Medtronic valuation


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Medtronic valuation

  1. 1. James Groh and Dan Wisner MGT 5903Management Strategy and Policy Fall 2012 Company Valuation Medtronic By James Groh Dan Wisner Submitted to Dana Wang, Ph.D. November 13, 2012 1
  2. 2. James Groh and Dan WisnerGeneral Environment: Medtronic takes advantage of several factors external to the medicaldevice industry in which it operates.Demographic: The incidence of type 1 diabetes, which is ultimately fatal unless treated withinsulin, is increasing by about 3% per year (Aanstoot, 2007). Although injection is the mostcommon method of administering insulin, the insulin pump shown in Figure 1 in the Appendix isa convenient replacement.Social cultural: Although the incidence of chronic diseases like type 1 diabetes has increased,patient lifestyle has become more active. Active diabetics prefer insulin pumps to traditionalinjections because once they have attached the insulin pump they do not need to replenish it withinsulin for three days (Insulin, 2012).Political/Legal: The 2010 Patient Protection and Affordable Care Act requires medical devicecompanies to pay 2.3% excise tax, potentially preventing them from funding additional research(Health, 2012).Technological: Bluetooth and other wireless technologies enable medical device companies todesign insulin pumps that patients control remotely, allowing them to be discrete in publicplaces.Economic: The high US unemployment rate has increased the number of uninsured, and withoutinsurance coverage, many people are unable to purchase needed medical devices (Landsbaum2011). Medicare’s “competitive bidding” program requires patients to purchase their insulinpumps from specific companies and to pay 20% of the Medicare-approved amount and theOriginal Medicare Part B deductible (Medicare, 2012). 2
  3. 3. James Groh and Dan WisnerGlobal: In 2010, global medical device sales totaled $164 billion and it is estimated that by2015, sales will reach $228 billion (King, 2011). Demand in developing countries such as Chinaand India is growing at a higher rate than in developed countries.Porter’s 5 Forces: There is a high level of competition, regulation, and capital investmentneeded in order to succeed in the medical device industry. An innovative first-mover likeMedtronic benefits from the high barriers to entry that make the medical device industryunattractive to potential entrants.Potential Entrants- The threat of new entrants is low because patent protection results in a first-mover advantage (Mehta, 2008). Furthermore, first-movers control significant market shareeven after patent expiration due to brand recognition.Suppliers: The power of suppliers is low because companies transform relatively common partsinto complex products. A device’s value is derived from its design and assemblage by skilledknowledge workers.Buyers: “Buyer power tends to be medium, since large purchases by hospitals or grouppurchasing organizations can be offset by individual physician preferences at a hospital (Mehta,2008).”Competitors: Competition is high and a firm’s primary source of competitive advantagedepends on R&D investment and the ability to obtain regulatory approvals in a timely manner. 3
  4. 4. James Groh and Dan WisnerSubstitutes- Substitutes include alternative medical therapies such as pharmaceutical andbiotechnology products. The threat of substitutes is low for most products, e.g. there is nocurrent replacement for a pacemaker.Value Chain Analysis: The value chain diagram is depicted in Figure 2 in the Appendix.In order for Medtronic to deliver products efficiently, Medtronic uses Lean Sigma operations andmanages all parts of its value chain.Resource Based View: Medtronic’s strategic resources include its patents, researchers, strongR&D and product development, goodwill, and use of cross-functional teams.Business-Level Strategy: Medtronic pursues a combination low-cost and differentiationbusiness-level strategy. Key to Medtronic’s achievement of low-cost leadership is its experiencecurve. Medtronic was founded in approximately 30 years before its major competitors enteredthe medical device industry, allowing it to gain experience with production processes.Medtronic has maintained its position through tight cost control of all activities in its value chain.In early 2011 citing expected cost savings, Medtronic canceled five contracts with the GPONovation LLC. (Kamp, 2011). By forward integrating to negotiate directly with physicians andhospital administrators Medtronic has eliminated a layer of cost to the consumer. Medtronic’slow-cost strategy protects it from a potential price war with competitors and from powerfulbuyers such as large hospitals who may demand price concessions. 4
  5. 5. James Groh and Dan WisnerWhile some of the more established product lines in the medical device industry, such aspacemakers, may experience price compression in the near future, because a hospital canpurchase a similar device from multiple companies, each company has established relationshipswith its customers, and while competitive, the products are not commodities. The learning curvewith each product and the perception that one product is safer and more effective createscustomer loyalty.Corporate-Level Strategy: Medtronic’s corporate level strategy centers on relateddiversification to achieve economies of scope. The medical device industry contains a diverserange of products and each of Medtronic’s business units competes in a distinct sector of theindustry. Table 1 in the Appendix shows that Medtronic’s revenue is distributed across itsbusiness units, and thus, the firm is protected against a downturn in one of its businesses. Thecompany has achieved synergy by sharing value-creating activities across its business unitsincluding manufacturing facilities, distribution channels, and sales forces.Medtronic initially sold only pacemakers, and thus, its initial core competencies were theutilization of technologies used in pacemakers: sensors and electrical stimulation. Medtronicapplied its sensing and stimulation competencies to treat many conditions besides irregularheartbeat, including Parkinson’s disease, chronic pain, and urinary incontinence. The companyhas attempted to expand its core competencies to include tissue engineering, implantablematerials, drug delivery, catheter technology, batteries, navigation, biologics and informationtechnology. However, some of these ventures have diverged too far from Medtronic’s primaryexpertise. Infuse, which was intended to stimulate the body to regrow bone was approved by the 5
  6. 6. James Groh and Dan WisnerFDA in 2002, and was Medtronic’s attempt to diversify its businesses to include biotechnology,thereby protecting itself against this substitute product. “Allegations later surfaced, though, thatMedtronic was coaxing doctors to use it in ways regulators hadnt approved—such as in necksurgery (Walsh, 2012).” In 2006, Medtronic paid $40 million to the Justice Department withoutadmitting any wrongdoing and in 2011 a review of the 13 original studies of Infuse found thatauthors with financial ties to the company reported 10 to 50 times fewer complications withInfuse than were found in FDA reports (Walsh, 2012).Despite some failures Medtronic has mostly successful in using of a combination of authors withfinancial ties to the company reported 10 to 50 times fewer complications to diversify intobusinesses aligned with its core competencies. In 1977, Medtronic moved into cardiovasculartherapies when it established its Heart Valves Division and introduced the Medtronic-Hallmechanical heart valve (Medtronic, 2010). The company has made numerous acquisitionsincluding Ardian, Inc., Jolife, PEAK Surgical, Inc. and Salient Surgical Technologies, Inc. in2011.Medtronic’s corporate-level groups include Medtronic International, Quality and Operations,Strategy and Innovation, and Healthcare Policy and Regulatory. Each group helps to leveragebest practices, knowledge, and technologies across the company. For example, Strategy andInnovation coordinates research and development capabilities across the entire company, andevaluates growth opportunities to strategically allocate investment dollars.Medtronic Financial Analysis 6
  7. 7. James Groh and Dan WisnerWe used company financial statements, shown in Tables 2 and 3 in the Appendix, to compareMedtronic and its major competitors. We examined ratios measuring profitability, managementeffectiveness, and the balance sheet.We examined Medtronic’s profitability by looking at profit margin and operating margin.Medtronic’s profit margin is 22.53%, while its closest competitor, St. Jude Medical Inc., has aprofit margin of 13.67%. Medtronic’s operating margin is 28.48%, while its closest competitor,Johnson and Johnson, has an operating margin of 25.58%. Medtronic’s high operating marginindicates that a major contributor to its profitability is due to its operational effectiveness.Managerial effectiveness was inferred by examining Medtronic’s return on assets (ROA), andreturn on equity (ROE). Medtronic’s ROA of 8.99% is slightly lower than its leadingcompetitor, St. Jude Medical, which has an ROA of 9.31%. Medtronic has a ROE of 20.60%while its closest competitor, St. Jude Medical, has an ROE of 16.48% showing that Medtronic’smanagement provides a solid return on both assets and equity.Other financial ratios were calculated using the companies’ balance sheets. Medtronic has thelowest current ratio, 1.58, among its competitors but still maintains a healthy current ratio for itsindustry. Its current ratio shows Medtronic has the ability to pay back its short term obligations,and provides a positive financial outlook. Medtronic has a P/E ratio of 11.86 while St. JudeMedical has a P/E ratio of 15.54 and Johnson & Johnson has a P/E ratio of 22.89. Medtronic’slower P/E and overall positive financial state indicates its stock may be undervalued. 7
  8. 8. James Groh and Dan WisnerForecasting Medtronic’s Financial StatementsThe medical device industry faces a 2.3% excise tax on medical devices. This tax will beimplemented starting in 2013. The tax will be levied on the total revenue of the companywhether it shows a profit or loss (MDMA, 2012). The tax will likely have a greater effect onsmaller companies within the industry due to economies of scope, and companies with lowerprofit margins than Medtronic’s. The tax may reduce the creation of new jobs and stunt thegrowth of the industry in the long run. Medical device companies do not generally have powerto pass a tax onto their customers as consolidation among healthcare providers and decliningreimbursement rates has led to increased competition on the basis of price (MDT 10-K, 2009).An attempt to pass on the tax to customers may reduce Medtronic’s market share.5 year prediction: In 2013 Medtronic will see a spurt of growth as it takes market share fromsmaller companies unable to cope with the excise tax. Medtronic’s operating costs will increasedue to increased production, but they will be offset by sales growth. In 2014 Medtronic willreduce its operating costs as its Quality and Operations group finds ways to improve efficiency.Sales will increase less than in the previous year and the company will increase its long-terminvestments and property, plant, and equipment as it acquires smaller companies and theirpatents. In 2015 to 2017 the industry will stabilize after the excise tax leading to smaller butstable growth for Medtronic. A more detailed forecast is shown in Tables 4 and 5 in theAppendix.Comparisons to other analysts: estimates sales in 2013 to reach 16.45B, with ahigh of 16.71B, and low of 16.29B. 2014 estimates of sales are 16.99B, with a high of 17.48B 8
  9. 9. James Groh and Dan Wisnerand a low of 16.70B. Yahoo’s 2014 high level is our 2013 sales level. We expect Medtronic tocontinue its current success in 2013 and turn the threat of the newly implemented excise tax intoan opportunity. Although our estimated sales levels are high compared to,Medtronic is in a solid financial position to capitalize on the changes affecting the medicaldevice industry.Valuation: The discounted cash flow model indicates the intrinsic value of Medtronic’s stock is$49.87, which is more than $41.16, the current share price as of 9/10/12, and suggests the stockis undervalued. Our analysis of the company’s strategy and financial performance supports thisfinding. Tables 6 through 10 explain the valuation in detail.Medtronic is effectively positioned to continue its strategy of related diversification bypurchasing smaller companies experiencing losses as a result of the excise tax. Medtronic willcontinue its own internal R&D, which it will support through improved cost control. Thiscombination approach will result in solid growth for the company over the next few years. 9
  10. 10. James Groh and Dan WisnerReferencesAanstoot, HJ; Anderson, BJ, Daneman, D, Danne, T, Donaghue, K, Kaufman, F, Réa, RR,Uchigata, Y (2007 Oct). “The global burden of youth diabetes: perspectives and potential”.Pediatric diabetes. 8 Suppl 8 (s8): 1–44.Health Care Reform, Device Tax.,-Device-TaxInsulin Pumps., Jon. "Medtronic Makes Pact-Ending Move ." Wall Street Journal 25 02 2011, n. pag.Web. 12 Nov. 2012., Mike. “$164 bn Medical Devices Market Dominated by US Companies”. October18,2011., Mark. “Health care coverage tied to unemployment rate.” The Orange CountyRegister, September 26, 2011. 10
  11. 11. James Groh and Dan WisnerMehta, Shreefal. Commercializing Successful Biomedical Technologies: Basic Principles forthe Development of Drugs, Diagnostics and Devices. 2008.Medicare. Diabetic Insulin Pumps. 2012. A Legacy of Innovation The Medtronic Story. 09 2010. Form 10-K for the fiscal year ended June 23, 2009. (2012). Health care reform, device tax. Retrieved from,-Device-Tax/upWalsh, James. "Medtronics pull influenced Infuse articles, report finds." StarTribune 25 082012, n. pag. Web. 12 Nov. 2012. 11
  12. 12. James Groh and Dan WisnerFigure 1: Insulin Pump. Medtronic offers the only FDA-approved integrated diabetesmanagement system consisting of an insulin pump, continuous glucose monitoring (CGM) andtherapy management software. An insulin pump is a small device about the size of a small cellphone that is worn externally and can be discreetly clipped to your belt, slipped into a pocket, orhidden under your clothes. It delivers precise doses of rapid-acting insulin to closely match yourbody’s needs: • Small amounts of insulin delivered continuously (24/7) for normal functions of the body (not including food). This replaces your long-acting insulin. • Additional insulin you program “on demand” to match the food you are going to eat or to correct a high blood sugar.Taken from Medtronic website: Appendix
  13. 13. James Groh and Dan Wisner Figure 2: The Value Chain General Administration: Leadership communicates with employees, giving frequent updates on industry and firm; employees feel part of the team; drives commitment and production Human Resources: recruits, hires, and retains best within industry; benefits package – 401K, tuition assistance, training, promotion from within. Involved in charity work – Juvenile Diabetes Research Foundation; employees are involved in the community and take pride being a part of MedtronicSupport Technology Development: Medtronic puts high emphasis on Research and Development; has entire R&D division in Northridge, CA. FDA approval is essential on all developed products. Company must meet constant regulation changes while meeting patient demands Procurement: 38 manufacturing facilities throughout the world; raw materials purchased from numerous suppliers globally. Works closely with carefully selected suppliers; trains suppliers in Lean Sigma to improve operational efficiency. Inbound Logistics: Operations: close Outbound Logistics: Marketing and Sales: Service: 24/7 support system to raw materials communication Distribution facilities “Manage Markets” manages troubleshoot and provide Primary Activities purchased globally between R&D, located globally; helps relationship with insurance equipment assistance, handle from carefully manufacturing, and meet patient demands. companies. contracts with equipment return, and answer selected suppliers. distribution. R&D Works closely with insurance agencies is vital to general billing questions. Suppliers are trained division in CA. UPS to meet shipping make products affordable. Company contacts patient in Lean Sigma Production facilities demands. Sales team work regionally directly to discuss operations. Must located throughout with doctors to recommend equipment/expectations. remain flexible to the globe to meet Medtronic products. Provides financial assistance to meet changing changes in patient Marketing team publishes ads patients; payment plans. global demands. needs quickly and and articles in medical Coordinates payment from Medtronic maintains efficiently. journals to gain exposure to insurance company and delivery strict oversight of doctors. Utilization of social to doctor. supplier relations media, iPhone apps, and Lenny the Lion – an ambassador to young children with diabetes. Agreement with Skin-It so patients can design custom covers for medical equipment. Appendix
  14. 14. James Groh and Dan Wisner % RevenueBusiness unit FY2011 Example product TreatmentCardiac Rhythm DiseaseManagement (CRDM) 31 Implantable pacemakers regulate heartbeatSpinal and Biologics Artificial Cervical Discs (Spinal); replace damaged or degenerated discs in theBusiness 21 INFUSE Bone Graft (Biologics) neck; stimulates the body to regrow boneCardiovascular 20 Stent grafts aortic aneurysms Medtronic Deep Brain Stimulation Neuromodulation 10 Therapy Parkinsons disease Diabetes 8 Insulin pump Diabetes Surgical Technologies 7 O-arm 2D/3D Imaging System intraoperative imagingTable 1: List of Medtronic’s business units. Only the major business units are listed so the total %Revenue is slightly less than 100.Information taken from Medtronic’s website: Appendix
  15. 15. James Groh and Dan Wisner BSX = Boston MDT = Medtronic Scientific Corporation JNJ = Johnson & Johnson STJ = St. Jude Medical Inc.Market Cap: 41.99B 7.07B 192.63B 11.70BEmployees: 44944 24000 129000 16000Qtrly Rev Growth (yoy): 0.02 -0.07 0.07 -0.04Revenue (ttm): 16.25B 7.28B 65.92B 5.54BGross Margin (ttm): 0.76 0.65 0.68 0.73EBITDA (ttm): 5.45B 1.66B 20.26B 1.63BOperating Margin (ttm): 0.28 0.13 0.26 0.24Net Income (ttm): 3.46B -4.02B 8.50B 756.79MEPS (ttm): 3.47 -2.81 3.05 2.38P/E (ttm): 11.86 N/A 22.89 15.54PEG (5 yr expected): 2.01 1.73 2.22 1.12P/S (ttm): 2.58 0.96 2.91 2.1Profit Margin = Net income/ RevenuesOperating margin = Operating Income/ Net SalesReturn on Assets = Net Income/ Total AssetsReturn on Equity = Net Income / Total EquityCurrent Ratio = Current Assets / Current LiabilitiesEarnings Per Share = Net Income – Dividends on preferred Stock/ Average Number of Shares OutstandingPrice-Earnings Ratio = Market Value per Share / EarningsTable 2: Direct Competitor Comparison - Medical Device Industry. Ratios inherent to the balance sheet. From Medtronic competitors (2012, 11 10). Appendix
  16. 16. James Groh and Dan Wisner BSX = Boston Scientific MDT = Medtronic Corporation JNJ = Johnson & Johnson STJ = St. Jude Medical Inc. Fiscal Year Fiscal Year Fiscal Year Fiscal Year Fiscal Year Ends: 26-Apr Fiscal Year Ends: 30-Dec Fiscal Year Ends: 1-Jan Fiscal Year Ends: 30-Dec 30-Sep- 30-Sep- 29-Sep- Most Recent Quarter (mrq): 27-Jul-12 Most Recent Quarter (mrq): 12 Most Recent Quarter (mrq): 12 Most Recent Quarter (mrq): 12 Profitability Profitability Profitability Profitability Profit Margin (ttm): 22.53% Profit Margin (ttm): -55.28% Profit Margin (ttm): 12.90% Profit Margin (ttm): 13.67% Operating Margin (ttm): 28.48% Operating Margin (ttm): 13.48% Operating Margin (ttm): 25.58% Operating Margin (ttm): 24.37% Management Effectiveness Management Effectiveness Management Effectiveness Management Effectiveness Return on Assets (ttm): 8.99% Return on Assets (ttm): 3.19% Return on Assets (ttm): N/A Return on Assets (ttm): 9.31% Return on Equity (ttm): 20.60% Return on Equity (ttm): -43.84% Return on Equity (ttm): N/A Return on Equity (ttm): 16.48% Income Statement Income Statement Income Statement Income Statement Revenue (ttm): 16.25B Revenue (ttm): 7.28B Revenue (ttm): 65.92B Revenue (ttm): 5.54B Revenue Per Share (ttm): 15.54 Revenue Per Share (ttm): 5.08 Revenue Per Share (ttm): 23.91 Revenue Per Share (ttm): 17.61 Qtrly Revenue Growth (yoy): 1.60% Qtrly Revenue Growth (yoy): -7.40% Qtrly Revenue Growth (yoy): 6.50% Qtrly Revenue Growth (yoy): -4.10% Gross Profit (ttm): 12.30B Gross Profit (ttm): 4.96B Gross Profit (ttm): 44.67B Gross Profit (ttm): 4.08B 6 6 6 6 EBITDA (ttm) : 5.45B EBITDA (ttm) : 1.66B EBITDA (ttm) : 20.26B EBITDA (ttm) : 1.63B Diluted EPS (ttm): 3.47 Diluted EPS (ttm): -2.81 Diluted EPS (ttm): 3.05 Diluted EPS (ttm): 2.38 Qtrly Earnings Growth (yoy): 5.20% Qtrly Earnings Growth (yoy): N/A Qtrly Earnings Growth (yoy): -7.30% Qtrly Earnings Growth (yoy): -22.30% Balance Sheet Balance Sheet Balance Sheet Balance Sheet Total Cash (mrq): 2.49B Total Cash (mrq): 352.00M Total Cash (mrq): 16.92B Total Cash (mrq): 1.05B Total Cash Per Share (mrq): 2.44 Total Cash Per Share (mrq): 0.26 Total Cash Per Share (mrq): 6.14 Total Cash Per Share (mrq): 3.33 Total Debt (mrq): 10.87B Total Debt (mrq): 4.26B Total Debt (mrq): 17.56B Total Debt (mrq): 2.52B Total Debt/Equity (mrq): 63 Total Debt/Equity (mrq): 62.32 Total Debt/Equity (mrq): 29.07 Total Debt/Equity (mrq): 53.15 Current Ratio (mrq): 1.58 Current Ratio (mrq): 1.75 Current Ratio (mrq): N/A Current Ratio (mrq): 2.26 Book Value Per Share (mrq): 16.91 Book Value Per Share (mrq): 4.97 Book Value Per Share (mrq): 21.97 Book Value Per Share (mrq): 15.02 Cash Flow Statement Cash Flow Statement Cash Flow Statement Cash Flow Statement Operating Cash Flow (ttm): 4.63B Operating Cash Flow (ttm): 1.24B Operating Cash Flow (ttm): N/A Operating Cash Flow (ttm): N/A Levered Free Cash Flow (ttm): 2.80B Levered Free Cash Flow (ttm): 1.04B Levered Free Cash Flow (ttm): N/A Levered Free Cash Flow (ttm): N/ATable 3: Direct Competitor Comparison - Medical Device Industry. Profitability and managerial effectiveness. From Medtronic competitors (2012, 1110). Appendix
  17. 17. James Groh and Dan WisnerPeriod Ending 30-Apr-10 29-Apr-11 27-Apr-12 2013 2014 2015 2016 2017Total Revenue 15,392,000 15,508,000 16,184,000 17,478,720 18,352,656 19,270,289 19,848,397 20,443,849Excise Tax 174,787 367,053 385,406 394,983 404,788Cost of Revenue 3,582,000 3,700,000 3,889,000 4,369,680 4,496,401 4,721,221 4,862,857 5,008,743Gross Profit 11,810,000 11,808,000 12,295,000 12,934,253 13,489,202 14,163,662 14,590,557 15,030,318 Operating Expenses Research Development 1,424,000 1,472,000 1,490,000 1,112,346 1,214,028 1,274,730 1,313,150 1,352,729 Selling General and Administrative 5,432,000 5,537,000 5,987,000 6,117,552 6,423,430 6,648,250 6,748,455 6,950,909 Non Recurring 447,000 518,000 189,000 300,000 300,000 300,000 300,000 300,000 Others 317,000 339,000 335,000 358,314 376,229 395,041 406,892 419,099 Total Operating Expenses 7,620,000 7,866,000 8,001,000 7,888,212 8,313,687 8,618,020 8,768,497 9,022,736Operating Income or Loss 4,190,000 3,942,000 4,294,000 5,046,041 5,175,515 5,545,642 5,822,060 6,007,582 Income from Continuing Operations Total Other Income/Expenses Net - - - - Earnings Before Interest And Taxes 4,190,000 3,942,000 4,294,000 5,046,041 5,175,515 5,545,642 5,822,060 6,007,582 Interest Expense 246,000 278,000 149,000 125,000 120,000 115,000 110,000 105,000 Income Before Tax 3,944,000 3,664,000 4,145,000 4,921,041 5,055,515 5,430,642 5,712,060 5,902,582 Income Tax Expense 861,000 609,000 730,000 826,735 849,327 912,348 959,626 991,634 Minority Interest - - - Net Income From Continuing Ops 3,083,000 3,055,000 3,415,000 4,094,306 4,206,188 4,518,294 4,752,434 4,910,948 Non-recurring Events Discontinued Operations 16,000 41,000 202,000 50,000 50,000 50,000 50,000 50,000 Extraordinary Items - - - Effect Of Accounting Changes - - - Other Items - - -Net Income 3,099,000 3,096,000 3,617,000 4,044,306 4,156,188 4,468,294 4,702,434 4,860,948Table 4: Income Statement forecast. From Medtronic income statement. (2012, 11 10). Retrieved from Appendix
  18. 18. James Groh and Dan WisnerTable 4 (Cont.):2013 - Revenue and Costs of Goods Sold: Based on the current industry environment, revenue is projected to increase 8%. Given the addition of an excise tax implemented in 2013, it isestimated the tax will affect total revenue roughly 1% for 2013. The cost of revenue has typically been around 24% of total revenue. Given the effect on smaller companies and theincreased amount of sales, the percentage is estimated to increase to 25% of sales.Operating Expenses: Research and Development typically ranges at 9% of total revenue. In 2013, this number is expected to decrease as a percentage to 8.6%, given the increase inrevenue. Selling and general admin is normally between 34-35% of total revenue, and is estimated to be 35% in 2013. Non recurring expenses are likely to occur in 2013, as the excisetax goes into effect. Non recurring expenses are often unpredictable, so it is estimated $300,000,000 will occur in this year and is used every year thereafter. Other expenses rangearound 2.05% of total revenue. Total operating expenses equal $788,212,000 and leave a total Operating Income of $5,046,041,000.Medtronic’s interest expense is estimated to decline due to the company using increase cash flows to pay back company debt.In 2013, the company finishes with a net income of $4,044,306,000. This is an 11.8% increase from 2012.2014 - Revenue and Costs of Goods Sold: For 2014 Revenue is projected to increase 5%. This year, the excise tax is predicted to affect total revenue roughly 2% for 2014, due to theexpansion of international sales where no excise tax is implemented. The cost of revenue is estimated to be 24.5% of total revenue.Operating Expenses: Research and Development typically ranges at 9% of total revenue. In 2014, this number is expected to increase to 9%, as the sales levels balance out. Selling andgeneral admin is estimated to be 35% in 2014. Non recurring expenses estimated the same again at $300,000,000. Total operating expenses equal $8,313,687,000 and leave a OperatingIncome of $5,175,515,000.Medtronic’s interest expense is estimated to decline again due to the company using increase cash flows to pay back company debt.In 2014, the company finishes with a net income of $4,156,188,000. This is a 2.7% increase from 2013. This is consistent with the slowed growth of sales after a large burst in 2013.2015 - Revenue and Costs of Goods Sold: For 2015 Revenue is projected to increase 5%. This year, the excise tax is predicted to affect total revenue roughly 2% for 2015, due to theexpansion of international sales where no excise tax is implemented. The cost of revenue is estimated to be 24.5% of total revenue.Operating Expenses: Research and Development is expected to remain at 9% of total revenue. Selling and general admin is estimated to drop to 34.5% in 2015. Medtronic’s interestexpense is estimated to decline due to the company using increase cash flows to pay back company debt.In 2015, the company finishes with a net income of $4,468,293,000. This is a 7.4% increase from 2014.2016 – 2017 - Revenue and Costs of Goods Sold: Both years are estimated to increase sales by 3%. The excise tax will decline as a result of increased international revenue.Operating Expenses: Research and development continues to be factored at a rate of 9% of total revenue, while selling and admin decline to 34%, as management finds more effectiveways to offset the excise tax.In 2016, the company finishes with a net income of $4,702,434,000. This is a 5.2% increase from 2015.In 2017, the company finishes with a net income of $4,860,948,000. This is a 3.4% increase from 2016. Appendix
  19. 19. James Groh and Dan WisnerPeriod Ending 30-Apr-10 29-Apr-11 27-Apr-12 2013 2014 2015 2016 2017AssetsCurrent Assets Cash And Cash Equivalents 1,400,000 1,382,000 1,248,000 1,435,200 1,449,350 1,463,844 1,471,163 1,478,519 Short Term Investments 2,375,000 1,046,000 1,344,000 1,008,000 1,100,000 1,105,500 1,111,028 1,116,583 Net Receivables 3,879,000 4,284,000 4,448,000 5,115,200 4,750,000 4,845,000 4,893,450 4,942,385 Inventory 1,481,000 1,619,000 1,800,000 1,480,000 1,850,000 1,887,000 1,905,870 1,924,929 Other Current Assets 704,000 819,000 675,000 650,000 650,000 650,000 650,000 650,001Total Current Assets 9,839,000 9,150,000 9,515,000 9,688,400 9,799,350 9,951,344 10,031,510 10,112,415Long Term Investments 4,632,000 6,116,000 7,705,000 8,244,350 8,574,124 9,002,830 9,182,887 9,366,545Property Plant and Equipment 2,421,000 2,488,000 2,473,000 2,596,650 2,700,516 2,808,537 2,864,707 2,922,002Goodwill 8,391,000 9,520,000 9,934,000 10,420,000 10,836,800 11,270,272 11,495,677 11,725,591Intangible Assets 2,559,000 2,725,000 2,647,000 2,752,880 2,752,880 2,752,880 2,752,880 2,752,880Accumulated Amortization - - -Other Assets 248,000 362,000 305,000 305,000 305,000 305,000 305,000 305,000Deferred Long Term Asset Charges - 314,000 504,000 -Total Assets 28,090,000 30,675,000 33,083,000 34,007,280 34,968,670 36,090,862 36,632,662 37,184,432LiabilitiesCurrent Liabilities Accounts Payable 2,546,000 2,915,000 2,583,000 2,455,000 2,553,200 2,655,328 2,708,435 2,762,603 Short/Current Long Term Debt 2,575,000 1,723,000 3,274,000 3,100,000 3,255,000 3,417,750 3,588,638 3,768,069 Other Current Liabilities - 88,000 -Total Current Liabilities 5,121,000 4,726,000 5,857,000 5,555,000 5,808,200 6,073,078 6,297,072 6,530,673Long Term Debt 6,944,000 8,112,000 7,359,000 7,015,000 7,225,450 7,442,214 7,665,480 7,895,444Other Liabilities 1,307,000 1,408,000 2,143,000 2,143,000 2,143,000 2,143,000 2,143,000 2,143,000Deferred Long Term Liability Charges 89,000 461,000 611,000 387,000 387,000 387,000 387,000 387,000Minority Interest - - -Negative Goodwill - - -Total Liabilities 13,461,000 14,707,000 15,970,000 15,100,000 15,563,650 16,045,292 16,492,552 16,956,117Stockholders EquityCommon Stock 110,000 107,000 104,000 104,000 104,000 104,000 104,000 104,000Retained Earnings 14,826,000 16,085,000 17,482,000 18,907,280 19,405,020 20,045,571 20,140,110 20,228,315Other Stockholder Equity -307000 (224,000) (473,000) (334,670) (334,670) (334,669) (334,668) (334,667)Total Stockholder Equity 14,629,000 15,968,000 17,113,000 18,572,610 19,070,350 19,710,902 19,805,442 19,893,648Table 5: Balance Sheet forecast. From Medtronic balance sheet. (2012, 11 10). Retrieved from Appendix
  20. 20. James Groh and Dan WisnerTable 5 (Cont.):2013 - Medtronic is expected to increase sales in 2013 given the excise tax negatively affecting smaller medical device suppliers. Medtronic will capitalize on the shift in the industry,and will have increased cash and cash equivalents by 15% of 2012 levels. Medtronic will also reduce its short term investments by 25%, as the company focuses on increasingproduction and focuses efforts internally. Net receivables will increase by 15%, as the sales are expected to increase. Inventory levels will drop as the company capitalizes on increasedsales due to the economic condition on smaller companies. Other current assets continue to drop. Total current assets for the end of the year total $9,688,400,000.Long term investments begin to increase towards the end of 2013 as Medtronic begins to expand operations. This includes the purchase of smaller companies being negatively impactedby the excise tax. An estimated 7% increase in long term investments, as the company uses internal funding to expand. Property plant and equipment will increase in 2013 by anestimated 5%, as the company begins purchasing smaller companies. Goodwill and intangible assets increases as well with the purchase of existing companies.Current Liabilities decrease as a result of increased cash flow, and the reduction of accounts payable and long term debt, while stockholders equity increases due to the increase in totalassets.2014 - In 2014, sales levels increase at a smaller rate. Medtronic’s activities include the increase in purchases of smaller companies, resulting in an increase in total assets. Netreceivables drop as a result of sales leveling off, and inventory levels increase. In 2014, total current assets reach a level of $9,799,350,000.In order to continue the purchase of smaller companies in 2014, Medtronic will have to borrow money in the form of debt. It is estimated short/current long term debt increases by 5% in2014. Long term debt increases by 3% and other liabilities remain at the 3 year average.2015 - Growth in sales levels continue, leading to an increase in cash and cash equivalents. Net receivables increase, as well as inventory. This leaves a total for current assets in 2015 tobe $9,951,344,000.Long term investments continue to increase by 5% in 2015 with the continued purchasing of smaller companies and the expansion of overseas production. We estimate continuedgrowth of property plant and equipment and goodwill.2016-2017 - Sales growth continues, but at a smaller rate as shown on the income statement. Investment activities also slow as a result of other large companies purchasing the ailingsmall companies, reducing the options for further expansion domestically. By 2016, it is estimated most of the smaller companies affected by the excise tax will have been purchased, orpositively rebounding into turning a profit.Medtronic is likely to continue increasing its short and long term debt as a result of expansion into foreign soil. Expanding overseas reduces the impact of the excise tax, and is the nextmove in Medtronic’s strategy. Appendix
  21. 21. James Groh and Dan Wisner Present FCFF(t) or value Year Value TV(t) at 9.94%0 FCFF(0) 4,2741 FCFF(1) 4,647 = 4,274 × (1 + 8.73%) 4,2272 FCFF(2) 4,972 = 4,647 × (1 + 7.00%) 4,1143 FCFF(3) 5,235 = 4,972 × (1 + 5.28%) 3,9404 FCFF(4) 5,421 = 5,235 × (1 + 3.55%) 3,7115 FCFF(5) 5,520 = 5,421 × (1 + 1.83%) 3,4375 TV(5) 69,289 = 5,520 × (1 + 1.83%) ÷ (9.94% – 1.83%) 43,146Intrinsic value of capital 62,575Less: Short-term borrowings (fair value) 3,274Less: Long-term debt (fair value) 8,186Intrinsic value of common stock 51,115 Intrinsic value of common stock (per share) $49.87 Current share price as of 9/10/12 $41.16Table 6: Intrinsic Stock Value. The discounted cash flow model was used to valuate the stock. All data in USD $ in millions, exceptper share data. FCFF is the free cash flow to the firm, explained in Table 7, and TV is the total value of the cash flows to the firm.The cash flows are discounted at the WACC of 9.94% as shown in Table 8. The growth rates for all years are explained in Tables 9and 10. Data obtained from Appendix
  22. 22. James Groh and Dan Wisner Net earnings 3,617 Add: Net noncash charges 835 Less: Change in operating assets and liabilities, net of effect of acquisitions 18 Net cash provided by operating activities 4,470 Add: Cash paid for interest, net of tax 288 Less: Additions to property, plant and equipment -484 FCFF 4,274Table 7: Medtronic’s free cash flow to the firm (FCFF) for year 0, i.e. fiscal year 2011 which ended on 4/29/2012. FCFF is describedas the cash flows after direct costs and before any payments to capital suppliers. It is distinguished from free cash flow to equity(FCFE) which is described as the cash flows available to the equity holder after payments to debt holders and after allowing forexpenditures to maintain the companys asset base. Required rate Value Weight Calculation of return Equity (fair value) 42,191 0.79 11.73% Short-term borrowings (fair value) 3,274 0.06 3.27% = 4.05% × (1 – 19.15%) Long-term debt (fair value) 8,186 0.15 3.38% = 4.18% × (1 – 19.15%)Table 8: WACC calculation. All Values are in USD $ in millions. The required rate of return on debt is after tax and the estimatedeffective tax rate is 19.15%. WACC=(Weight Equity)(Required rate of return Equity)+(Weight Short-term borrowings)(Required rateof return Short-term borrowings)+(Weight Long-term debt)(Required rate of return Long-term debt). WACC = 9.94% Appendix
  23. 23. James Groh and Dan Wisner Apr 27, Apr 29, Apr 30, Apr 24, Apr 25, Apr 27, Average 2012 2011 2010 2009 2008 2007Provision for income taxes 730 627 870 425 654 713Net earnings 3,617 3,096 3,099 2,169 2,231 2,802Tax rate1 16.79% 16.84% 21.92% 16.38% 22.67% 20.28%Interest expense 349 450 402 217 255 228Interest expense, after tax2 290 374 314 181 197 182Dividends to shareholders 1,021 969 907 843 565 504Interest expense (after tax) and dividends 1,311 1,343 1,221 1,024 762 686EBIT(1 – Tax Rate)3 3,907 3,470 3,413 2,350 2,428 2,984Short-term borrowings 3,274 1,723 2,575 522 1,154 509Long-term debt 7,359 8,112 6,944 6,772 5,802 5,578Shareholders’ equity 17,113 15,968 14,629 12,851 11,536 10,977Total capital 27,746 25,803 24,148 20,145 18,492 17,064RatiosRetention rate (RR)4 0.66 0.61 0.64 0.56 0.69 0.77Return on invested capital (ROIC)5 14.08% 13.45% 14.13% 11.67% 13.13% 17.49%AveragesRR 0.66ROIC 13.29%Growth rate of FCFF (g)6 8.73%Table 9: The year 1 growth rate is determined using the Sustainable Growth Rate model. Data is in USD $ in millions. 1. Tax rate = 100 × Provision for income taxes ÷ (Net earnings + Provision for income taxes) = 100 × 730 ÷ (3,617 + 730) = 16.79% 2. Interest expense, after tax = Interest expense × (1 – Tax rate) = 349 × (1 – 16.79%) = 290 3. EBIT(1 – Tax Rate) = Net earnings + Interest expense, after tax = 3,617 + 290 = 3,907 Appendix
  24. 24. James Groh and Dan Wisner 4. RR = [EBIT(1 – Tax Rate) – Interest expense (after tax) and dividends] ÷ EBIT(1 – Tax Rate) = [3,907 – 1,311] ÷ 3,907 = 0.66 5. ROIC = 100 × EBIT(1 – Tax Rate) ÷ Total capital = 100 × 3,907 ÷ 27,746 = 14.08% 6. g = RR × ROIC = 0.66 × 13.29% = 8.73% Year Value g(t) 1 g(1) 8.73% 2 g(2) 7.00% 3 g(3) 5.28% 4 g(4) 3.55% 5 and thereafter g(5) 1.83% Table 10: The growth rate for years 2 through 4 are obtained by decreasing by the same rate from year 1 until the growth rate of year 5 and thereafter is obtained. That decrease is approximately 1.73% per year. The growth rate for year 5 and thereafter is calculated using the single-stage model.g = 100 × (Total capital, fair value0 × WACC – FCFF0) ÷ (Total capital, fair value0 + FCFF0) = 100 × (53,651 × 9.94% – 4,274) ÷ (53,651 + 4,274) = 1.83%where: Total capital, fair value0 = year 0 fair value of debt and equity (USD $ in millions) FCFF0 = year 0 free cash flow to the firm (USD $ in millions) Appendix