [1] St. Jude has already seen a major recall of its “Riata” leads. St. Jude generates about $200 million from its U.S. ICD lead business and about $1.8 billion from total ICD business, which could be up for grabs due to the aforementioned troubles. [1] This gives Medtronic, the market leader in the U.S., a chance to increase its market share.

Additionally, the Center for Medicare & Medicaid Services (CMS), a government agency responsible for administering Medicare, is providing MRI coverage for Medicare beneficiaries who have FDA-approved MRI-safe pacemakers. As Medtronic holds the FDA approval for Revo MRI SureScan, the first MRI-safe pacemaker, the medical device maker can have the first mover advantage.

Further, Medtronic is actively pursuing the inorganic route in the Chinese market. (Read Medtronic Eyes M&A To Tap Chinese Market Growth) Emerging markets, including China, have been experiencing double-digit growth. So, any move toward making inroads into these markets will only help Medtronic fend off weakness in developed markets.

As the segment is the largest revenue contributor and constitutes more than 25% of our price estimate, even small improvements ahead of our expectations will have a big impact on Medtronic’s valuation. If Medtronic is able to maintain its market share at current levels by the end of Trefis forecast period, this could translate into a share price of $50, an upside of nearly 10% to our current price estimate of $46.

2. Lower Decline in Spinal Division Market Share (+5-10%):

In 2011, the division’s revenues were $3.3 billion, a 4% decrease from the previous year. Medtronic’s market share declined from 40.2% in 2008 to 35.2% in 2011 as revenues declined due to a federal probe and certain negative reports published in The Spine Journal regarding the use of its INFUSE Bone Graft product, which was said to pose greater risks than earlier reported. Following this, the product sales have seen a continuous decline. We expect the company’s market share to decline to 28% mainly on these issues.

However, Medtronic could protect its market share from declining further with the recent acquisition of Osteotech, the leader in the growing biologic products market. Further, the medical device maker recently announced plans to acquire Chinese medical devices maker China Kanghui Holdings that could strengthen its foothold in the rapidly-growing Chinese device market (Read Medtronic Pays Princely Sum For Greater China Access With Acquisition). China Kanghui has a diversified portfolio of orthopedics, spine, and surgical instrumentation products along with strong local R&D and cheap manufacturing operations. The acquisition could help Medtronic arrest an expected decline in its spinal division. In that case, the market share could remain slightly above 35%, and there would be potential upside of nearly 5% to our price estimate. If it regained the 40% market share it had a few years ago, this would imply 10% upside to our estimates.

Under both of these scenarios, we could see 15-20% upside translating to a price estimate of more than $52-55 for Medtronic.

Notes:

  1. St. Jude Medical shares slide 13 percent on FDA report, Reuters, Nov 21 2012

Disclosure: No positions

Source: How Medtronic Could Justify A $55 Stock Value