Medtronic Buys Kanghui To Expand Orthopedic Market Presence In China

Medtronic buys the second largest orthopedic company in China on Sept. 27, gaining a strong local operation in the country and leaving the future of Medtronic’s 2007 ortho joint venture with Weigao uncertain.

SHANGHAI – Five years after forming a joint venture with Shandong Weigao Group Medical Polymer Co. Ltd. for orthopedic device marketing in China, Medtronic PLC has made another significant move in the space with an $816 million acquisition of China Kanghui Holdings, China’s second-largest orthopedic company.

Announced Sept. 27, the deal gives Medtronic access to Kanghui’s portfolio of 36 trauma and spine devices, as well as Kanghui’s local know-how in China.

In addition to a bigger and more direct local presence, including R&D, manufacturing and distribution operations in China, Kanghui provides a “foothold in the emerging global value segment in orthopedics,” Medtronic said. Emerging markets outside of China represent 23% of Changzhou-based Kanghui’s estimated sales of about $65 million in 2012, and the firm’s revenues are expected to grow about 20% annually, analysts noted.

While expanding Medtronic’s current offerings in orthopedic surgery and complementing its existing spine, neurosurgery, neuromodulation and other offerings, the deal also aligns with Medtronic’s broader corporate globalization strategy. The firm opened an innovation center in Shanghai in August (Also see "Medtronic Banks On China For R&D; Plans To Hire 1,000 Staff For New Shanghai Center" - Scrip, 30 Aug, 2012.).

Medtronic will pay $30.75 per share for Kanghui – a 22% premium over the firm’s Sept. 27 closing price of $25.11. While worth $816 million in aggregate, Medtronic values the deal at $755 million, net of Kanghui’s cash on hand. Medtronic expects the deal to close in the next few months, pending Kanghui shareholder approval.

There is only one domestic Chinese orthopedic device manufacturer bigger than Kanghui, Trauson Holdings Co. Ltd. While Trauson has a larger spine and original equipment manufacturer supply business, Kanghui leads in trauma. Both of the companies are aggressively exploring the orthopedic joint market, where multinational firms dominate and Weigao is the only sizeable domestic player. Kanghui is also exploring global markets with its lower priced products to compete with multinational firms’ premium products (Also see "Kanghui: A New Strategic Opens The Door To Orthopedics In China" - In Vivo, 1 Oct, 2011.).

The timing of the Kanghui deal is good for Medtronic. China is trying to consolidate purchasing deals for orthopedic products, which likely will benefit leading domestic companies and increase their market share over the next three to five years (Also see "China Conducts First-ever Centralized Tender For Orthopedic Products" - Scrip, 16 Aug, 2012.).

“We expect the transaction to immediately step up Medtronic's direct presence in China's rapidly growing value segment, bolster Kanghui's R&D and product launches in spine and joints, and accelerate Medtronic's expansion in other emerging markets,” Cowen analyst Katherine Lu wrote in a Sept. 28 note.

Kanghui, Trauson, and Weigao’s 2012 First Half (In RMB millions)

	Kanghui	Trauson	Weigao/Medtronic JV	Weigao
Revenue	183.8	205.8	N/A	146.4
Net Profit	64.4	64.6	~59.6	N/A
Trauma Revenue	111.1	114.4	N/A	N/A
Spine Revenue	58.6	43.4	N/A	N/A
OEM Revenue	14.1	26.2	N/A	N/A

Source: Company reports

Future Of Medtronic’s Weigao Venture Uncertain

Medtronic’s purchase of Kanghui may imply that Medtronic’s marriage with Weigao will reach an end when the firms’ joint venture expires in January 2014, market watchers suggest.

In December 2007, Medtronic acquired 15% of Weigao for $220 million and injected an additional $20 million to establish a joint venture in Weihai, a major seaport city in Shandong province, to market and distribute Medtronic’s spinal products in the premium segment and Weigao’s spinal and orthopedic products in the mid- to low-end segments in China (Also see "Medtronic Boosts Ortho Presence In China Under Weigao Joint Venture" - Medtech Insight, 7 Jan, 2008.).

Medtronic holds 51% of the JV company and Weigao holds the remaining 49%, with two Medtronic execs sitting on Weigao's board of directors, and Medtronic has a call option to acquire the rest of the JV.

“We believe the acquisition of Kanghui will likely replace Medtronic’s joint venture with Weigao in China … as there appears to be significant product overlap,” Wells Fargo analyst Larry Biegelsen wrote in a Sept. 28 report.

“It’s not clear if the joint venture will end, be extended or if Medtronic will simply buy Weigao as well,” Mizuho Securities analyst Michael Matson wrote in a Sept. 28 report.

Medtronic has a call option to buy the JV for $398-696 million, which can be exercised from July 2012 to May 2013.

If the venture is not extended, it could end up being a good thing for Weigao, boosting profits, some analysts said.

“We believe the potential break-up with Medtronic could present opportunities to Weigao, as the company could take back the orthopedic business, which we believe is still growing at a healthy rate of 20%,” Citi analyst Richard Yeh wrote in a Sept. 28 note. “Meanwhile, the challenges that Weigao is likely to face include how to drive its sales team to compete in the market.”

Citi estimates sales of Weigao orthopedic business could reach RMB 377 million in 2013, up 55% from RMB 243 million in 2011.

Based on Citi’s survey of 400 Chinese hospitals, the hospital penetration of Weigao, Medtronic and Kanghui was 31.7%, 23.5% and 16.4% respectively, “and we expect the penetration of Weigao could increase with the potential break-up with Medtronic,” Yeh noted.

China’s Competitive Orthopedic Market

Multinationals such as Johnson & Johnson, Stryker Corp., Smith & Nephew PLC, Medtronic and Zimmer Biomet Holdings Inc. dominate China’s ortho market with more than 60% share of the joint and spine segments. Leading domestic companies like Kanghui, Weigao and Trauson are competing better in the trauma market, where they control roughly 57% of the market, according to Citi.

China’s leading medical device company Mindray Medical International Ltd. entered the orthopedic market with a relatively small $35.5 million acquisition of domestic player Dragonbio (Also see "Mindray Jumps Into Orthopedic Space With Sixth Acquisition In Last 18 Months" - Scrip, 11 Jun, 2012.).

China’s orthopedic implant market exceeded $1.3 billion in 2011, Trauson said in its Aug. 20 half-year report. The country’s domestic orthopedic companies have “narrowed the quality gap with international brands,” according to the company.

“This, along with an advantage in cost and price, has made China’s domestic orthopedic companies a force to be reckoned with in the global market,” Trauson said. Overall, China’s RMB 400 billion ($63 billion) medical device industry is growing about 20% annually, according to the China Medical Device Association.