For the past several quarters, including the fiscal third quarter whose results Medtronic announced last week, we have heard the same refrain from the large Minnesota-based medical device maker.
That its core spine business is stabilizing and showing signs of improvement.
While that may be true, the overall story of Medtronic Spine has not changed. Quarter after quarter the business dips a bit further. The reasons are many – there are pricing pressures from its hospital customers, an acquisition that was too expensive and never bore fruit and of course the controversy surrounding its once-blockbuster bone-growth product InFuse whose sales have slumped dramatically.
Caught in this cycle, it’s a surprise that Medtronic hasn’t got rid of the business. But turns out that the Spine business is like an albatross hanging around Medtronic’s neck – a burden that it must carry, at least for the immediate future.
The Spine business produces more than half the free cash flow in the U.S., according to an analysis Novarro conducted last August. In other words, the business is invaluable to shareholder value.
“If you are producing half of the U.S. free cash flow, ok and all of a sudden you get rid of it, now what do I do to fund my dividend, to fund my [share] buy back,” Novarro said.
The company could take on some debt to perform these activities, but Medtronic has no appetite for it, Novarro says.
Medtronic has nearly $10 billion in cash lying overseas, he says but to bring it back to the U.S. would mean a big tax penalty. Naturally, that is not something that is palatable either.
But how is it that a non-performing unit is paradoxically such a significant contributor to free cash flow?
Simple, says Novarro. The spine business, unlike most other segments within Medtronic, has low expenses because it doesn’t conduct some of the expensive, large-scale clinical trials that those divisions do.
“The Spine business requires less R&D funding – most of the products are approved through the 510(k) route,” Novarro says.
But aside from the purely financial, there are other factors that make a Spine sale less likely. Medtronic spent $4 billion to acquire Kyphon under former CEO Bill Hawkins but couldn’t integrate it well. The benefits of that acquisition never materialized. That makes the Spine division a little unattractive.
Then there is the fate of InFuse, the bone-growth product that is now under review by Yale researchers. A series of articles in the peer-reviewed Spine Journal alleged in 2011 that doctors who had been compensated by Medtronic for other activities knowingly underreported the risks of the product. Yale, which is reviewing the data that was the basis for the FDA approval, is expected to release results of its review soon.
Meanwhile, a separate Department of Justice Investigation into alleged illegal off-label promotion of Infuse closed without the DOJ charging Medtronic with anything.
Still, sales of the product are in free fall – in the last quarter that ended Jan. 25, the company’s Infuse revenue dropped 21 percent. Novarro said if the Yale review is positive, it won’t bring those customers back, but it may stem the losses.
For all the above reasons, the Spine division may be a millstone that Medtronic has to carry around for a while.
--By Arundhati Parmar, Senior Editor, MD+DI
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