Medtronic CEO: Covidien deal will accelerate med tech investment in the U.S.

Omar Ishrak is chairman and CEO of Minneapolis-based devicemaker Medtronic. The company surprised market analysts in June in announcing plans to purchase Ireland-based surgical supplier Covidien for $42.9 billion. Under the deal, Medtronic will move its headquarters to Dublin, joining a wave of companies shifting their head offices to countries with lower corporate tax rates, which has sparked anger in Washington. Ishrak joined Medtronic in 2011 from GE Healthcare Systems, where he served as CEO. Modern Healthcare reporter Jaimy Lee recently spoke with Ishrak about Medtronic's acquisition strategy, how it's working with hospital purchasers and why the Covidien deal makes sense for Medtronic. This is an edited transcript.

Modern Healthcare: Why did you buy Covidien, which offers a very different product portfolio than Medtronic's?

Omar Ishrak: The product portfolio is very complementary. And the philosophies of the two companies are very similar. We're looking toward accelerating our growth strategies, which are around innovation and therapy, globalization and economic value. We find that Covidien's portfolio enables us to accelerate our growth in all of these areas. In addition, the long-term sustainability and the consistency of our financial expectations are further bolstered by the addition.

MH: How do the two companies fit in the U.S. market?

Ishrak: One of the aspects of change in the U.S. driven by the Affordable Care Act is value-based healthcare. Medtronic is a strong supporter of this transition. The value proposition of Covidien's technologies is they primarily deliver hospital efficiency while Medtronic's chronic disease therapies deliver value in post-acute settings. When these two are combined, we've become an attractive partner and a supplier because we can deliver value both within and outside the hospital.

MH: Will this deal offset the pricing pressure that devicemakers are facing?

Ishrak: Hospitals and other providers generally are looking at longer time horizons. In that environment, we can, together with Covidien, have the most assets to offer through which they can realize value. The pricing of specific products is a secondary matter. What matters is the pricing of the overall package that will deliver the outcome, including more than the device. To do that we have to expand our scope, and Covidien allows us to do that.

The other way in which the combination of Covidien and Medtronic can help is that hospitals increasingly are being organized by clinical and functional line administrators. In cardiology, a single cardiology line manager is responsible for the functionality of the cardiology department. Physicians generally work very closely with this line administrator, but the line administrator makes all the purchasing decisions. In that environment, a broad array of products and services that covers everything that line administrator is looking for and that allow the department to function more effectively are the things that are of value. Package deals done in that fashion are already something like 20% to 25% of our revenue.

Together with Covidien, we now have an entry into the line administrator for general surgery. There, with some of our surgical technologies coupled with Covidien's surgical solutions, which are much bigger than ours, we will have an excellent position as we try to enter that segment.

MH: How has Medtronic partnered with hospitals?

Ishrak: The example I just gave is a partnership, where we work with the cardiac line administrator and become long-term partners to help operate that department more efficiently. The other type of partnership is where private payers are working with us through our offerings in post-acute settings through Cardiocom, our heart failure management patient monitoring system. There we're partnering with providers and private payers to manage patients outside the hospital.

In Europe, we manage cath labs for something like 15 major hospital systems. There we enter into five- to seven-year contracts where we are responsible together with the hospital to deliver good outcomes while operating the cath labs efficiently. We at times provide the capital to purchase the cath lab. We provide the devices and tools through which the hospital can run more efficiently. With Covidien, we now can apply the same model to surgical departments.

The U.S. model is a little different. We don't manage cath labs, it's cardiovascular. It's more like an agreement where we supply a breadth of products and build long-term partnerships with different sites where we provide device technology and partner with physicians.

MH: Are you seeing any significant shifts in the way that hospitals are purchasing?

Ishrak: Hospitals and others want to deal with partners who have scale and size, and some of that is pricing. But the movement toward value-based healthcare is much more important. Healthcare cannot be treated in isolation that you buy something for a certain amount of value and that's fixed. Over time what you buy has value that is realized much later after the initial transaction. Purchasing organizations over time will adapt their thinking to look at value much more quantitatively. We are quite willing to be partners in taking financial risks because we feel that our products and technologies have real value, and we have clinical data to prove that. We'd like to work with providers who are willing to work with us to jointly deliver on that value. Purchasing is going to change to a much more value-based approach than a singular transaction-based approach.

MH: Is Medtronic currently involved in any agreements with U.S. hospitals where the company is taking on risk?

Ishrak: The Department of Veterans Affairs is a big customer of ours (through Cardiocom) where we are basically paid on a per-patient basis, and we essentially lose money if the outcome is poor. We're developing offerings, particularly in cardiology, where we will create contracts that will be dependent on performance or outcomes.

MH: What are you looking for in future deals?

Ishrak: Our strategy has been very consistent. We've isolated three major clinical areas. One is cardiovascular, one is neuromusculoskeletal, and the third is diabetes. Within these three areas, we want to have the greatest breadth possible. Some aspects of Covidien help in that regard, such as the drug-coated balloon in peripheral vascular. We look at different companies with different unique technologies to help fill out our expertise in those three clinical areas.

So we're looking at patient management for heart failure. That's where Cardiocom came in. We are looking at different methods for the care of diabetes patients. We also have looked at areas through which diagnostics can be better performed in cardiology. We recently announced the Corventis acquisition. We intend to keep doing that with companies and targets around the world.

Finally, we want to globalize our company more, so we're building a very early footprint in some of the emerging markets where we think value products will start to become more important. We did the acquisition in China a couple of years ago for orthopedics called Kanghui. We've also done a minority investment in Lifetech, a cardiac company in China.

MH: What is your reaction to the calls in Washington for legislation restricting corporations from moving their headquarters abroad to lower tax bills.

Ishrak: Our Covidien transaction was about strategy. It helps us accelerate our growth strategies and it helps us fulfill our mission. That was the primary consideration. Having decided that Covidien is an attractive strategic partner, we then looked for the most optimum financial structure through which we can make the company most profitable, and the inversion structure was the most attractive, but not because the tax rates will change, because our tax rates will not change. Covidien's won't change and Medtronic's won't change. Our tax rates are around 17% or 18%, and that's not going to change.

What's going to change is that the new Medtronic will have access to cash generated by Covidien entities outside the U.S. The cash that's generated by Medtronic entities outside the U.S. even after the acquisition still will be subject to U.S. tax. The Covidien cash that's generated is not subject to U.S. tax today and will not be under this new structure. We intend to use that cash to invest in the U.S. in medical technologies that will broaden our focus in clinical areas where we've got expertise. We will invest in early-stage therapies in new clinical areas. Today, there's only so far we can go in terms of investment in the U.S. With the availability of the cash that's generated by Covidien on a worldwide basis and the use of that in the U.S., that will really accelerate our efforts to achieve that purpose.

We've made a formal commitment that we will invest at least $10 billion in the U.S. in med tech over the next 10 years, and that's beyond anything that Medtronic and Covidien are doing today. If anything, we will strive to increase that as we go forward. That's the best way of enhancing healthcare in the U.S. That's why we did this structure, and from our perspective this is the right thing to do.