What Medtronic’s Historic Deal Reveals About the Health Care Industry

Source: Thinkstock

Source: Thinkstock

As acquisitions go, this one was a whopper.

Minnesota-based medical devices giant Medtronic completed a $49.9 billion acquisition of Ireland-based surgical equipment maker Covidien in January. The acquisition is the largest such deal in the history of the medical device industry and achieves twin objectives: It consolidates operations and expertise of the two companies (one of which, Medtronic, is the largest medical device company in the world) and ensures substantial tax savings and free movement of cash for the merged entity.

“The Covidien acquisition accelerates our three primary strategies of therapy innovation, globalization, and providing economic value,” said Medtronic chief executive officer Omar Ishrak in a conversation with Cheat Sheet after the deal was completed. The merged entity — known as Medtronic Plc. — has 85,000 employees, $27 billion in revenues, and will be based in Ireland.

The acquisition is, at once, a defensive and offensive play by Medtronic in the face of changing trends within the medical device industry. It expands the company’s array of products and opens new operational areas and geographies. Simultaneously, the acquisition reduces Medtronic’s tax bill and  increases free cash flow available to the merged entity to bolster itself against competition.

Ishrak said the merged entity has a well-identified plan for growth in “the mid-single digits” for the merged entity. According to him, Covidien’s products and technologies enable Medtronic to “provide value inside and outside” medical establishments. “Our products require training and come much later in the customer development cycle as compared to Covidien’s products, which are introduced much earlier in the process,” he said.

Covidien’s products and technologies will also provide Ishrak with a vital cog in “supply-and-service” deals. As part of such deals, Medtronic will finance construction of hybrid operating labs and manage their operations. In return, the hospital will commit to a fixed per patient fee of seven years that includes cost of Medtronic’s devices used in procedures.

The deal also broadens Medtronic’s geographic reach in emerging markets, where Covidien has a sizable presence. According to Ishrak, the company’s reach into Latin America and the Middle East has doubled in size as a result of the deal. “In particular, Latin America rivals China in market size now because of the deal,” he said.

Medtronic’s acquisition of Covidien was announced last year and has been the center of much press attention because of its tax implications. The deal is part of the growing trend of so-called inversion deals. American multinationals often use such deals to escape prohibitive corporate tax rates in the United States. In Medtronic’s case, the company said that it would save $800 million in business and product synergies through the acquisition.

However, the company did not put a dollar amount to its tax savings.

The media’s spotlight on the Covidien acquisition deal raised public outcry and led the Obama administration to release a notice in September that made it mandatory for such deals to be financed through external borrowing. (Medtronic had intended to use its overseas cash earnings of $13.5 billion to finance the transaction). Illinois-based AbbVie’s acquisition of Shire Plc was scuttled as a result of the notice. However, Medtronic persisted.

“They (the tax benefits) don’t even factor in the business model for this acquisition,” said Ishrak, adding that the additional free cash flow generated as a result of the transaction will be used to invest in businesses here in the States. The company has already committed to invest $10 billion over the next decade in medical technology businesses here in the United States. “Not being able to repatriate our overseas earnings inhibited our investments in this space,” Ishrak said.

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