Medtronic's Chinese buy advances global strategy

In June, Medtronic Inc. CEO Omar Ishrak told an investors' conference that part of his company's mission for the future was "expanding access and enhancing value" in China.

In August, Ishrak told Medtronic shareholders that China "is a big piece" of Medtronic's expectations for 20 percent annual growth in emerging markets.

And, on Sept. 11, Chief Financial Officer Gary Ellis said "China is a big, big factor in our overall emerging-markets expectations."

Get the message? If not, Medtronic hammered it home Thursday night with the announcement that it has agreed to pay $816 million for China Kanghui Holdings Inc., an orthopedic implant maker.

The move does precisely what Ishrak and Ellis have been promising -- an expansion into emerging markets. It also aligns precisely with Medtronic's oft-stated strategies of globalization and increasing what executives call "value" products in those markets.

In the process, Medtronic is adding a Chinese company that has enjoyed 20 percent annual growth into an emerging-market portfolio that Medtronic expects to grow 20 percent annually and generate 20 percent of the Fridley-based company's revenue within a few years.

Larry Biegelsen, a senior analyst for Wells Fargo Securities, said in a note to investors Thursday that the transaction is "consistent" with Medtronic's strategy.

Ishrak was traveling overseas Friday and wasn't available for comment. But he has repeatedly talked about Medtronic following a dual-track, but linked, approach to emerging markets.

First, he has said, Medtronic must increase its sales of top-of-the-line therapies to take advantage of a growing middle and upper class. Simply expanding sales of existing products to those who can afford them is a $5 billion annual opportunity, he told shareholders in August.

"Our first priority in the globalization journey is to deepen the penetration of our existing therapies for the hundreds of millions of people that can both benefit from and also afford the therapies," he said. In part, he said, Medtronic is doing that by increasing awareness about the therapies it offers.

But the other track of the strategy is to find ways to develop and penetrate what Medtronic calls the "value segment" of emerging markets -- developing different pricing tiers and lowering the cost of manufacturing overseas. To that end, the Kanghui acquisition makes sense.

According to Biegelsen, Kanghui -- based just outside of Shanghai -- specializes in trauma and spine orthopedic products. The company sells about 80 percent of its products in China, "but a significant portion in emerging international markets," Biegelsen said.

That could be a key component to keeping costs down to better reach the "value" market, said Ralph Hall, a University of Minnesota law professor and a medical device industry lawyer. But that is not the only advantage Medtronic may enjoy from this move, he said.

"The Chinese market is a developing system. It is evolving and there are advantages in a number of areas," Hall said. "Cost, access to talent, access to a more nimble R&D process. Yes, low costs are part of it. Do not underestimate the potential value of the high-end market."

Even if China's middle and upper classes account for 6 percent of its more than 1 billion people, Hall said, selling them top-shelf products would be the same as selling a device to every citizen of France.