Medtronic's plan to buy Covidien is likely a play to address price erosion among hospital customers by creating a go-to seller of a wide range of medical supplies.
The proposed $42.9 billion deal would pair Medtronic, which is best known for high-cost heart devices and spine products, with Covidien, an Irish supplier of midmarket medical products used in surgery and patient monitoring.
One reason cited for the deal is the tax inversion accomplished by moving Medtronic's headquarters from Minneapolis to Dublin, taking advantage of Ireland's low corporate tax rate. But market analysts and others say it's also driven by the same factors causing consolidation among hospitals, physicians' offices and drug companies.
Hospitals, facing declining reimbursement rates and drops in patient volume, have started to aggressively push back on what they pay for medical supplies. In other instances healthcare providers are consolidating the number of suppliers they contract with as they hunt for lower prices on supplies ranging from pacemakers and stents to gloves, staplers and other commodity items.
“You're seeing a lot of different pockets of consolidation within healthcare,” said David Kaplan, credit analyst with ratings agency Standard & Poor's. “With increased size, (Medtronic) can also afford to take market share and compete more on price.”
The union of Medtronic and Covidien would create a formidable player in the U.S. medical supply market because of the sheer size of their business along with their combined reach—there is little overlap between the manufacturers' businesses besides the cardiovascular and surgical product categories. It would generate about $26 billion in total sales, making it the second-largest device company in the world.
“It's a reflection that the dynamics in the marketplace are impacting all constituents, including the supplier community,” said Jody Hatcher, president and CEO of Novation, one of the largest healthcare group purchasing organizations in the U.S. The combined company would be Novation's largest supplier if the deal goes through. Hospitals made $49 billion in purchases last year through contracts with the Irving, Texas-based GPO, and $2.2 billion of that came from contracts with Medtronic and Covidien.
Other recent large medical technology deals have occurred between companies that sell similar products. Johnson & Johnson acquired competing orthopedics manufacturer Synthes in 2012 for $21.3 billion and Zimmer recently announced a deal to buy Biomet—they both make musculoskeletal devices—for about $13 billion.
However, it's unclear whether the deal will lead to higher prices for hospitals or if the company will lower its prices in some categories to boost market share among customers. Covidien's surgical products are known to be less expensive than the ones sold by Johnson & Johnson's Ethicon business, and Covidien's overall product portfolio generally has lower prices than the expensive implantables that generate the majority of Medtronic's business.
“By broadening its portfolio of hospital-based products, it's possible (Medtronic) will be able to leverage its position better,” said Diana Lee, senior credit officer at Moody's Investors Service.
As cost-conscious hospital executives have become more sensitive to supply costs, manufacturers have had to shift their long-standing sales model to instead target administrators rather than physicians. Experts say that Medtronic and Covidien are both viewed as companies that have quickly adapted to the new selling environment and are willing to partner with hospitals.
In a statement, Medtronic said the combined company will “provide a broader array of complementary therapies and solutions that can be packaged to drive more value and efficiency in healthcare systems.”
Analysts say that will be appealing to hospitals. The deal “would create the ultimate buffet table of medical device products, producing a very large one-stop shop for discussions with hospital administrators,” said Joanne Wuensch, research analyst with BMO Capital Markets.
“Hospitals are always going to push on price,” she added. “If you walk in with one product, you don't have much to negotiate with.”
The cash-and-stock deal is expected to close later this year.
Follow Jaimy Lee on Twitter: @MHjlee
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