Investor Edge: Medical Device Makers Slip on Moody's Warning

Shares of medical device makers fell after Moody's Investors Service warned the industry may face pricing pressure as more doctors leave private practice to form alliances with hospitals and other large healthcare systems.

Shares of medical device makers slumped this week after Moody’s Investors Service warned the industry may face pricing pressure as more doctors leave private practice to form alliances and partnerships with hospitals and other large healthcare systems.

The number of physicians involved in mergers or acquisitions jumped to 2,910 in 2009, nearly twice the number seen the year before, according to the latest cost-trend report from PriceWaterhouseCoopers. Behind the wave of consolidation are Medicare and other payment cuts introduced by the federal health reform law, the survey concluded.

In a note released Thursday, Moody’s said these new alliances between physicians and hospitals are reducing the influence medical device makers have in selling products directly to doctors.

"As hospitals increasingly provide physicians with greater incentives to control costs, they are better positioned to limit the number of vendors," the note said.

The note also said device makers could feel even more price pressures if the federal government begins bundling all claims payments for physician and hospital care. In San Antonio, Texas, Baptist Health System is part of a federal experiment in which Medicare is combining payments to doctors and hospitals. Baptist said in May it had already saved about $2 million since starting the program a year earlier.

Under the new healthcare reforms, medical device makers will also soon be hit by a 2.3 percent excise tax on companies that supply devices such as heart defibrillators and surgical tools. (The tax doesn’t apply to eyeglasses, contact lenses, hearing aids, or other retail medical devices sold to the public.) The new tax, slated to take effect in 2013, is projected to cost the industry an estimated $20 billion over the next decade. The Medical Device Manufacturers Association has said the new tax will force many small and midsized companies to lay off workers and curb research and development of new medical tools.

Winners and Losers

Who might winners and losers be in this changing environment?

The Moody’s note said makers of "physician-preference items," such as defibrillators, orthopedic implants and stents, will be particularly affected by pricing pressures over the next 10 years.

Defibrillator and stent makers include Johnson & Johnson (NYSE: JNJ), Medtronic Inc. (NYSE: MDT), and Boston Scientific Corp. (NYSE: BSX). Orthopedic implant manufacturers include Zimmer Holdings Inc. (ZMH), Smith & Nephew PLC (NYSE: SNN), Stryker Corp. (NYSE: SYK), and Wright Medical Group Inc. (NASDAQ: WMGI).

Diana Lee, a vice president at Moody’s, said in Thursday’s report that medical device companies that develop distinctive and cost-effective products will fare best in this new environment.

This week Brett Horn, Associate Director of Equity Research at Morningstar.com, picked Becton Dickinson & Co. (NYSE: BDX) as a “solid buy idea” using Morningstar’s “Ultimate Stock Picker” screen. The screen sifted through companies that have earned at least a 15 percent return on equity (ROE) every year for the last decade -- in other words, companies that are consistent value creators. Becton Dickinson shares were at $69.20 in midday trading Friday.

In other market-moving news this week:

Boston Scientific on Thursday said the Food and Drug Administration approved two spinal cord stimulation lead splitters for use in treating chronic pain of the trunk, back and/or limbs. The splitters assist in delivering electrical pulses to the spinal cord that mask pain signals to the brain. Its shares were at $5.96 in midday trading Friday.

CareFusion Corp. (NYSE: CFN) shares were lower after Stifel Nicolaus & Co. initiated coverage of the stock with a “hold” investment rating. (A hold rating is typically viewed as a positive sign for a company’s outlook.) Its shares were at $23.50, a 52-week low.