Medtronic valuation

James Groh and Dan Wisner

MGT 5903

Management Strategy and Policy

Fall 2012

Company Valuation

Medtronic

By

James Groh

Dan Wisner

Submitted to

Dana Wang, Ph.D.

November 13, 2012

1


General Environment: Medtronic takes advantage of several factors external to the medical

device industry in which it operates.

Demographic: The incidence of type 1 diabetes, which is ultimately fatal unless treated with

insulin, is increasing by about 3% per year (Aanstoot, 2007). Although injection is the most

common method of administering insulin, the insulin pump shown in Figure 1 in the Appendix is

a 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 traditional

injections because once they have attached the insulin pump they do not need to replenish it with

insulin for three days (Insulin, 2012).

Political/Legal: The 2010 Patient Protection and Affordable Care Act requires medical device

companies 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 to

design insulin pumps that patients control remotely, allowing them to be discrete in public

places.

Economic: The high US unemployment rate has increased the number of uninsured, and without

insurance coverage, many people are unable to purchase needed medical devices (Landsbaum

2011). Medicare’s “competitive bidding” program requires patients to purchase their insulin

pumps from specific companies and to pay 20% of the Medicare-approved amount and the

Original Medicare Part B deductible (Medicare, 2012).

2


Global: In 2010, global medical device sales totaled $164 billion and it is estimated that by

2015, sales will reach $228 billion (King, 2011). Demand in developing countries such as China

and 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 investment

needed in order to succeed in the medical device industry. An innovative first-mover like

Medtronic benefits from the high barriers to entry that make the medical device industry

unattractive 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 share

even after patent expiration due to brand recognition.

Suppliers: The power of suppliers is low because companies transform relatively common parts

into complex products. A device’s value is derived from its design and assemblage by skilled

knowledge workers.

Buyers: “Buyer power tends to be medium, since large purchases by hospitals or group

purchasing 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 advantage

depends on R&D investment and the ability to obtain regulatory approvals in a timely manner.

3


Substitutes- Substitutes include alternative medical therapies such as pharmaceutical and

biotechnology products. The threat of substitutes is low for most products, e.g. there is no

current 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 and

manages all parts of its value chain.

Resource Based View: Medtronic’s strategic resources include its patents, researchers, strong

R&D and product development, goodwill, and use of cross-functional teams.

Business-Level Strategy: Medtronic pursues a combination low-cost and differentiation

business-level strategy. Key to Medtronic’s achievement of low-cost leadership is its experience

curve. Medtronic was founded in approximately 30 years before its major competitors entered

the 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 GPO

Novation LLC. (Kamp, 2011). By forward integrating to negotiate directly with physicians and

hospital administrators Medtronic has eliminated a layer of cost to the consumer. Medtronic’s

low-cost strategy protects it from a potential price war with competitors and from powerful

buyers such as large hospitals who may demand price concessions.

4


While some of the more established product lines in the medical device industry, such as

pacemakers, may experience price compression in the near future, because a hospital can

purchase a similar device from multiple companies, each company has established relationships

with its customers, and while competitive, the products are not commodities. The learning curve

with each product and the perception that one product is safer and more effective creates

customer loyalty.

Corporate-Level Strategy: Medtronic’s corporate level strategy centers on related

diversification to achieve economies of scope. The medical device industry contains a diverse

range of products and each of Medtronic’s business units competes in a distinct sector of the

industry. Table 1 in the Appendix shows that Medtronic’s revenue is distributed across its

business units, and thus, the firm is protected against a downturn in one of its businesses. The

company has achieved synergy by sharing value-creating activities across its business units

including manufacturing facilities, distribution channels, and sales forces.

Medtronic initially sold only pacemakers, and thus, its initial core competencies were the

utilization of technologies used in pacemakers: sensors and electrical stimulation. Medtronic

applied its sensing and stimulation competencies to treat many conditions besides irregular

heartbeat, including Parkinson’s disease, chronic pain, and urinary incontinence. The company

has attempted to expand its core competencies to include tissue engineering, implantable

materials, drug delivery, catheter technology, batteries, navigation, biologics and information

technology. However, some of these ventures have diverged too far from Medtronic’s primary

expertise. Infuse, which was intended to stimulate the body to regrow bone was approved by the

5


FDA 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, that

Medtronic was coaxing doctors to use it in ways regulators hadn't approved—such as in neck

surgery (Walsh, 2012).” In 2006, Medtronic paid $40 million to the Justice Department without

admitting any wrongdoing and in 2011 a review of the 13 original studies of Infuse found that

authors with financial ties to the company reported 10 to 50 times fewer complications with

Infuse than were found in FDA reports (Walsh, 2012).

Despite some failures Medtronic has mostly successful in using of a combination of authors with

financial ties to the company reported 10 to 50 times fewer complications to diversify into

businesses aligned with its core competencies. In 1977, Medtronic moved into cardiovascular

therapies when it established its Heart Valves Division and introduced the Medtronic-Hall

mechanical heart valve (Medtronic, 2010). The company has made numerous acquisitions

including Ardian, Inc., Jolife, PEAK Surgical, Inc. and Salient Surgical Technologies, Inc. in

2011.

Medtronic’s corporate-level groups include Medtronic International, Quality and Operations,

Strategy and Innovation, and Healthcare Policy and Regulatory. Each group helps to leverage

best practices, knowledge, and technologies across the company. For example, Strategy and

Innovation coordinates research and development capabilities across the entire company, and

evaluates growth opportunities to strategically allocate investment dollars.

Medtronic Financial Analysis

6


We used company financial statements, shown in Tables 2 and 3 in the Appendix, to compare

Medtronic and its major competitors. We examined ratios measuring profitability, management

effectiveness, 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 a

profit 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 margin

indicates 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), and

return on equity (ROE). Medtronic’s ROA of 8.99% is slightly lower than its leading

competitor, 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’s

management provides a solid return on both assets and equity.

Other financial ratios were calculated using the companies’ balance sheets. Medtronic has the

lowest current ratio, 1.58, among its competitors but still maintains a healthy current ratio for its

industry. 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. Jude

Medical has a P/E ratio of 15.54 and Johnson & Johnson has a P/E ratio of 22.89. Medtronic’s

lower P/E and overall positive financial state indicates its stock may be undervalued.

7


Forecasting Medtronic’s Financial Statements

The medical device industry faces a 2.3% excise tax on medical devices. This tax will be

implemented starting in 2013. The tax will be levied on the total revenue of the company

whether it shows a profit or loss (MDMA, 2012). The tax will likely have a greater effect on

smaller companies within the industry due to economies of scope, and companies with lower

profit margins than Medtronic’s. The tax may reduce the creation of new jobs and stunt the

growth of the industry in the long run. Medical device companies do not generally have power

to pass a tax onto their customers as consolidation among healthcare providers and declining

reimbursement 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 from

smaller companies unable to cope with the excise tax. Medtronic’s operating costs will increase

due to increased production, but they will be offset by sales growth. In 2014 Medtronic will

reduce 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-term

investments and property, plant, and equipment as it acquires smaller companies and their

patents. In 2015 to 2017 the industry will stabilize after the excise tax leading to smaller but

stable growth for Medtronic. A more detailed forecast is shown in Tables 4 and 5 in the

Appendix.

Comparisons to other analysts: Yahoo.com estimates sales in 2013 to reach 16.45B, with a

high of 16.71B, and low of 16.29B. 2014 estimates of sales are 16.99B, with a high of 17.48B

8


and a low of 16.70B. Yahoo’s 2014 high level is our 2013 sales level. We expect Medtronic to

continue its current success in 2013 and turn the threat of the newly implemented excise tax into

an opportunity. Although our estimated sales levels are high compared to Yahoo.com,

Medtronic is in a solid financial position to capitalize on the changes affecting the medical

device 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 stock

is undervalued. Our analysis of the company’s strategy and financial performance supports this

finding. Tables 6 through 10 explain the valuation in detail.

Medtronic is effectively positioned to continue its strategy of related diversification by

purchasing smaller companies experiencing losses as a result of the excise tax. Medtronic will

continue its own internal R&D, which it will support through improved cost control. This

combination approach will result in solid growth for the company over the next few years.

9


References

Aanstoot, 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.

http://www.medicaldevices.org/issues/Health-Care-Reform,-Device-Tax

Insulin Pumps. http://www.diabetes.org/living-with-diabetes/treatment-and-

care/medication/insulin/insulin-pumps.html

Kamp, Jon. "Medtronic Makes Pact-Ending Move ." Wall Street Journal 25 02 2011, n. pag.

Web. 12 Nov. 2012.

http://online.wsj.com/article/SB10001424052748703409304576166903268690560.html.

King, Mike. “$164 bn Medical Devices Market Dominated by US Companies”. October

18,2011. http://www.companiesandmarkets.com/News/Healthcare-and-Medical/164-bn-

Medical-Devices-Market-Dominated-by-US-Companies/NI2332

Landsbaum, Mark. “Health care coverage tied to unemployment rate.” The Orange County

Register, September 26, 2011. http://orangepunch.ocregister.com/2011/09/26/health-care-

coverage-tied-to-unemployment-rate/50963/

10


Mehta, Shreefal. Commercializing Successful Biomedical Technologies: Basic Principles for

the Development of Drugs, Diagnostics and Devices. 2008.

Medicare. Diabetic Insulin Pumps. 2012. http://www.medicare.com/equipment-and-

supplies/diabetic-supplies/diabetic-insulin-pumps.html

Medtronic. A Legacy of Innovation The Medtronic Story. 09 2010.

http://www.medtronic.com/wcm/groups/mdtcom_sg/@mdt/@corp/documents/documents/medtr

onic-history-pdf.pdf.

Medtronic. Form 10-K for the fiscal year ended June 23, 2009. www.sec.gov/edgar.shtml

MDMA. (2012). Health care reform, device tax. Retrieved from

http://www.medicaldevices.org/issues/Health-Care-Reform,-Device-Tax/up

Walsh, James. "Medtronic's pull influenced Infuse articles, report finds." StarTribune 25 08

2012, n. pag. Web. 12 Nov. 2012. http://www.startribune.com/lifestyle/health/175804281.html.

11


Figure 1: Insulin Pump. Medtronic offers the only FDA-approved integrated diabetes
management system consisting of an insulin pump, continuous glucose monitoring (CGM) and
therapy management software. An insulin pump is a small device about the size of a small cell
phone that is worn externally and can be discreetly clipped to your belt, slipped into a pocket, or
hidden under your clothes. It delivers precise doses of rapid-acting insulin to closely match your
body’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:
http://www.medtronicdiabetes.com/treatmentoptions/insulinpumptherapy

Appendix


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 Medtronic
Support

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


%
Revenue
Business unit FY2011 Example product Treatment
Cardiac Rhythm Disease
Management (CRDM) 31 Implantable pacemakers regulate heartbeat
Spinal and Biologics Artificial Cervical Discs (Spinal); replace damaged or degenerated discs in the
Business 21 INFUSE Bone Graft (Biologics) neck; stimulates the body to regrow bone
Cardiovascular 20 Stent grafts aortic aneurysms
Medtronic Deep Brain Stimulation
Neuromodulation 10 Therapy Parkinson's disease
Diabetes 8 Insulin pump Diabetes
Surgical Technologies 7 O-arm 2D/3D Imaging System intraoperative imaging
Table 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: http://www.medtronic.com/about-medtronic/business-overview/index.htm.

Appendix


BSX = Boston
MDT = Medtronic Scientific Corporation JNJ = Johnson & Johnson STJ = St. Jude Medical Inc.
Market Cap: 41.99B 7.07B 192.63B 11.70B
Employees: 44944 24000 129000 16000
Qtrly Rev Growth (yoy): 0.02 -0.07 0.07 -0.04
Revenue (ttm): 16.25B 7.28B 65.92B 5.54B
Gross Margin (ttm): 0.76 0.65 0.68 0.73
EBITDA (ttm): 5.45B 1.66B 20.26B 1.63B
Operating Margin (ttm): 0.28 0.13 0.26 0.24
Net Income (ttm): 3.46B -4.02B 8.50B 756.79M
EPS (ttm): 3.47 -2.81 3.05 2.38
P/E (ttm): 11.86 N/A 22.89 15.54
PEG (5 yr expected): 2.01 1.73 2.22 1.12
P/S (ttm): 2.58 0.96 2.91 2.1

Profit Margin = Net income/ Revenues
Operating margin = Operating Income/ Net Sales
Return on Assets = Net Income/ Total Assets
Return on Equity = Net Income / Total Equity
Current Ratio = Current Assets / Current Liabilities
Earnings Per Share = Net Income – Dividends on preferred Stock/ Average Number of Shares Outstanding
Price-Earnings Ratio = Market Value per Share / Earnings

Table 2: Direct Competitor Comparison - Medical Device Industry. Ratios inherent to the balance sheet. From Medtronic competitors (2012, 11 10).
http://finance.yahoo.com/q/co?s=MDT+Competitors.

Appendix


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/A

Table 3: Direct Competitor Comparison - Medical Device Industry. Profitability and managerial effectiveness. From Medtronic competitors (2012, 11
10). http://finance.yahoo.com/q/co?s=MDT+Competitors.

Appendix


Period Ending 30-Apr-10 29-Apr-11 27-Apr-12 2013 2014 2015 2016 2017
Total Revenue 15,392,000 15,508,000 16,184,000 17,478,720 18,352,656 19,270,289 19,848,397 20,443,849
Excise Tax 174,787 367,053 385,406 394,983 404,788
Cost of Revenue 3,582,000 3,700,000 3,889,000 4,369,680 4,496,401 4,721,221 4,862,857 5,008,743
Gross 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 9,022,736
Operating 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 4,860,948
Table 4: Income Statement forecast. From Medtronic income statement. (2012, 11 10). Retrieved from http://finance.yahoo.com/q/is?s=MDT.

Appendix


Table 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 is
estimated 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 the
increased 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 in
revenue. 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 excise
tax 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 range
around 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 the
expansion 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 and
general 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 Operating
Income 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 the
expansion 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 interest
expense 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 effective
ways to offset the excise tax.


Appendix


Period Ending 30-Apr-10 29-Apr-11 27-Apr-12 2013 2014 2015 2016 2017
Assets
Current 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 704,000 819,000 675,000 650,000 650,000 650,000 650,000 650,001
Total Current Assets 9,839,000 9,150,000 9,515,000 9,688,400 9,799,350 9,951,344 10,031,510 10,112,415
Long Term Investments 4,632,000 6,116,000 7,705,000 8,244,350 8,574,124 9,002,830 9,182,887 9,366,545
Property Plant and Equipment 2,421,000 2,488,000 2,473,000 2,596,650 2,700,516 2,808,537 2,864,707 2,922,002
Goodwill 8,391,000 9,520,000 9,934,000 10,420,000 10,836,800 11,270,272 11,495,677 11,725,591
Intangible Assets 2,559,000 2,725,000 2,647,000 2,752,880 2,752,880 2,752,880 2,752,880 2,752,880
Accumulated Amortization - - -
Other Assets 248,000 362,000 305,000 305,000 305,000 305,000 305,000 305,000
Deferred 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 37,184,432
Liabilities
Current 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 6,530,673
Long Term Debt 6,944,000 8,112,000 7,359,000 7,015,000 7,225,450 7,442,214 7,665,480 7,895,444
Other Liabilities 1,307,000 1,408,000 2,143,000 2,143,000 2,143,000 2,143,000 2,143,000 2,143,000
Deferred Long Term Liability Charges 89,000 461,000 611,000 387,000 387,000 387,000 387,000 387,000
Minority 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 16,956,117
Stockholders' Equity
Common Stock 110,000 107,000 104,000 104,000 104,000 104,000 104,000 104,000
Retained Earnings 14,826,000 16,085,000 17,482,000 18,907,280 19,405,020 20,045,571 20,140,110 20,228,315

Other 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 19,893,648
Table 5: Balance Sheet forecast. From Medtronic balance sheet. (2012, 11 10). Retrieved from http://finance.yahoo.com/q/bs?s=MDT.

Appendix


Table 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 increasing
production 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 increased
sales 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 impacted
by 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 an
estimated 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 total
assets.

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. Net
receivables 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% in
2014. 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 to
be $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 continued
growth 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 ailing
small 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, or
positively 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 next
move in Medtronic’s strategy.

Appendix


Present
FCFF(t) or value
Year Value
TV(t) at
9.94%
0 FCFF(0) 4,274
1 FCFF(1) 4,647 = 4,274 × (1 + 8.73%) 4,227
2 FCFF(2) 4,972 = 4,647 × (1 + 7.00%) 4,114
3 FCFF(3) 5,235 = 4,972 × (1 + 5.28%) 3,940
4 FCFF(4) 5,421 = 5,235 × (1 + 3.55%) 3,711
5 FCFF(5) 5,520 = 5,421 × (1 + 1.83%) 3,437
5 TV(5) 69,289 = 5,520 × (1 + 1.83%) ÷ (9.94% – 1.83%) 43,146
Intrinsic value of capital 62,575
Less: Short-term borrowings (fair value) 3,274
Less: Long-term debt (fair value) 8,186
Intrinsic value of common stock 51,115

Intrinsic value of common stock (per share) $49.87
Current share price as of 9/10/12 $41.16
Table 6: Intrinsic Stock Value. The discounted cash flow model was used to valuate the stock. All data in USD $ in millions, except
per 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 9
and 10. Data obtained from http://www.stock-analysis-on.net/NYSE/Company/Medtronic-Inc/Profile.

Appendix


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 4,274
Table 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 described
as 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 for
expenditures to maintain the company's 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 estimated
effective tax rate is 19.15%. WACC=(Weight Equity)(Required rate of return Equity)+(Weight Short-term borrowings)(Required rate
of return Short-term borrowings)+(Weight Long-term debt)(Required rate of return Long-term debt). WACC = 9.94%

Appendix


Apr 27, Apr 29, Apr 30, Apr 24, Apr 25, Apr 27,
Average
2012 2011 2010 2009 2008 2007

Provision for income taxes 730 627 870 425 654 713
Net earnings 3,617 3,096 3,099 2,169 2,231 2,802
Tax rate1 16.79% 16.84% 21.92% 16.38% 22.67% 20.28%

Interest expense 349 450 402 217 255 228
Interest expense, after tax2 290 374 314 181 197 182
Dividends to shareholders 1,021 969 907 843 565 504
Interest expense (after tax) and dividends 1,311 1,343 1,221 1,024 762 686

EBIT(1 – Tax Rate)3 3,907 3,470 3,413 2,350 2,428 2,984

Short-term borrowings 3,274 1,723 2,575 522 1,154 509
Long-term debt 7,359 8,112 6,944 6,772 5,802 5,578
Shareholders’ equity 17,113 15,968 14,629 12,851 11,536 10,977
Total capital 27,746 25,803 24,148 20,145 18,492 17,064
Ratios
Retention rate (RR)4 0.66 0.61 0.64 0.56 0.69 0.77
Return on invested capital (ROIC)5 14.08% 13.45% 14.13% 11.67% 13.13% 17.49%
Averages
RR 0.66
ROIC 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


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

Medtronic valuation

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