Covidien eyeing growth in medical-devices division

As soon as Tyco International Ltd. spun off its Tyco Healthcare division in June 2007, executives at the newly independent company – renamed Covidien Ltd. – set out their strategy. They planned to shift the company toward higher-growth, higher-margin products by pruning unprofitable units from its multitude of brands like Mallinckrodt and Kendall, while ramping up internal research and development.
The company analyzed its products “literally by SKU,” or stock-keeping unit, with an eye on profitability, Richard J. Meelia, who stayed as Covidien’s chairman, president and CEO after 12 years leading Tyco Healthcare, told investors in a July conference call.
As an example, Meelia cited SharpSafety, a European needle and syringe division that “there was no profitability associated with [and for which] there was no way to profitability.” And so, he said, Covidien “essentially wound that down to nothing.”
The strategy appears to be paying off. Covidien posted a $1.4 billion profit in its 2008 fiscal year on sales that rose 11 percent to $9.9 billion. The company, which has its executive offices in Mansfield, ranked 295th on this year’s FT Global 500 list of the world’s largest companies by market capitalization.
Although this year’s earnings have been hampered by the recession, Covidien surprised Wall Street analysts at its annual investor meeting in September by predicting its sales will rise between 4 and 7 percent next year. Brokerages rushed to raise their share price targets.
In an intriguing signal of management’s priorities, much of Covidien’s annual meeting was turned over to panel discussions and presentations by doctors about the opportunities for evidence-based medicine – a key priority in the Obama administration’s health-reform efforts. In a presentation, executives argued that making an economic case for product effectiveness will be key for medical companies in the coming years.
To that end, Covidien outlined plans to raise its annual spending on R&D to roughly 5.5 percent of sales, compared with 2.9 percent of sales, or $267 million, spent on research in 2007 and 3.9 percent, or $296 million, spent so far this year.
Covidien executives see their strongest near-term prospects for growth in the medical-devices division, which accounted for 57 percent of sales in 2008, totaling $5.9 billion. They forecast medical-device sales will increase 7 to 10 percent next year. They also expect sales to rise by 2 to 5 percent in the medical-supplies unit, which contributed 17 percent of revenue last year. Part of that growth is coming from acquisitions. Covidien has bought 15 companies since 2005, and all but one of them has been in the medical-devices field, including the three purchased so far this year.
The company also has high hopes for products that assist with minimally invasive surgery, which is cheaper than traditional surgery and leads to less scarring and fewer complications. Although it has been a struggle to get doctors to embrace it, use of minimally invasive surgery increases “pretty dramatically” once they try it, Meelia said. It is also popular with patients, and Covidien hopes they will push surgeons to use it.
The picture is less rosy for Covidien’s pharmaceutical division. The company was forced to stop selling its lucrative generic version of OxyContin last spring in order to settle a patent infringement suit brought by OxyContin owner Perdue Pharma LP. Covidien said drug sales could fall as much as 2 percent next year with the painkiller gone.
The company has signed three drug-licensing agreements recently and also has four applications pending at the Food and Drug Administration. But “absent [FDA] product approvals, we’re going to be struggling to find any significant growth in pharma,” Meelia said.
Tao Levy, an analyst with Deutsche Bank Securities, is more optimistic. He thinks Covidien’s investment in a robust drug-development capability will start to pay dividends soon. “These businesses have been undergoing a transformation over the past two years which we are just now starting to see the benefits of,” Levy wrote in a note to clients after the September meeting.
And new products won’t be the only factor contributing to Covidien’s growth.
Like a number of other big firms, Covidien moved its incorporation from Bermuda to Ireland earlier this year in anticipation of a U.S. crackdown on tax havens. (Its formal name thus changed from Covidien Ltd. to Covidien Plc.) Despite that, the company expects it will manage to reduce its tax rate from 26 percent this year to around 22 percent in 2010. •