St. Jude Medical deal latest sign of pricing pressure for med-tech firms

Medical device companies are getting bigger through mergers to offset the growing size of their customers and the shrinking prices for their products.

Larger scale was a driver, analysts say, behind the $49.9 billion merger last year between Medtronic and Covidien, which moved the company's official headquarters from Fridley to Ireland for tax reasons.

Now, it's zapping another coveted Fortune 500 headquarters in the Twin Cities with Abbott Laboratories' acquisition of Little Canada-based St. Jude Medical, valued at more than $30 billion including assumed debt.

Device companies once were on a relatively even playing field with the physician groups that made decisions about buying medical devices, said Thomas Gunderson, a retired financial analyst who now serves as an executive in residence at the Medical Industry Leadership Institute at the University of Minnesota.

Now, large hospital chains are making the purchasing decisions and want to deal with one vendor that can supply as many of their needs as possible.

"The hospitals and the payers got bigger faster than the med-tech companies did. So, that put them at a disadvantage with bids and contracts," he said. "Now, as the med-tech companies catch up, it puts them on a more even playing field."

Whether it's hospitals, pharmaceutical companies, health insurers or medical device manufacturers, most parts of the health care industry are driving toward consolidation, said David Heupel, senior research analyst at Thrivent Financial in Minneapolis.

The rationale among medical technology firms, he said, has to do with the continuing pressure from hospitals for deeper discounts in the prices they pay for medical devices.

Manufacturers can't grow by hiking prices, so consolidation offers them the chance for a larger market share, Heupel said, as they offer hospitals a wider array of the products. Consolidation offers a chance to sell products more efficiently, as well, through an existing base of sales and marketing.

"There's pricing pressure on these businesses and products," Heupel said. "The more scale you can offer, I think there's some attractiveness to that."

Larger scale can help a company manage and develop a global supply chain, said Stephen Parente, a professor of finance at the U's Carlson School of Management. That's especially important for medical device manufacturers that have responded to flattening U.S. sales over the past decade by turning to international markets.

With larger scale, a manufacturer benefits from a broader pipeline of products in development, Parente said, so there's less risk if any one prospect fizzles.

"There's less competition, too, potentially, so you can command a better price," he said. "You also have a more effective sales force, and so if you actually make your revenue targets you might have more negotiating room in your price when you need to."

The Carlson School is one of many places around town that touts the concentration of corporate headquarters in the Twin Cities as a key selling point.

Even so, Parente said he wasn't overly negative about the local impact from the St. Jude Medical news.

The locally based firms Cardiac Pacemakers in Arden Hills and SciMed in Maple Grove were acquired years ago. They are now operated by Massachusetts-based Boston Scientific, he pointed out, yet those operations continue to be vibrant contributors to the local cluster of medical technology firms.

"My guess is this will be similar to what happened with Boston Scientific, where there's still a very substantial presence here," Parente said.

Since he started as an executive with Medtronic in the early 1980s, Dale Wahlstrom has seen a lot of acquisitions involving local med-tech firms. To the long list of potential advantages with size, Wahlstrom adds that bigger manufacturers have more clout to negotiate lower prices from their suppliers.

Wahlstrom also serves as an executive in residence at the U's Medical Industry Leadership Institute. For emotional reasons, he said he doesn't like to see the St. Jude deal because it means the loss of another independent Minnesota company — much like a part of him misses Northwest Airlines whenever he boards a Delta jet.

But the track record suggests the local community doesn't have much to fear, Wahlstrom said, since there haven't been many examples in med-tech of outside buyers simply shutting down the local operations.

"We have great lawyers, great regulatory consultants, great clinical consultants — our infrastructure to support the medical device community is second to none," he said. "As long as we can sustain that, I believe we will continue to be a benefactor of these kinds of business deals."

But in some ways, things are clearly changing, said Gunderson, the retired financial analyst.

Med-tech companies have been active in local philanthropy, he said, but that could slowly diminish over the years as top decisionmakers will be out of state. Plus, the home office will be near Chicago, so the best and brightest might be drawn to headquarters, rather than a division in Minnesota.

More broadly, Thursday's announcement is just one part of what Gunderson calls "an inevitable maturation of the market." Back in the day, the Twin Cities had Earl Bakken's Medtronic which spun off scores of start-ups that were backed by venture capital. Revenue grew at 20 to 25 percent per year, and growing companies helped create a vibrant cluster of medical device professionals.

Now, the growth rates are more like 3 to 5 percent per year, Gunderson said, and so the companies must change.

"If you're not going to be growing at those rates, you need to figure out what you can do to manage your costs best," he said. "One of those things is consolidation. It also happens to be what the new customer wants, which is the hospital."

Christopher Snowbeck • 612-673-4744

Twitter: @chrissnowbeck