Changing of the Guard at Medtronic Draws Industry Attention

During the annual shareholders meeting of Medtronic Inc. (Minneapolis), on August 23, the company's board of directors elected William A. Hawkins III to the position of president and chief executive officer, carrying out a succession plan that had been announced in February of this year.

As part of the plan, Michael F. DeMane, previously senior vice president and president of Medtronic's business in Europe, Canada, Latin America, and emerging markets, was named to the position of chief operating officer. Arthur D. Collins Jr., previously Medtronic chairman and CEO, is expected to remain as a director and chairman of the board until the annual shareholders meeting in August 2008.

Hawkins assumes command of a leading medtech company that can lay claim to a string of technological advances and product innovations, including the development of the first cardiac pacemaker. As the largest pure-play company in the industry, Medtronic has a strong record of achievement forged over its nearly six-decade history. Today, the company has leading products in most of the medtech segments in which it operates. Such segments include cardiac rhythm management (CRM); cardiovascular; neuromodulation; spine; diabetes; ear, nose, and throat; and physio-control.

Medtronic has a diverse product portfolio, a robust R&D budget, an active product pipeline through both organic growth and acquisitions, and has made extensive gains in key international markets. In fiscal 2007 (ending April 27, 2007), the company's revenues grew 8.8% year over year, with net income increasing by 9.8% and earnings per share increasing 15.3%. Considering some of the speed bumps the company has encountered over the past year, particularly in the CRM sector, Medtronic's performance metrics appear to suggest good positioning for solid future growth.

Tim Nelson, assistant vice president and senior research analyst at Piper Jaffray & Co. (Minneapolis), says that he considers Medtronic to be "the premier medical device company in the world". Nevertheless, he admits, "The company's core markets are sputtering. They need to get ICDs [implantable cardioverter defibrillators] and spine going again."

Some industry analysts have gone further, no longer considering Medtronic to be the high-flyer that it once was in the medtech space.

While most analysts still praise Medtronic for the quality and innovation of its products, some have begun to criticize the company's overly optimistic projections and forecasts, which have often come up short. The most frequent refrain from Wall Street is the call for company management to take actions that will boost shareholder value. Medtronic stock is up only about 4% since the beginning of 2007, and is often characterized in the business press as a laggard.

Another frequent criticism concerns the delays that Medtronic has experienced in getting products to market. Some of these setbacks are seen as the result of unrealistic expectations set by the company. A case in point is the Endeavor drug-eluting stent. Even though the company just got word that FDA's circulatory systems advisory panel will review the coronary device on October 10, Medtronic is still expecting regulatory approval for U.S. market entry before the end of the year—a view that most analysts consider overly optimistic. When Endeavor was first announced, Medtronic forecast FDA approval in 2005.

Considering Medtronic's missed earnings forecasts, lagging stock price, product delays, and declining sales in its signature CRM product line, industry analysts have been eager to explore how the new CEO might run the company differently from his predecessor, Art Collins, who had held the top spot since 2001. During Collins's six-year tenure, Medtronic's annual revenues doubled and earnings per share nearly tripled. Yet the stock produced a return of only about 25% to shareholders—performing worse than the average listing on the Standard & Poor's 500.

Following his appointment as CEO, Hawkins made himself readily available for interviews with industry analysts. Earlier this month, he participated in both the Bear Stearns (New York) and Thomas Weisel Partners (Boston) healthcare conferences. As might have been expected of a new leader just weeks into his position, however, Hawkins didn't stray very far from espousing a stay-the-course strategy. And he politely sidestepped the question "Would there be a Hawkins agenda?" from Thomas Weisel Partners' medtech analyst Robert Faulkner.

Hawkins had been Medtronic's president and chief operating officer since 2004, and had previously run its vascular business after joining the company in 2002. In his early investor conferences, he referred to Collins' tenure as the "digestive era," during which new technologies and markets had to be absorbed and thoroughly understood in terms of product development applications and opportunities. Without criticizing his predecessor, he emphasized the need to apply technologies, innovations, and successful operations models across the entire company.

Hawkins referred to the period going forward as the "balancing era." Expressing the view that Medtronic's "whole is greater than the sum of its parts," Hawkins said that in the future there would be less isolation and more information-sharing and integration between and among the company's various divisions and product lines. The need, he said, was to continue to grow the top line while the company exercised greater operational leverage.

In his assessment of Medtronic's products and markets, Hawkins noted that the CRM sector was recovering in the United States while posting significant growth in Asia, particularly in China. He described the company's diabetes-care products as "red hot."

In the cardiovascular area, Hawkins said that the company expects the Endeavor drug-eluting stent to perform well—with a revenue forecast of $30 million a month after U.S. market entry. The device has already captured 20% of the market in Europe, in spite of the fact that concerns about the safety of drug-eluting stents remain largely unabated. Citing Endeavor's "unique safety attributes," Hawkins said, "We're going to surprise people."

Piper Jaffray's Nelson also offers a strong assessment of the Endeavor device. "It's backed by excellent data, a superior safety record, and it's not as prone to stent thrombosis, which has been linked to competitive devices."

The recently approved Prestige artificial cervical disk and the pending $3.9 billion acquisition of Kyphon Inc. (Sunnyvale, CA) will further strengthen the company's spinal division. Hawkins said that Medtronic has already trained more than 1400 physicians on how to successfully implant the Prestige device. He also noted that the Kyphon deal had already cleared the antitrust regulatory hurdle and should close in the first quarter of 2008. Although the company's neuromodulation division failed to meet expectations in the most recent quarter, Hawkins sees pain management as a key driver of the company's growth going forward.

Noting that 90% of the world's population is outside the United States, Hawkins said the company expects to achieve double-digit growth in international markets, particularly in Asia. China is on track to become Medtronic's second-largest market after the United States, taking that position from Japan. International sales currently account for about 30–35% of annual company revenues, although they reached 38% in the most recent quarter.

Shortly after becoming CEO, Hawkins took the top 25 people at Medtronic to northern Minnesota for a series of open-ended brainstorming sessions on the future direction of the company. Discussing that event, Hawkins said that he came away convinced that Medtronic has the people, products, resources, energy, and commitment for renewed and sustained growth going forward.

But the first challenges will be for Hawkins himself: to convince industry analysts that Medtronic is taking a new tack to get out of its current doldrums, and then to deliver corresponding results. It's been widely reported that Hawkins has long relished taking the top medtech revenue position away from Johnson & Johnson Inc. (J&J; New Brunswick, NJ). Ironically, there's been some speculation in the financial press that if Medtronic continues to disappoint investors, it may become the target of a takeover attempt—with J&J frequently cited as a likely suitor.

© 2007 Canon Communications LLC

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