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Contributors: Douglas McIntyre Jon C. Ogg

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Thursday, August 03, 2006

Medtronic Woes Signals the Need to Diversify


Medtronic (MDT) is at new 52-week lows today. The shares are down over 12% to $44.66, under the old $46.41 lows for the last year. It guided $0.53 to $0.55 EPS versus estimates of $0.57.

The competitors St. Jude (STJ) and Boston Scientific (BSX) are also down in sympathy. STJ is down 10% at $33.85 and BSX is down 6.8% at $16.41.

This puts the stock about 25% under the higher-end of its yearly trading band, but what is interesting is that this has been dead money for years. Since the start of 2000 MDT has been stuck in a trading band of $40.00 to almost $60.00.

Morgan Stanley, Goldman Sachs, Merrill Lynch and several other firms all issued downgrades on the MDT this morning. What you have to wonder is just how much these analysts get paid. It is being proven time and time again that no one can know all of the intricacies inside a company if they are an outsider, but on a longer-term valuation basis these guys need to be evaluating how they treat stocks. It sure feels like at the point of the economic cycle the US is in that we could be getting wedged or stuck into a potentially very long-term secular trading range. If that occurs, it means that you have to trade in and out, and these guys need to be entering positions when stocks are at the lower-end of a longer-term band and exiting positions when everyone loves the stock and it has run up quite a bit. Does it pay to always be a contrarian? No, of course not. But getting in when the bad news is drawing to close and getting out when everyone on the street all of a sudden realized the company is doing great is usually much more financially rewarding than picking last year’s winners.

The company blamed this actually on weak defibrillator sales in the US. It would be tempting to say someone should acquire MDT, but with a $52 Billion market cap that may be a tough call. What looks like really need to happen is that these medical device companies need to broaden out. Yes Wall Street is placing a value on "focusing on core operations" and on spinning off units to unlock shareholder value. The problem is that that is what Wall Street does. Wall Street wants to make fees, and breaking companies up and repackaging them makes fees. More diversified companies are not as sexy, but they can deliver more value and certainly are less subjective to a one-product issue blowing the company up.

So who would be the right merger partner any for these companies? It is getting harder and harder for the pure-play device companies to merge because there are so many. Johnson & Johnson (JNJ) is in the midst of gobbling up Pfizer's (PFE) consumer products unit for some $16 Billion in cash, and they are already a leader in so many segments. Most likely JNJ is done with non-niche acquisitions for some time. Both Pfizer (PFE) and Merck (MRK) have signaled in the past that they would be interested in diversifying, but with all the troubles they have had it is unknown if they even could or would look to branch out. There has been ongoing talk for over a year that the implantable replacement joint companies such as Zimmer (ZMH), Biomet (BMET), Smith & Nephew (SNN) and others may need to merge, and many have been in the rumor mill on and off.

Please understand that this is not saying one of these will get acquired tomorrow. This is signaling and pointing out a need of what these companies need to do to get back on track. Many of these potential mergers would require very little shock factor to the companies involved, and about the only people that would have to get booted are the accounting and HR people. This conversation has come up in the past on and off, but what is definite is that almost ALL of these other companies are going to need to have more than what they have now to shield themselves from the woes they have been enduring.

We’ll see what happens through time, and hopefully the bankers are thinking the same way.

Jon C. Ogg
August 3, 2006

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