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EQUITY RESEARCH
UNITED STATES OF AMERICA HEALTHCARE - Medical Equipment & Supplies
MEDTRONICCOMPANY UPDATE: Prospects for 2004
BUYBUY
PAGE 1ANN RIFE COX ENDOWMENT FUND
|COXSMUSM
SCHOOL
OF BUSINESS
That’s a lot of Solid Heart Beats. April 8, 2004
COMPANY PROFILE
Medtronic is one of the largest medical technology
company that manufacturers implantable biomedical
devices, with sales to over 120 countries. The
Company treats chronic diseases by primarily offering
products, which include bradycardia pacing, tachy-
arrhythmia management, heart failure, atrial fi brillation,
coronary vascular disease, endovascular disease,
peripheral vascular disease, heart valve replacement,
extra-corporeal cardiac support, minimally invasive
cardiac surgery, malignant and non-malignant pain,
diabetes, urological disorders, gastroenterological
ailments, movement disorders, spinal surgery,
neurosurgery, neurodegenerative disorders and
ear, nose and throat (ENT) surgery. Medtronic
operates in fi ve business segments: Cardiac Rhythm
Management (CRM); Neurological and Diabetes;
Spinal, Ear, Nose and Throat, and Surgical Navigation
Technologies (SNT); Vascular, and Cardiac Surgery.
Cardiac Rhythm Management products (bradycardia
& tachycardia) accounted for 47.4% of 2002 sales;
Neurological, Spinal, and Diabetes, 35.3%; Vascular
products (stents), 10.1%; and Cardiac Surgery (heart
values, perfusion systems), 7.2%.SOURCE: Valueline and Reuters.com
INVESTMENT THESIS
Healthy, diverse revenue base with a strong balance sheet. Although Medtronic is trading
at a premium, their diverse business combinations and rich cash fl ow offers management an
opportunity to augment internal growth with further acquisitions and stock repurchases.
Favorable demographics and trends will drive growth in the market. Irrespective
of company size and product, Medtronic’s overall customer base seems to be expanding
domestically and overseas as changing demographics and rising standards of living will
demand a steady stream of new and improved medical products.
Market consensus expects growth expectations for 2004 and 2005 to be around 15%.
After with net income falling in 2001 and 2002 – due to increased acquisitions and competition
from drug-eluting stents (DES), Medtronic’s businesses have strengthen and stabilized with
diversifi ed product lines. The Company’s bare metal stents seems to be performing well
in Europe and is again penetrating the DES (medical devices that improve coronary artery
disease) market. Meanwhile, the important CRM business will perservere positively, given
both a recent sharp increase in reimbursement for Medicare and a strong product pipeline.
Research & Development (R&D) expenditures have continued to pay off. Medtronic
recently launched two FDA-approved heart devices designed to treat irregular heart beats and
abnormalities. The Food and Drug Administration (FDA) also approved their CD Horizon
Legacy 5.5 spinal system. Further, the FDA approved the Guardian continuous glucose
monitoring system. Also, Medtronic’s Physio-Control division announced a partnership
with Walgreens to sell automated external defi brillators online. Medtronic further received
Japanese approval for their Sprinter Semi-Compliant Rapid Exchange Balloon Dilatation
Catheter. Additionally, Medtronic is continuing SCD-HeFT research, the largest implantable
cardioverter defi brillators (ICD) trial to date, for benefi ts of ICDs in a broad group of patients
at risk of sudden cardiac arrest. Results of this Medtronic-National Institute of Health co-
sponsored trial will emerge near the end of fi scal year 2004. Recently, Medtronic received
FDA-approval to begin its Endeavor III clinical study – a randomized trial study evaluating
the safety and effi cacy of Medtronic’s Endeavor DES.
DES represents an opportunity for further growth for Medtronic in 2004-2006. Drug-
coated stents constitute the next, biggest development in stent technology and promise to
double the size of $2.5 billion sector. Data from Endeavor I and II DES showed positive
results, and their DES program remains on track to obtain European approval in late 2004,
US approval in late 2005, and Japanese approval in late 2006. If expectations fall through,
Medtronic will be the third market entrant in the US DES market after Boston’s Scientifi c’s
recent Taxus DES FDA-approval. According to Merrill Lynch Research, Medtronic could
potentially capture US DES revenues of $360-plus million and 10% of the market share.
Benjamin Q. Luong Email: [email protected]
Kanaiya Kapadia Email: [email protected]
Miranda Peters Email: [email protected]
Ryan Wannemacher Email: [email protected]
FINANCIAL STATISTICS
Price: $48.90 (as of April 8, 2004)
Symbol | Exchange: MDT | NYSE
52-Week Range: $42.90-$52-92
Market Capitalization: $59.169 billion
Shares Outstanding: 1,210 billion
Relative Price-to-Earnings (P/E): 1.10
Trailing P/E: 31.96 (Stock) vs. 30.85 (Industry)
Forward P/E: 25.70 (Stock) vs. 22.50 (Industry)
Current PEG Ratio: 1.8 (Stock) vs. 1.51 (Industry)
Forward PEG Ratio: 1.6 (Stock) vs. 1.25 (Industry)
Return on Assets (ROA): 18.1%
Return on Equity (ROE): 19.3%
Annual Dividend: 0.30
Dividend Yield: 0.59%
Price Target: $59.39
Financial History
SOURCE: Company
Reports
MDT | PAGE 2SOUTHERN METHODIST UNIVERSITY
ANN RIFE COX ENDOWMENT FUNDSMU : COX SCHOOL OF BUSINESS
BUSINESS MODEL
The Medical Equipment and Supplies Industry develops,
manufactures and markets products used to improve patient
health. These include commodity-type items such as kits, trays,
gloves, gowns, syringes, and other disposable medical supplies.
Medical device products provide a steady cash fl ow for companies
and usually some of their revenues are budgeted for Research &
Development (R&D). Important value-added products include
infusion and related intravenous supplies and equipment,
diagnostic and laboratory products, wound-management
supplies, orthopedic, reconstructive implants, spinal devices,
surgical devices, cardiac products, and diagnostic equipment.
The Industry’s most profi table groups are those involved with
innovative high-technology products, such as implantable
and external cardiac defi brillators, orthopedic devices, and
sophisticated diagnostic imaging systems. New products will be
the engine of growth in the market because they have a very high
growth potential. Currently, the Standard & Poor’s (S&P) Health
Care Equipment Index gained 8.4% compared to a 1.1% gain from
the consolidated S&P Health Care Index.
Business Segments
Generally, markets for certain products, such as cardiac and
orthopedic devices are dominated by a small number of players,
including Medtronic, Guidant Corporation, and Boston Scientifi c.
Currently, the industry is intensifying into new market prospects,
such as orthobiologics, deep brain stimulation, drug-coated
coronary stents, congestive heart failure treatment, and robotic
surgery. The United States (US) will particularly benefi t
cardiovascular products, such as pacemaker, defi brillators, and
angioplasty catheters, which are used mostly on elderly patients.
Also, this Industry represents several, developed business
segments that Medical Device manufacturers can derive their
revenues from: Cardiology, Diagnostic Imaging, Orthopedics,
In-vitro Diagnostics, Peripheral Vascular Disease, and other (see
Chart A).
Cardiology: In 2002, worldwide medical device sales accounted
for approximately 6.9%. Cardiac Rhythm Management (CRM)
represented 44% of the cardiology market. Other products such as
coronary stents took 17%; angioplasty, angiographic catheters and
other interventional devices accounted for 13%; products used
in bypass procedures, heart values and other surgical items took
15%; vascular grafts and other vascular products contributed 5%,
and the rest, 6%. According to the American Heart Association’s
Heart and Stroke Statistical Update 2002, since 1999, 62 million
Americans had some form of cardiovascular disease (CVD) and
accounted for 40.1% of all deaths that year. Since 1900, CVD
has been the Number One killer in the US every year, except
1918. Global CVD market is expected to expand by 13% to 14%
annually through 2007 (see Chart C).
Diagnostic Imaging: This particular segment has been steady,
measuring in the range between $4.5 billion to $5.0 billion. As
of to date, diagnostic imaging product sales still come from
conventional x-ray equipment, ultrasound imaging, magnetic
resonance imaging, radiation therapy, nuclear medicine, and
computed tomography.
Orthopedics: These products are used to repair or replace parts of
the human skeletal system. Generally, they have been achieving
a compound annual growth rate of 7 to 9%, generating global
orthopedic industry generated sales of about $13 billion. US,
Europe, Asia, and other markets have contributed sales of 63%,
19%, 13%, and 5%, respectively. An area growing faster than 20%
annually, is the $2.4 billion spine market. Over 10,000 spinal cord
injuries occur each year in the US and nearly 50% of which are
related to motor vehicle accidents. Additionally, in the US, there
are 1.1 million spinal procedures each year.
In-vitro Diagnostics: This segment represents a worldwide
market worth of about $23 billion, accounting for an estimated
12% of total industry sales. In-vitro diagnostics involve tests
performed on blood, urine, and other body fl uids and tissues to
detect pathological conditions. For overseas markets, especially
in development nations, a stronger growth in this segment is
expected.
Peripheral Vascular Disease (PVD): This newly-interested
segment focus on non-coronary diseases of the vascular system,
including the brain. For instance, the most prevalent diagnosis
is a stroke. PVD affects about one in 20 persons over the age
of 50 or about eight million people in the US. PVD is attractive
to medical device manufacturers because they can extend their
patient treatment capacity to both arterial and venous diseases and
aneurysms (localized swellings in arteries). Guidant, Medtronic,
and Boston Scientifi c have become leading innovators in this
segment market.
Specifi cally, Medtronic’s diverse core businesses focus in
Cardiology, Orthopedics, Peripheral Vascular Disease, and
Neurology areas (see Chart E).
CHART A : Projected US Sales for 2005
SOURCE: Standard & Poor’s
MDT | PAGE 3SOUTHERN METHODIST UNIVERSITY
ANN RIFE COX ENDOWMENT FUNDSMU : COX SCHOOL OF BUSINESS
OVERALL MARKET PERSPECTIVE
Market Size
The worldwide medical device business represented a global
market of about $190 billion in 2002 — an increase of about 10%
from $172 billion in 2001. According to Standard & Poor’s, US
medical device manufacturers continue to generate about 40% of
their unit sales in foreign markets, regardless of the pricing benefi ts
accruing from a weakened US dollar relative to both the Euro and
the Yen. During 2002, about $85 billion, or 45%, of industry sales
were generated overseas.
Industry Outlook
Industry outlook remains favorable and positive. According
to Standard & Poor’s, worldwide market growth for medical
supplies and devices is expected to be around 12% as of mid-
2003. While rising healthcare cost seems to be the focus around
the world, the aging population, the availability of new and better
medical treatments, and the global demand for healthcare products
and services continues to be strong worldwide, particularly in
developing markets. U.S. companies are benefi ting from sales of
new technology devices by forcing a premium on unit pricing in
comparison to older products. Aided by price and volume increases
and favorable foreign exchange fl uctuations, Standard & Poor’s
expect industrywide sales growth will approximate 15% growth in
2004. Interventional cardiology and cardiac rhythm management,
spinal surgery and orthopedic joint replacements will be among
the products that will contribute to that growth. Earnings will be
expected to grow approximately 18% to 20% in 2004. Expansion
in gross margins due to a higher proportion of sales from new
products, stable R&D outlays, reduced interest costs, and positive
tax rate implications will drive this performance measure.
Recently, the Centers for Medicare & Medicaid Services proposed
new rates for implantable cardioverter defi brillators (ICDs)
which will increase Medicare reimbursements by 3.9%. This
guideline as well as few other legislations, such as Medicare RX
($400 billion budget allocated for the elderly) is expected to
increase the number of people receiving ICDs by about 65,000
per year. An increase in Medicare reimbursements is seen as a
positive factor.
Drug-coated (or -eluting) coronary stents have become the
center of the attention. The fi rst product line approval by the
FDA was given to Johnson & Johnson (J&J) for their Cypher stent.
This drug device is intended to help reduce restenosis (reblockage)
of a treated coronary artery. Coronary stents are fl exible metal
tubes that are inserted into diseased coronary arteries after an
angioplasty procedure — a catheter with a small balloon at the
end is inserted into a blocked artery. Once the infl ating balloon
clears the blockage, the balloon catheter is removed and the stent,
which acts as a platform to keep the artery open, is inserted.
While the procedure can effectively restore blood fl ow to the
heart and often eliminates the need for invasive coronary artery
bypass graft (CABG) surgery, vessel reclosure or restenosis at
the site of the stent may occur. This negative after-effect can be
treated by coating the stent with drugs. Recently, medical device
companies have demonstrated that drug-coated coronary stents can
signifi cantly reduce restenosis. The drugs used to coat coronary
stents are anticancer compounds that inhibit cell proliferation and
dynamically allows for release of the drug over a period of time.
So far, J&J has been unable to meet all of the demand coming
from physicians and their patients for their Cypher product,
which leaves ample room for competitors to penetrate the market.
Coronary stents presently account for industrywide sales of $2.5
billion or about 19% of the interventional cardiology market. As
other companies gain FDA approval for their drug coated stent,
the global stent market will reach $4.5 billion by the end of 2004
(see Chart B).
Increases in Mergers & Acquisitions. A number of smaller
acquisitions are taking place run by some of the largest players,
who seek to fi ll their product lines with niche acquisitions. These
deals will provide great opportunity for them to capitalize on the
recent increases in stock prices and historically low levels of
interest rates.
Continued aging population = more patient population.
Medicare constituents at the age of 65 and older may more than
double in the coming decades, from 37 million today to 70 million
in 2030 and 82 million in 2050. Although the elderly represents
slightly less than 13% of the total US population, they contribute
an estimated 40% of total healthcare expenditures. Also, an aging
bundle of baby boomers will provide further stimulus for industry
wide demand. Baby boomers currently represent 23% of the US
population. According to the World Health Organization, the
global over-65 age population is projected to rise from 390 million
in 1997 to 800 million people by 2025. However, an expected 24
million deaths per year will increase in the years ahead mostly
because many people have unhealthy lifestyles, such as smoking,
obesity, poor diet, or lack of exercise.
CHART B : Drug-Eluting Stent (DES) Market
SOURCE: Standard & Poor’s
MDT | PAGE 4SOUTHERN METHODIST UNIVERSITY
ANN RIFE COX ENDOWMENT FUNDSMU : COX SCHOOL OF BUSINESS
Outpatient procedures heightens equipment sales. Inpatient
procedures are shifting towards the less expensive outpatient
settings. Nearly 75% of all surgical procedures will be performed
on an outpatient basis because new medical device technology
has helped fuel this trend. With the aid of new medical products,
surgeons now perform a one-day surgical procedure for conditions
that once required expensive inpatient surgery, lengthy and
expensive hospital stays, and weeks of recuperation.
Managed care enterprises = Biggest customer. Managed Care
enterprises have developed infl uential, bargaining power within
medical markets. Managers of health maintenance organizations
(HMOs), preferred provider organizations (PPOs), large hospital
consortiums, government agencies, and other large managed
care buyers have made more purchasing decisions. For instance,
60% of all medical device purchases in the United States are
made by managed care buyers, and this percentage is projected
to rise to over 80% by 2005, according to the Advanced Medical
Technology Association.
Increased Internet-based sales usage. In order to combat
competitive pricing pressures on gross margins, many medical
device manufacturers have resorted to the Internet to close this
offset by boosting shipment volumes.
PRODUCTS AND SERVICES (see Chart D and G)
Medtronic operates in fi ve key business units developing products
in Cardiac Rhythm Management (CRM), Cardiac Surgery,
Vascular, Neurological and Diabetes, and Spinal, ENT and SNT.
Medtronic CRM develops products that restore and regulate a
patient’s heart rhythm, as well as improve the heart’s pumping
function. The business markets implantable pacemakers,
defi brillators, cardiac ablation catheters, monitoring and diagnostic
CHART D : Medtronic Product Pipeline
CHART C : Cardiovasuclar IndustrySOURCE: Standard & Poor’s
SOURCE: Company Reports & Website
MDT | PAGE 5SOUTHERN METHODIST UNIVERSITY
ANN RIFE COX ENDOWMENT FUNDSMU : COX SCHOOL OF BUSINESS
devices and cardiac resynchronization devices, including the fi rst
implantable device for the treatment of heart failure. In addition,
the business markets automated external defi brillators (AEDs)
- which are increasingly being placed in public places, such as
businesses, airports, shopping centers and even homes - and
the industry’s fi rst Internet-based network to enable physicians
to remotely monitor their patients who have cardiac devices.
Medtronic Cardiac Surgery develops products that are
used in both arrested and beating heart bypass surgery.
The business also markets the industry’s broadest line
of heart valve products for both replacement and repair,
plus autotransfusion equipment and disposable devices
for handling and monitoring blood during major surgery.
Medtronic Vascular develops products and therapies that treat a
wide range of vascular diseases and conditions. These products
include coronary, peripheral and neurovascular stents, stent graft
systems for diseases and conditions throughout the aorta, and distal
protection systems. The business is also moving forward with the
development of a drug-eluting stent to prevent restenosis. Medtronic
Vascular also markets a full line of balloon angioplasty catheters,
guide catheters, guidewires, diagnostic catheters and accessories.
Medtronic Neurological and Diabetes offers therapies for
movement disorders, chronic pain and diabetes. It also offers
diagnostics and therapeutics for urological and gastrointestinal
conditions, including incontinence, benign prostatic hyperplasia
(BPH)/enlarged prostate and gastroesophageal refl ux disease
(GERD). Products include infusion and neurostimulation systems,
as well as shunts and powered surgical tools for cranial surgery.
Medtronic Spinal, ENT and SNT develops and manufactures
products that treat a variety of disorders of the cranium
and spine, including traumatically induced conditions,
deformities and tumors. It also develops image-guided
surgical navigation systems (SNT) and a wide range of
products for use in ENT (ear, nose and throat) procedures.
COMPETITION
Three main competitors fight for this market: Guidant Corporation,
St. Jude Medical, and Boston Scientific Corporation (see Chart D,
E, F and Exhibit 1). Medtronic ranks 1st among others due to their
diverse product segments and sales, capturing much of CRM.
Guidant Corporation (GDT)
The Company develops, manufactures and markets implantable
defi brillator systems, implantable pacemaker systems, coronary
stent systems, angioplasty systems and cardiac surgery systems.
Guidant’s lifesaving medical technologies are designed to improve
life-threatening cardiac and vascular disease. Its primary medical
devices treat the heart, managing its rhythms, clearing its arteries
and permitting less-invasive surgeries. Guidant has principal
operations in the United States, Europe and Asia. Guidant recently
won FDA approval for their new cardiac devices and ICD.
SOURCE: Yahoo!.com
CHART E : Competitve factors - Product Line SalesSOURCE: Standard & Poor’s
CHART D : Competitve factors - Geographic Sales
MDT | PAGE 6SOUTHERN METHODIST UNIVERSITY
ANN RIFE COX ENDOWMENT FUNDSMU : COX SCHOOL OF BUSINESS
St. Jude Medical, Inc. (STJ)
Together with its subsidiaries, STJ develops, manufactures and
distributes cardiovascular medical devices for the global cardiac
rhythm management (CRM), cardiac surgery (CS) and cardiology
and vascular access (C/VA) therapy areas. The Company’s
principal CRM products are bradycardia pacemaker systems
(pacemakers), tachycardia implantable cardioverter defi brillator
systems and electrophysiology catheters. Its principal CS
products are mechanical and tissue heart valves, and valve repair
products. C/VA products offered include vascular closure devices,
angiography catheters, guidewires and hemostasis introducers.
The principal geographic markets for St. Jude Medical’s products
are the United States, Europe and Japan. The Company also sells
its products in Canada, Latin America, Australia, New Zealand and
the Asia-Pacifi c region.SOURCE: Yahoo!.com
Boston Scientific Corporation (BSX)
A worldwide developer, manufacturer and marketer of medical
devices whose products are used in a range of interventional
medical specialties, including interventional cardiology, peripheral
interventions, neurovascular intervention, electrophysiology,
vascular surgery, endoscopy, oncology, urology and gynecology.
The Company’s products are offered for sale by two dedicated
business groups, Cardiovascular and Endosurgery. The
Cardiovascular organization focuses on products and technologies
for use in interventional cardiology, peripheral interventions,
vascular surgery, electrophysiology and neurovascular
procedures. The Endosurgery organization focuses on products
and technologies for use in oncology, endoscopy, urology and
gynecology procedures. During 2003, approximately 72% of
the Company’s net sales were derived from the Cardiovascular
business and approximately 28% from the Endosurgery business.
Boston Scientifi c recently won FDA approval for their Taxus DES
and launched their Sentinol self-expanding Nitinol Biliary Stent
System. Boston recently acquired Precision Vascular for new
projects in interventional cardiology, oncology, and endoscopy.
SOURCE: Yahoo!.com
RISK ANALYSIS
According to S&P, widening government budget defi cits both
in the US and abroad may result in industrywide pricing
pressure. Thus, longer-term growth in healthcare spending may
slide steeply.
Foreign markets are stressed out. Europe: France and
Germany account for nearly 50% of the continent’s medical device
sales. Due to increased budget defi cits, these two countries have
focused on lowering healthcare expenditure levels. Japan: At
about $24 billion annually, Japan is the largest global market for
medical technologies. US manufacturers exports about $2 billion
to Japan each year. According to the S&P, Japan represents about
10% of industry sales by US manufacturers in 2002. However,
trends indicated this has fallen in recent years. China: In order to
combat these political policies, US medical device manufactures
have resorted to the Chinese market — an area of potential
growth. According to the US Department of Commerce, US
medical device exports to China doubled to $227 million from
1997 to 2002. Regardless, Medtronic’s foreign operations could
be negatively impacted by changes in foreign policy changes on a
political, social and economic level.
Additionally, foreign governments frequently impose
reimbursement limits. In effect, government spending will be
controlled and their citizens will be able to obtain medical products
and services at a low cost. Executive decisions regarding limiting
or eliminating reimbursement for Medtronic products may have a
materially adverse affect on their net earnings.
Increased Market Risk. Due to the global nature of their
operations, Medtronic is also susceptible to foreign currency
exchange rate fl uctuations. However, the primary currencies are
hedged towards the Euro and the Japanese Yen so that earnings
and cash fl ow volatility will be minimized. In 2002, foreign
translations were favorable in sales and product growth.
Increased regulatory requirements from Food and Drug
Administration (FDA) and other comparable foreign agencies.
There has been an increase in the amount of testing, such as side-
effects testing, and documentation required for FDA clearance of
new drugs and devices, which consequently increases new product
introductions expenses. Future FDA approval or non-approval
of medical devices could adversely impact Medtronic’s fi nancial
condition and market position.
Increased Legal Implications. While companies must navigate
FDA requirements prior to commercializing their products,
intellectual property lawsuits, such as patent infringements, are an
important risk element, along with potential product recalls. Many
suits, involving Guidant, J&J, Boston Scientifi c, Arterial Vascular
Engineering, and Medtronic still have ongoing battles with each
other with fi nal rulings still pending. Medtronic also operates
in an industry vulnerable to product liability claims brought by
individuals or class groups seeking monetary relief.
CHART F : Competitive Factors Matrix*
*Ratings based on three factors on a scale from 1 to 5: CRM Sales, COGS-to-
Sales, and Patents. Medtronic (blue), Guidant (purple), St. Jude (yellow), Boston
Scientifi c (baby blue).
MDT | PAGE 7SOUTHERN METHODIST UNIVERSITY
ANN RIFE COX ENDOWMENT FUNDSMU : COX SCHOOL OF BUSINESS
CUSTOMERS
Medtronic’s revenue base includes a diverse mixture of customers
from around the world. The Company supply medical device
products for health care facilities, such as managed care
enterprises and hospitals; physicians and profi t and non-profi t
organizations in the fi eld of cardiology, cardiovascular surgery,
electrophysiology, endrocrinology, ENT surgery, gastroenterology,
guided surgery (SNT), neurology, neurosurgery, oncology, pain
management, spinal surgery, urology/urogynecology, vascular
and many other medical fi elds; and patients with diseases,
such as Abdominal Aortic Aneurysm (AAA), Bladder Control
Problems, Benign Prostatic Hyperplasia (enlarged prostate),
Cancer, Diabetes, Digestive Problems, Heartburn (GERD), Heart
Conditions, Hydrocephalus, Ménière’s Disease, Pain, Parkinson’s
Disease, Seizures and Fainting, Severe Spasticity, Shaking/Tremor,
Sinusitis, Spinal Disorders, Unexplained Fainting and many other
chronic diseases.
DUE DILIGENCE
Medisend is a non-profi t organization based in Dallas and recycles
the medical surplus (surgical, diagnostic, and therapeutic medical
supplies and equipment) of wealthy countries. According to
Medisend, more than $6 billion worth of medical surplus is
generated in the US. Medisend gathers these medical surplus and
distributes them to more than 71 countries. In their biomedical
equipment storage area, Medisend carries numerous working
equipment that have been replaced by newer technology.
Medisend receives requests from these 71 developing countries
for their older generation biomedical equipment because there
is a shortage and a lack of government funds to purchase new
equipment. However, with only a small amount of equipment
left in stock, Medisend can supply those countries with limited
capability. Thus, Medisend suggested that overall demand for new
or old equipment and supplies will accelerate in the future.
PAST ACQUISITIONS
Medtronic slid downwards during 2001 and 2002 due to
increased acquisitions, but has now stabilized and strengthen
their diversifi ed product lines for future growth. For instance, the
Company acquired Spinal Dynamic Corporation for development
of an artifi cial disc designed to maintain mobility of the cervical
spine. The artifi cial disc is currently marketed in Europe and will
hit the US markets by 2007. During the second quarter of 2002,
the Company completed acquisitions in Minimed (world leader
in developing medical systems for treating diabetes) and Medical
Research Group (developer of implantable pumps and sensors for
treating diabetes) for a total purchase price of $3.807 billion. In the
third quarter of fi scal year 2002, Medtronic acquired Endonetics
(developer of technologies for the diagnosis and treatment of
gastroesophageal refl ux disease or GERD) for $67.2 million. In
the fourth quarter of fi scal year 2002, the Company also acquired
VidaMed, Inc. (developer of non-surgical treatment products for
benign prostatic hyperplasia or BPH) for $328.6 million.
MANAGEMENT & OWNERSHIPSource: Dun & Bradstreet and Yahoo!.com
CEO & CHAIRMAN: ARTHUR D COLLINS JR (1948)
Graduated Miami University of Ohio. Graduated Wharton School,
MS in business administration. 1978-1992 Abbott Laboratories,
various management positions, lastly Corporate Vice President.
Jun 1992-present: Medtronic, Inc.
CHIEF FINANCIAL OFFICER: ROBERT L RYAN (1943)
Prior to 1982 several management positions at Citibank and
McKinsey & Company. 1982-1993 Union Texas Petroleum Corp,
treasurer, 1983 Controller, 1984 Vice President Finance and Chief
Financial Offi cer.
Apr. 1993-present Medtronic, Inc, Senior Vice President and
Chief Financial Offi cer
GENERAL COUNSEL DAVID J SCOTT
He came to Medtronic from United Distillers & Vintners (UDV)
in London, England, where he has served as general counsel since
1997. Prior to that, he served as Senior Vice President and General
Counsel for London-based International Distillers & Vintners
(IDV). He graduated from Cornell Law School in 1978 and started
his professional career as a trial lawyer in upstate New York.
SENIOR EXECUTIVE STEPHEN MAHLE
He has been Senior Vice President and President, Cardiac
Rhythm Management, since January 1998. Prior to that, he was
president, Brady Pacing, from May 1995 to December 1997 and
vice president and general manager, Brady Pacing, from January
1990 to May 1995. Mr. Mahle has been with the company for 28
years and served in various general management positions prior
to 1990.
SENIOR EXECUTIVE ROBERT M GUEZURAGA
He has been Senior Vice President and President, Cardiac Surgery,
since August 1999, and served as Vice President and General
Manager of Medtronic Physio-Control International, Inc., from
September 1998 to August 1999. Mr. Guezuraga joined the
company after its acquisition of Physio-Control International, Inc.
in September 1998, where he had served as president and chief
operating offi cer since August 1994. Prior to that, Mr. Guezuraga
served as president and CEO of Positron Corporation from 1987
to 1994 and held various management positions within General
Electric Corporation, including GE’s Medical Systems division.
Breakdown of Major Holders
% of Shares held by All Insider and 5% Owners: 1%
% of Shares held by Institutional & Mutual Fund Owners: 70%
% of Float held by Institutional & Mutual Fund Owners: 70%
Number of Institutions Holding Shares: 10
MDT | PAGE 8SOUTHERN METHODIST UNIVERSITY
ANN RIFE COX ENDOWMENT FUNDSMU : COX SCHOOL OF BUSINESS
FUNDAMENTAL ANALYSIS (see Exhibit 1)
Sales and Net Income (see Chart G)
Medtronic ranks 1st
in sales and net income among our
choice of comparable companies. Net income was driven by
growth in Medtronic’s Cardiac Rhythm Management (CRM) and
Spinal, Ear, Nose, and Throat (ENT), and Surgical Navigation
Technology (SNT) operating segments. CRM net sales increased
23% because of new product introductions, continued strong
growth in existing products, growth in the emerging heart failure
market, and the acceleration in growth of the tachyarrhythmia
market. Therefore, Medtronic achieved a 47% increase in net
sales of implantable defi brillators and a 10% increase in net sales
of pacing systems. Spinal, ENT, and SNT net sales increased 32%
because of continued strong growth in existing products, growth
in the spinal market, continued acceptance of their INFUSE Bone
Graft product for spinal fusion and their rapidly growing family of
MAST (Minimally Access Spine Technologies) products.
Earnings per Share (EPS) Medtronic seems to be the underperformer in EPS each
year, but still exhibits EPS growth appreciation each year. We
believe Medtronic’s different fi scal year-end date among others
accounts for this discrepancy or offset as there may be cyclical
factors not incorporated into EPS estimates.
Balance Sheet Medtronic has a large cash amount of $1,190.3 billion,
which allows them to potential pursue opportunities to capitalize
on new investments. Total debt, common equity, assets, receiv-
ables, and inventory are high across the board.
Stock Data
Medtronic’s current stock price is relatively low among
the comparable companies. Medtronic also possess higher than
aggregate common shares, market capitalizations and enterprise
value.
Financial Ratios Medtronic exhibited a high Last Fiscal Year (LFY) EBIT-
DA margins of 30.6% against other comparable companies. Yet,
Medtronic and Guidant also hold LFY gross margins of approxi-
mately 75%. Medtronic maintains relatively well-above averaged
and better Return on Equity (ROE) of 19.3%, shy under St. Jude
Medical’s ROE of 20.9%. Return on Assets (ROA) in terms of
measuring profi tability for Medtronic is also well-above average
at 18.1%. Current ratio is also very low at 1.11, indicating that
Medtronic is less liquid than others.
Growth Historical 3-year revenue growth rate for Medtronic
looks attractive at 15.18% while St. Jude has a history of 17.91%
growth. Medtronic’s year-over-year (YOY) EPS growth and pro-
jected growth in EPS with the next fi ve years is relatively moder-
ate at around 16%. However, Morningstar.com determined the
latest quarter YOY EPS growth rate to be 56.0%. Also, Medtronic
offers a Dividend Yield of 0.59%.
Risk Debt does not seem to be a critical risk factor for Medtron-
ic. Standard and Poor’s Rating Group and Moody’s Investors Ser-
vice issued Medtronic a strong long-term debt ratings of AA- and
A1, respectively, and strong short-term debt ratings of A-1+ and
P-1, respectively. Current ratings have remained unchanged and
rank Medtronic in the top 10% of all U.S. companies.
Relative Valuation Medtronic’s Current Fiscal Year (CFY) Price-to-Earn-
ings (P/E) is fairly high at 30.0 while Next Fiscal Year (NFY) P/E
also remains high at 25.7. Because the P/E ratios are somewhat
high, the market seems to be more willing to pay for each dollar of
annual earnings. However, Medtronic’s TTM P/E ratio of 31.96
is lower than its main competitors whereas Boston Scientifi c,
Guidant and St. Jude Medical have P/E ratios of 78.52, 51.9, and
40.49, respectively. Also, Relative P/E is high at 1.10, but below
St. Jude Medical’s 1.24. Additionally, Medtronic’s current P/E-to-
Growth (PEG) ratio is high at 1.8 when compared to the Industry’s
1.51 PEG ratio. NFY PEG also remains high at 1.6 for Medtronic.
TTM PEG ratio of 1.68 from Medtronic lies between Boston Sci-
entifi c’s and St. Jude Medical’s PEG numbers. In sum, Medtronic
demonstrates an overall easing combination of comparative, valu-
ation measures.
DFCF MODEL ASSUMPTIONS (see Exhibit 2)
We made several assumptions that will serve as inputs into our
DFCF model for simplicity purposes.
Capital Expenditures-to-Depreciation ratio Using Medtronic’s 2003 fi nancial fi gures, we arrived at
a ratio of 0.93 and gradually grew to 1.50 for purposes of grow-
ing capital expenditures and expectations that the Company will
pursue investments throughout forecasted years. The decrease
in capital expenditures from 2003 to 2004 results from a sharp
decrease in Long-term Net Assets from 2003 to 2004 as working
capital dramatically increased in 2003.
Revenue growth % Historically, Medtronic has achieved around 15% rev-
enue growth each year. We have conservatively determined that
Medtronic will implicitly grow at an average of 12.8% throughout
forecasted years, although market consensus predict 15%. For
years 2004 and 2005, we project revenue to grow at 11%. In the
years 2006 to 2009, we expect Medtronic to recognize at least
12% revenue growth based on new product releases. Gradually,
revenue growth will drop 100 basis points and will eventually
reach 12% towards the terminal year. We also expect Medtronic
to receive large synergies from their entrance in the DES market
during years 2005 to 2009. By 2010 and beyond, Medtronic may
pursue expansion plans and in effect, may reduce revenue growth.
MDT | PAGE 9SOUTHERN METHODIST UNIVERSITY
ANN RIFE COX ENDOWMENT FUNDSMU : COX SCHOOL OF BUSINESS
Our revenue assumptions are based on the following reasons: our
investment thesis outlined at the beginning, increased competi-
tion that could detract revenues from Medtronic, increased price
pressure from foreign markets and competition, strong product
demand, and solid business segments. We also believe Medtronic
will be able to sustain 12% revenue growth terminally for these
following reasons in addition to continuing, favorable demograph-
ics.
Cost of Goods Sold (COGS) and Selling, General, and
Administrative (SGA) Effi ciencies We assumed COGS growth effi ciencies to range from
11.6% to 11.7% growth each year — in-line with about 24% of
revenues produced each year (see Exhibit 2 - Key Percentages).
We also assume SGA growth effi ciencies to slowly decline from
11.5% to 11.3% (in-line with about 31% of revenues produced
each year) towards terminal year as Medtronic attempts to estab-
lish signifi cant quality measures. However, we projected 11.5%
SGA growth in the terminal year for perpetuity.
Depreciation-to-Assets Using Medtronics’ 2003 fi nancial fi gures, we arrived at
4.3% (also see Exhibit 2 - Key Percentages) and assumed this per-
centage remained constant for purposes of growing depreciation
throughout forecasted years.
Debt Interest Rate % Using interest expense by long-term and short-term debt,
we determined the debt interest rate to be 8.3% and assumed this
percentage remained constant for purposes of growing interest
expense throughout forecasted years.
Tax rate Medtronic has benefi ted from their tax strategies that
allowed them to use a tax rate below the standard. Therefore, we
used a fair tax rate of 31.7% for 2003 and kept this fi gure constant
throughout forecasted years.
Working Capital Growth
Working capital dramatically increased from 2002 to
2003. According to Company reports, the increase in working
capital primarily relates to the reclassifi cation of $1,973.8 million
of contingent convertible debentures from current liabilities to
long-term liabilities in the second quarter of fi scal year 2003. In
April 26, 2002, Medtronic’s working capital, current ratio, and net
cash position were negatively impacted by the $4,057.6 million
of cash paid in fi scal year 2002 for acquisitions. From 2004 and
beyond, we normalized working capital and long-term net assets
by growing working capital at fl exible growth rates. We assumed
working capital to slowly grow at 8% by 2007 after assuming
Medtronic achieves 12% revenue growth from their DES and
other product releases in 2006.
Debt Growth We assumed a 10% growth in debt for the next three years
as Medtronic utilizes new capital for R&D expenses for furthering
completion of product trials and then moderately grew their debt
to 15% by 2006.
Key Percentages for 2003 Percentages for each line item indicate as percentage of
revenue except for Depreciation, which is a ratio between current
year’s Depreciation and previous year’s Long-term net assets.
These percentages were used to forecast most line items in fore-
casted years (see Exhibit 2).
Beta We regressed the beta equity of the fi rm using Medtronic
and S&P returns of the last ten years to arrive at 0.964 (see Exhibit
3).
Weighted Average Cost of Capital (WACC) With our inputs and class consensus of a risk-free rate of
2.7% and a Market Premium of 6%, we calculated the WACC to
be 8.48% for the levered fi rm (see Exhibit 3).
Terminal Growth % We used 4% as a terminal growth input to determine the
intrinsic value of the company (see Exhibit 4).
FINAL VALUATION & CONCLUSION
Based on our assumptions, we have determined that Medtronic
is undervalued on a Discounted Free Cash Flow (DFCF) basis.
We feel that Medtronic has the capability and the capacity to
pursue and achieve much growth in the industry. We also feel
Medtronic’s diverse business segments will attract a large portion
of the overall customer base, capturing signifi cant revenues, and
thus, justifi es the premium price. If Medtronic performs better
than expected 15% revenue growth over our forecasted 13% in the
coming years, Medtronic will undoubtedly be an attractive stock
in comparison to other competitors and be in a strong position.
Further, we believe favorably that Medtronic will be able to obtain
FDA-and-abroad approval as well as penetrate the DES market
as a top-line competitor. In conclusion, we view these factors,
including favorable investment highlights, positive qualitative
and quantitative analysis, modest fundamentals, and strong
management structure constitute Medtronic an attractive buy.
MDT | PAGE 10SOUTHERN METHODIST UNIVERSITY
ANN RIFE COX ENDOWMENT FUNDSMU : COX SCHOOL OF BUSINESS
EXHIBIT 1 : Comparable Company Analysis
Rex
Th
om
pso
n P
/E A
ggre
gate
Rati
o (
Th
om
pso
n P
EA
R)
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ethod i
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able
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cap
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izat
ion by t
he
sum
of
the
each
com
par
able
s’ c
om
mon s
har
es t
imes
thei
r E
PS
.
MDT | PAGE 11SOUTHERN METHODIST UNIVERSITY
ANN RIFE COX ENDOWMENT FUNDSMU : COX SCHOOL OF BUSINESS
EX
HIB
IT 2
: P
roje
cted
Fin
anci
als
MDT | PAGE 12SOUTHERN METHODIST UNIVERSITY
ANN RIFE COX ENDOWMENT FUNDSMU : COX SCHOOL OF BUSINESS
EX
HIB
IT 2
: P
roje
cted
Fin
anci
als
(conti
nued
)
MDT | PAGE 13SOUTHERN METHODIST UNIVERSITY
ANN RIFE COX ENDOWMENT FUNDSMU : COX SCHOOL OF BUSINESS
EXHIBIT 3 : Risk and Required Return
CHART G : Net Sales by operating segmentsSOURCE: Company Reports
MDT | PAGE 14SOUTHERN METHODIST UNIVERSITY
ANN RIFE COX ENDOWMENT FUNDSMU : COX SCHOOL OF BUSINESS
EX
HIB
IT 4
: S
ensi
tivit
y A
nal
ysi
s
MDT | PAGE 15SOUTHERN METHODIST UNIVERSITY
ANN RIFE COX ENDOWMENT FUNDSMU : COX SCHOOL OF BUSINESS
GLOSSARY
SOURCE: Company Reports