Medtronic Seeks Wider Health-Care Reach in Covidien Deal

Medtronic Inc.’s deal to buy Covidien Plc will make the medical device maker No. 1 or No. 2 in six of the top 10 categories for hospital purchases.

The U.S. company known mostly for developing sophisticated devices that shock the heart into beating properly is now becoming a Dublin-based generalist, broadening its focus to include Covidien’s everyday hospital supplies, a pact with the drugmaker Sanofi to develop care strategies for diabetics and opening heart catheterization labs in the U.K. and India.

While the Covidien deal revolves around the tax advantages Medtronic will gain by changing its legal residence to Dublin, that’s a part of a bigger strategy aimed at breaking loose from its historic dependence on heart pacemakers and defibrillators, Medtronic Chief Executive Officer Omar Ishrak said.

“Sure there’s more cash flexibility and we’ll use that to our advantage, but the strategic element of this deal is extremely important,” Ishrak said yesterday in a conference call with analysts. “We’re not just focused now going forward on selling devices, we’re working with hospitals and governments around the world to provide basically the procedural solution.”

Medtronic will pay about $42.9 billion for Covidien, or $93.22 for each share of Dublin-based Covidien, the companies said in a statement. The combined company will be based for tax purposes in Ireland, giving Medtronic access to about $14 billion in cash it holds abroad to avoid paying U.S. corporate income tax, the world’s highest. Medtronic is now based in Minneapolis.

Struggling Growth

Both companies have struggled for growth in recent years as hospitals and insurers push to cut costs and control medical procedure rates. In the U.S., the Patient Protection and Affordable Care Act has put even more pressure on medical centers to work more efficiently and reduce repeat hospital admissions.

Covidien generated $10.2 billion in fiscal year 2013, roughly the same as five years earlier. Medtronic with $16.6 billion in sales for the fiscal year ended in April, has been growing in the low single digits.

Medtronic has grappled since 2010 with declining sales in its two biggest categories -- heart rhythm devices like implanted defibrillators and spinal products -- as questions have emerged about their safety and overuse. At the same time, hospitals and insurers clamped down on which patients qualified for therapy and pressed for lower prices, curtailing what had been two growing industries.

Expensive Products

The move is further evidence that sales of the company’s core products, sophisticated and high-margin devices to treat heart and spinal conditions, are unlikely to return to the torrid growth experienced around the turn of the century. Ishrak now is focused on providing hospitals and insurers with clear evidence that the products have economic value and expanding Medtronic’s base to offer health-care services.

“It would create the ultimate buffet table of medical device products, producing a very large one-stop shop for discussions with hospital administrators,” Joanne Wuensch, an analyst with BMO Capital Markets in New York, said in a note to clients. “Big picture, this consolidation phase of the medical device evolution makes sense to us, and it should provide increased pricing stability and leverage for the companies taking the leap.”

Combining the sales of Medtronic and Covidien will put them closer to Johnson & Johnson, with $28.5 billion in device sales, according to Derrick Sung, an analyst at Sanford C. Bernstein in New York.

Size, Scale

The larger footprint “is a long-term benefit that we think will be critically important as we move down the path of health-care reform in the U.S.,” Sung said in a note to investors. “A Covidien deal will allow Medtronic to rival Johnson & Johnson’s med-tech business in size and scale as the world’s largest medical device company.”

The purchase dwarfs Medtronic’s largest deal to date, the acquisition of Kyphon Inc. for $3.8 billion in 2007. Medtronic has completed 30 acquisitions in the past decade at a total cost of $10.4 billion, according to data compiled by Bloomberg.

The deal is likely to spark further consolidation in the industry, Ishrak said. It will take broad, multifunctional companies to succeed as health care integration continues and rivals will need to work together to keep pace, he said.

“If we can set that to be the template for a company, others have to follow,” he said. “I think consolidation of some sort is inevitable, it’s just a matter of time.”

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