According to the China Daily, medical device giant Medtronic (NYSE:MDT) may be mulling to pursue M&A to strengthen its foothold in the rapidly growing Chinese device market and has identified a number of targets. The news doesn’t come as a major surprise as China is a preferred choice for expansion for the major device makers. These companies including Johnson & Johnson (NYSE:JNJ), Boston Scientific (NYSE:BSX) and Medtronic continue to grapple with slowing growth due to pricing pressure following the U.S. healthcare reforms and European austerity plans. On the other hand, emerging markets including China have been experiencing rapid growth. So, any move toward making in-roads into these markets will only help these companies fend off weakness in developed markets.
With a huge population base of nearly 1.3 billion, aging population, increasing affluence and healthcare spending, we expect the demand for medical devices to shoot up. Many estimate China’s medical devices market size at around $60 billion and expect the market to grow by 20% annually through 2015, much higher than 7% in developed markets. That is why even as many medical devices giants have cut their overall R&D costs in a bid to improve margins, they have announced several investments in China to grow organically. They have either opened technology centers, R&D centers or signed collaborations agreements. Recently, St Jude Medical set up two technology centers in China and decided to provide training to local doctors to promote its products. GE Healthcare opened an R&D center in the country while doubling its sales staff. Johnson & Johnson is also collaborating with government departments and academic institutions to make in-roads into the Chinese market. 
However, this is the first time one of the giants has decided to actively pursue inorganic route in the country as many consider quality and staff training one of the major barriers for M&A. But there is no guarantee of a successful product through R&D and collaborations either. Further, it takes time to create impact in the customers’ minds. Besides technological innovations and launching new products, the local market preference and distribution network are some of the major factors that affect any medical device company’s position in the market.
M&A could give Medtronic ready access to products that local customers can easily associate with. We believe the company can better leverage its brand name and scale to increase market share of the acquired company’s products. In addition, Medtronic is usually associated with higher quality products and could use its quality control procedure to improve product quality of the acquired company. We expect other competitors to follow the M&A route.
While Medtronic’s emerging market sales have seen double digit growth in the past couple of years, we expect this growth to remain robust and see the emerging markets’ overall revenue contribution to the company growing. We believe with this strategy the company could be well-poised to grab a share of the rapidly growing market. If Medtronic manages to exceed our expectations, this could result in an upside to our $41 price estimate, which is in line with the current market price. The company’s stock has risen nearly 10% since we launched coverage on the company.Notes: