Star Tribune (Minneapolis) Lee Schafer column

July 05--It's become easy to miss all the smart thinking that went into Medtronic's decision to buy Covidien for $42.9 billion.

And no, there was nothing particularly innovative about moving the corporate mailing address to Ireland to save a couple of percentage points on taxes.

This so-called "corporate inversion" has become the dominant story, of course, but a plan to relocate to Ireland barely even qualifies as thinking. It's about as clever as buying a condo in Naples to avoid Minnesota state income taxes.

Medtronic CEO Omar Ishrak has tried to explain why the deal is actually about business strategy, insisting that the motive was not about tax rates. He made some headway within the investment community, but business journalists don't appear as willing to believe him.

Not that Medtronic appears particularly frustrated with its public relations problem. But it seems clear that it underestimated just how mad individual shareholders would get once they learned they faced a capital-gains tax from the transaction and perhaps how many folks in our community felt betrayed that one of ours was leaving for tax reasons.

The story of the deal really goes back to the appointment of Ishrak in 2011. Geoff Martha, the Medtronic executive now leading the integration of Covidien, joined Medtronic just after Ishrak, his former colleague at General Electric.

"We have looked at opportunities to do this since I have been here," Martha explained last week.

Outsiders didn't see Covidien as a logical target for Medtronic, Martha said, "but it was really intriguing to us for a variety of reasons."

Covidien sells different and generally less complicated stuff than the kind of implantable devices Medtronic makes. Covidien products include surgical stapling devices, vessel sealing devices, patient monitoring equipment and what's commonly just called medical supplies.

As Martha talked through the thought process, however, that lack of overlap was one of the things that Medtronic's executives found most appealing.

There are, of course, some conventional merger benefits to be had here. Medtronic, for example, has a significantly larger group of clinical researchers, with a staff of about 1,500. Covidien doesn't have nearly that kind of capability to run multiple clinical trials, but could certainly use it as the company has new products in the pipeline that are more complicated than those of the past.

But the real goal for Medtronic was just to get a lot bigger, and become more far more important to government health ministers, large health care systems and large health insurance companies.

If being undersized seems hard to believe, given Medtronic's$17 billion in revenue last fiscal year, it helps to understand that Ishrak wants the company to shift into providing hospitals and other care systems with more cost-effective treatment solutions. It needs to move away from trying to sell them a new and improved -- and almost certainly more expensive -- device.

Here in the United States, the implications of health care reform have upended the financial model for a lot of health care providers. Big systems used to love specialty treatment centers that use a lot of Medtronic products -- like a spinal implant -- as they were a great way to make some real money.

Now specialty centers just look like they cost too much. Those costs include paying for new and improved models made by Medtronic. Maybe instead centers will elect to take another shipment of the old, far cheaper models.

Among other things, that's meant that despite spending about $1.5 billion a year on R&D, Medtronic has struggled to increase its revenue.

So Medtronic has elected to begin pitching itself as a partner with big health care systems to provide more than just products. The company is actually running cardiac catheter labs at hospitals in Europe, for instance, and it's difficult to overstate the significance of this kind of change.

To be successful with this strategy, size matters. As big as Medtronic is, having an even broader array of products and a bigger presence in markets throughout the globe are critical factors in its rollout of a solutions strategy.

Ishrak also has brought more emphasis to Medtronic's growth in emerging markets, although it's more likely called "globalization" by the company. Together, Covidien and Medtronic get about 14 percent of their revenue, or about $3.7 billion, from emerging markets and should be able to increase this business faster than it can in mature markets.

Size matters there, too, for some of the same reasons. The Medtronic-Covidien merger will be able to create a sales and distribution organization in more emerging markets. The company knows from experience that its own employees will be much better at educating physicians and government health policy officials -- really building a market -- than a network of distributors can be.

"Our products are fundamental to our solutions," Martha said. "[But] we will go in and start selling to governments, payers and providers on outcomes. That's really where we want to go. That's why this deal."

Little of this vision will be fully realized the day the transaction closes, either later this year or early in 2015. The following morning, the combined company will still be mostly selling products.

There may still be a salesperson calling on a bariatric surgeon at the same big hospital in the same half-hour as another Medtronic salesperson is calling on a cardiologist, with a third visiting an orthopedic surgeon.

But the company also will be moving as quickly as it can with a strategy of becoming the global health care solutions provider.

"We [will be] a big enough player that we can't wait for that to happen," Martha said. "We can't wait for the governments; we have to partner with them. That's where we're going, and this deal dramatically helps us."

This is the thinking that should make what Medtronic does top of mind for just about anyone else in the health care industry.

It's also why one can almost imagine Ishrak completing his first presentation to his board on the Covidien deal, and being asked, "Omar, aren't we going to pay a lower tax rate once we reincorporate in Ireland?"

"Oh yeah. That, too."

lee.schafer@startribune.com -- 612-673-4302

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