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Analyst Blog

Recently, the medical device players have shifted focus towards emerging markets, especially China. Medtronic (MDT - Analyst Report), in line with this strategy, has decided to acquire China Kanghui Holdings for $816 million in cash. After taking into account Kanghui's cash balance, the transaction value came in at $755 million. This deal would strengthen Medtronic’s orthopedic franchise in the fast growing Chinese market by bringing in trauma, spine and joint reconstruction products.

The transaction, expected to close in the next few months, is subject to certain approvals.  Medtronic expects that the deal would not impact its earnings in both fiscal 2013 and 2014 as the company intends to offset any dilutive impact of the transaction. 

The proposed acquisition of China Kanghui is in sync with Medtronic’s focus on globalization due to the opportunity rife in international destinations, especially in the emerging markets. Emerging markets remain a key focus area for the company. Management is targeting to achieve 20% of its revenues from the emerging markets by fiscal 2015−16 that will result in additional 300–500 basis points of revenue growth.

Healthcare, which is increasingly becoming a government priority in many emerging countries, along with a rise in economic standards in these regions, speaks for the immense potential for growth. It is expected that within the next decade, China will be the biggest health care market in the world, outpacing the US. However, revenues from this region during the last reported quarter increased 14% (at constant currency) but missed the company’s targeted growth rate of 20%.

Meanwhile, in August 2012, Medtronic inaugurated its Innovation Center in Shanghai, the first outside the US and Europe, to enhance local product research and development in that region. This center will collaborate with the global teams, local physicians, universities and research institutes to provide solutions for patients. Based on these initiatives, we expect this region to play a significant role in the growth path of the company. 

Recommendation

Medtronic is focusing on the emerging markets primarily to offset the hindrances it faces in two of its largest markets – US defibrillators and US spinal implants. We are also encouraged by the company’s portfolio expansion strategies though their contributions are not significant enough to drive top-line growth yet. However, unfavorable currency and macroeconomic uncertainties in Southern Europe adversely affected sales during the first quarter. These headwinds have also affected the company’s peers St Jude Medical (STJ - Analyst Report) and Boston Scientific (BSX - Analyst Report).

We have a ‘Neutral’ recommendation on Medtronic. The stock retains a Zacks #3 Rank (Hold) in the short term.

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