How To Justify Medtronic Reaching $50

Medtronic‘s (NYSE:MDT) stock has appreciated 15% this year and is approaching our $45 price estimate following several product launches and the announcement to acquire Chinese medical devices maker China Kanghui Holdings. (Read Medtronic Pays Princely Sum For Greater China Access With Acquisition) With the stock price coming closer to our estimate, we find it prudent to discuss Medtronic’s business model and see what factors could trigger an upside to our current price estimate.

One area in particular where the company can drive value is if it can maintain or limit the decline in its market share in 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 the treatment of abnormal heart conditions by 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 the musculoskeletal system. Additionally, it includes biologic solutions for the dental and orthopedic markets.

15% Upside Scenario | $52 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 (ICD), resulting in a 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 the company’s market share, reaching close to 20% by the end of our forecast period.

Medtronic, however, has received the FDA approvals and launched several new and innovative products. Additionally, the Center for Medicare & Medicaid Services (CMS), a government agency responsible for administering Medicare, reported that it will provide 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 company can have the first mover advantage. Further, Medtronic is bracing itself to actively pursue 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. 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.So, any move toward making in-roads 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 a small out-performance with respect to our expectations will have a huge impact on the company’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 $45.

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

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 witnessed 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 company recently announced to acquire Chinese medical devices maker China Kanghui Holdings that could strengthen its foothold in the rapidly-growing Chinese device market. 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 a potential upside of nearly 5% to our price estimate.

Combining both scenarios, a 10% upside from a lower decline in market share in cardiac rhythm management division and a 5% upside from a lower decline in market share in spinal division, we arrive at 15% upside or a price estimate of more than $52 for Medtronic.

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