Medtronic's Covidien deal raises bar for rivals to merge

Mon Jun 16, 2014 7:15pm EDT

Medtronic Chairman and Chief Executive Omar Ishrak speaks at the Reuters Health Summit in New York May 7, 2013. REUTERS/Brendan McDermid

Medtronic Chairman and Chief Executive Omar Ishrak speaks at the Reuters Health Summit in New York May 7, 2013.

Credit: Reuters/Brendan McDermid

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(Reuters) - Medtronic Inc's (MDT.N) $43 billion deal for Dublin-based Covidien Plc (COV.N) should accelerate already intense efforts by medical device rivals to seek merger partners, industry analysts and bankers said on Monday.

Medtronic announced the transaction on Sunday, saying it would re-base the combined company in Ireland, where it can take advantage of lower corporate tax rates and easier access to cash generated overseas.

The purchase also gives Medtronic more products, as well as greater leverage in negotiating with hospital clients that are taking a much harder line on device spending.

The intensified competition will bring new pressure on large device makers such as Abbott Laboratories (ABT.N), Stryker Corp (SYK.N) and St Jude Medical Inc (STJ.N) to seek acquisitions, industry watchers say. Medtronic plus Covidien will rival industry leader Johnson & Johnson's (JNJ.N) $28.5 billion in annual device revenue.

UK-based Smith & Nephew Plc (SN.L), which has already attracted takeover interest from companies seeking better tax rates overseas, remains high on the list of targets, they said. Device makers such as Boston Scientific Corp (BSX.N) should feel more pressure to get bigger or face being left out in the cold.

The merger mania is a product of pressures on the healthcare systems in the United States and in Europe, where hospitals are getting paid less to deliver care. U.S. hospital systems are consolidating and buying doctor practices to cope with the changes.

"It becomes more necessary for the medical device companies to have a broader product line in order to be able compete and have economies of scale," said Len Yaffe, portfolio manager of the San Francisco-based healthcare fund StockDoc Partners.

Medtronic said its own appetite for deals does not end with absorbing Covidien. It expects to use some of the additional cash flow from the deal on acquisitions and minority investments, and internal research and development.

"There still are plenty of opportunities for us to focus on other acquisitions, other innovation. That momentum doesn't need to stop, even in this integration period," Medtronic Chief Financial Officer Gary Ellis said in a conference call with analysts.

Medtronic has been especially eager to expand beyond selling devices to providing advisory services to hospitals.

"To the degree we can bring in other acquisitions to support that further, we will look closely at that," Chief Executive Omar Ishrak said.

EMULATING MEDTRONIC

The latest consolidation wave in the medical device arena began in April when Zimmer Holdings Inc (ZMH.N) reached a deal to buy rival Biomet Inc for more than $13 billion, expanding its orthopedic product offerings.

Rival orthopedics maker St Jude Medical "could be an acquirer of a smaller company to emulate what Medtronic is doing," Yaffe said.

Morningstar analyst Debbie Wang has Stryker atop her list of potential acquirers.

"That company is a serial acquirer and CEO Kevin Lobo has indicated that it is trying to move the company in the direction of becoming a larger partner with its hospital customers, the same strategy that Johnson & Johnson and Medtronic are taking to heart," Wang said.

Wang sees Edwards Lifesciences Corp (EW.N) as a target whose specialty in heart valves would fit in with a number of companies interested in cardiac products.

Yaffe listed Hospira Inc (HSP.N), Becton Dickson and Co (BDX.N), Baxter International Inc (BAX.N) and Massimo Corp (MASI.O) as attractive takeover candidates that could help a larger company become more of a one-stop shop for hospitals.

While several industry experts pointed to Boston Scientific as an acquirer, it could still be wary in the wake of its $27 billion purchase of Guidant in 2006. The deal left it heavily in debt and struggling with a depressed stock price for years.

Medtronic is acquiring Covidien in a so-called inversion transaction that allows it to reincorporate in Ireland.

Analysts said the strategy will give Medtronic access to cash generated through sales outside the United States and now held overseas without paying a penalty for repatriating the money. This benefit overshadows the modest reduction in the overall corporate tax rate that the company is forecasting.

Medtronic also said Monday it would maintain its prior forecast for fiscal 2015 earnings in the range of $4 to $4.10 a share. Its shares were off 1.4 percent at $59.87, while those of Covidien were up 20.7 percent at $86.93.

(Reporting by Susan Kelly in Chicago and Bill Berkrot in New York; Additional reporting by Soyoung Kim in New York; Editing by Michele Gershberg, Nick Zieminski and Steve Orlofsky)

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