Medtech’s Fiscal Feats and Flops of 2011

It is quite true what philosophy says, that life must be understood backwards. But then one forgets the other principle: that it must be lived forwards.

—Søren Aabye Kierkegaard

Time travel is a fascinating concept. Totally fictional, of course, but nonetheless intriguing, if only for the promises it holds for both humanity and society. Think for a moment about the ability to revisit the past and the potential impact that jaunt could have on the future (or present, depending on how one perceives time). Dozens of science-fiction novellas and films have used this concept as a central theme to force their main characters into a vexing yet interesting ethical confrontation about past transgressions. At some point in the tale (usually near the beginning), these characters face the ultimate test of their morality by tackling a question few people would be ready (or willing) to answer—would you change the past to improve the future?

The answer, of course, has provided the basis for countless numbers of fantastical plots. In Harlan Ellison’s 1957 short story “Soldier From Tomorrow,” for example, the protagonist, Qarlo Clobregnny, travels thousands of years back in time to warn the present-day world of impending armageddon.
Similarly, Michael “Puppy” Young, a history student at Cambridge University in author Steven Fry’s 1996 novel “Making History,” teams up with a physicist to prevent the birth of Adolf Hitler. The pair succeed, but their hopes of erasing the Holocaust from history are shattered when a new leader emerges (Rudolph Gloder) who is just as ruthless as Hitler but more efficient, charming, patient, reasonable and—frighteningly enough—more committed to genocide than the now non-existent fascist ruler. Under Gloder’s reign, the Nazis control Europe, develop an electronics industry of their own and build the world’s first nuclear weapons. The United States matches technological wits with the Nazis in 1941 and enters a Cold War with the Greater German Reich while supporting former Soviet guerrillas fighting in Siberia.

The future certainly changed, but not for the better.

As with most characters who attempt to alter the course of history, Young and his physicist friend learned a valuable lesson from their Hitler-annihilating crusade: Messing with the past potentially can have disastrous results for the future.

German philosopher Walter Benjamin refused to accept the notion that the past cannot be changed. He believed the past could be transformed by present actions; New Statesman author Terry Eagleton explained Benjamin’s thinking quite simply in a 2009 article about the philosopher, claiming, “What Benjamin meant was that how we act in the present can change the meaning of the past. The past may not literally exist (any more than the future does), but it lives on in its consequences, which are a vital part of it.”

How we act in the present also can change the future, based upon the lessons we’ve learned from the past. It is in this context, then, that we review the year’s top triumphs and tragedies in medtech finance and the lessons to be learned from them:

Conquering Catastrophe

The historic 9.0-magnitude earthquake off Japan’s northeastern coast on March 11 spawned a deadly tsunami that wiped out whole villages and precipitated the world’s worst nuclear accident in nearly a quarter century. Medical device firms feared the disaster would be as lethal to their supply chains as it was to the automotive and consumer electronics industries. Auto giants such as Ford Motor Co., Toyota Motor Corp. and General Motors Co. initiated a frantic (butalbeit fruitless) search for Xirallic after the Japanese factory that makes the pearl-luster pigment closed for repairs for two months. The temporary suspension in production forced many car dealers to limit the number of colors offered to consumers. Apple ran into a similar snag with the lithium-polymer batteries used in its iPod line. The batteries contain a polyvinylidene fluoride polymer made by Kureha Corporation of Tokyo, Japan (the company held a 70 percent market share on the polymer at the time of the quake). Though Kureha’s facility in Iwaki escaped the disasters relatively unscathed, extensive damage to a nearby port prevented deliveries of the materials necessary to manufacture the iPod battery polymer.

The device industry generally fared much better in the disaster, thanks to effective planning and, well, good luck. Few firms sustained damage to their Japanese facilities and only a handful of suppliers were forced to temporarily close up shop. Fortunately, many of the companies affected by the supply chain snafu had either enough raw materials on hand to meet local demand (such as Covidien plc) or adequate inventory levels to keep up with customer requests (Becton Dickinson and Company). Unlike auto makers, medical device manufacturers rarely rely on just one or two suppliers for key components or materials; such foresight helped them avoid a massive and costly supply chain disruption.

That foresight also helped device firms sidestep a potential earnings fiasco. After the double disaster struck in March, most medical device executives expected their Japanese or Asia-Pacific sales and revenue figures to fall dramatically in the second quarter (ended June 30). Industry analysts sounded the alarm for orthopedic firms in particular, warning that semi-elective surgeries such as hip and knee implants would be most vulnerable to a decline in demand.

Those declines never occurred, though (if they did, they were not significant enough to impact earnings). Companies such as Stryker Corp., Zimmer Holdings Inc. and Synthes Inc. reported healthy sales and revenue from their Japanese operations in the second quarter; during an earnings conference call in mid-July, Stryker CEO Stephen MacMillan called Japan one of the “bigger upside surprises” in the quarter.

Japan also was one of the top-grossing regions for Zimmer, which reported 6.9 percent overall sales growth for Asia-Pacific in Q2. Sales of reconstructive products in that market grew 4 percent on a constant currency basis, while knee sales climbed 2 percent and hip sales jumped 7 percent.

Synthes posted perhaps the most impressive gains in the Asia-Pacific region, generating $257.1 million in sales during the first half of 2011, a 27.4 percent increase (16.2 percent on a constant currency basis) compared with the $201.8 million the region generated in the first half of 2010.

Touché, Mother Nature.

Savings Through Consolidation

Most companies experience growing pains, trimming costs every now and then to save money and operate more efficiently. But medical device OEMs seemed to trim more “fat” than usual this year to offset sluggish sales and conserve cash. Boston Scientific Corp. and Medtronic Inc. each pruned more than 1,000 jobs from their payrolls as pricing pressures and nominal market growth took a toll on revenue. Even an 11 percent jump in fiscal third-quarter earnings couldn’t rescue the 1,500- 2,000 jobs on Medtronic’s chopping block. Nearly as many positions (1,400) are endangered at BSX, where executives have been working over the last two years to transform the company into a stronger, leaner, more competitive firm. Such improvements, though, rarely occur without sacrifice, and Boston Scientific has sacrificed at least 2,400 employees to date in pursuit of its reinvention.

Other companies making notable staff sacrifices this year included Biomet Inc., which cut up to 200 jobs amid a reorganization of its global reconstructive business. Most of the layoffs occurred in Europe; only 21 took place within the United States.

Workers at Stryker Corp. and Wright Medical Technology Inc. are getting a brief reprieve from the sacrifices they eventually will make for their respective companies. Stryker is eliminating 142 jobs over the next two years in Ireland (thanks to a consolidation of factories in Carrigtwohill), while Wright Medical’s cost restructuring plan calls for handing out pink slips to 6 percent of its workforce, or 80 employees.

Smith and Nephew plc underwent a consolidation as well over the summer, but the merger of its Memphis, Tenn.-based orthopedic unit and its endoscopy division in Andover, Mass., did not result in any layoffs. At least not yet.

Wall Street’s Stormy Summer

Medtech stock values bounced around like a ping pong ball in August after Europe’s debt debacle intensified and Standard & Poor’s downgraded America’s AAA credit rating for the first time in history. Double-dip recession fears also contributed to the meltdown, which left investors and device bigwigs alike exacerbated, frustrated, even a little nauseated. Orthopedic manufacturers generally fared worse than their medtech counterparts in the maelstrom, though no company escaped unscathed.
Gainesville, Fla.-based Exactech Inc. and Alphatec Holdings Inc. suffered the most significant losses—Exactech’s stock price plummeted 18 percent in one day and lost 9 percent of its value that first week after the downgrade, while Alphatec’s stock value dropped 15 percent in one day and 17 percent over two weeks. Boston Scientific Inc.’s stock lost more than 7 percent of its value twice during the week of Aug. 8, but it recovered remarkably well to end that week just 1.3 percent below itsAug. 5 closing price. Varian MedicalSystems Inc. shares also suffered a considerable loss, despite reporting stellar earnings in the third-quarter just two weeksbefore the volatility began.

Most investors and chief executives were relieved when the stock market ended its rebellious antics at the end of the summer and started acting normally again. But analysts believe such volatility is part of the landscape now, particularly as herd trading by hedge funds increases and traders react more emotionally to economic news.

Get ready for a bumpy ride ahead.

Medtech-Private Equity Reunion

Private equity has noticeably been absent in the medtech sector over the last few years, but it returned in a big way this past summer with the $6 billion buyout of advanced wound care specialist Kinetic Concepts Inc. (KCI) by Apax Partners LLP and two Canadian pension funds. The deal, one of the largest leveraged buyouts since Lehman Brothers imploded three years ago, drew interest from several large players in the private equity arena, including Nordic Capital and Avista Capital Partners, co-owners of Kinetic rival ConvaTec. The Skillman, N.J.-based wound therapy manufacturer reportedly made an 11th-hour bid for KCI shortly before the expiration of a “shopping” window on the Apex deal. Private equity firms also apparently courted AstraZeneca, Beckman Coulter Inc. and Synthes Inc., giving the medtech industry hope that private investment may truly be here to stay.

The ‘New Normal’

Change is never easy, but it doesn’t have to be paralyzing, either. It’s no secret that the medical device industry is slow to embrace change—it took the sector decades, after all, to warm up to the idea of outsourcing. But there are changes in the industry—namely, tighter regulation, pricing pressures and strict quality standards—that are not going away. The industry must get used to these changes (they are the “new normal,” according to finance and medtech experts) and welcome them rather than hoping they quickly pass. The industry also needs to reinvent its business model, perhaps experimenting with new research and development, commercial and customer service paradigms to find the magic formula that will return the sector to its glory days.

“The companies best positioned for success will be those that develop new offerings and solutions most relevant to a changing ecosystem,” states a report from global advisory services firm Ernst & Young. “Medtech companies have always taken on risk to innovate new products and technologies.
Going forward, one of the biggest risks may be the failure to innovate beyond the product and develop new offerings in new ways.”