Medtronic: Tapping the Brain for Profit

The implantable Medtronic Soletra sends electrical pulses to the brain.

Persuading people—lots of people—to have holes drilled into their skulls and electrode-tipped wires connected to their brains might seem like a puzzling corporate strategy. But when it comes from a company that's already induced hundreds of thousands of people to attach silver-dollar-size devices to their hearts, it just might work.

Medical device maker Medtronic has used its groundbreaking innovations in the field of cardiac rhythm disease management to build itself into a business with $13.5 billion in annual sales. It invented the battery-operated external pacemaker half a century ago and still maintains a 50 percent share in the market for pacemakers and implantable defibrillators. But now the company is turning to the brain to drive sales and earnings growth. Its neuromodulation unit makes devices that treat a slew of chronic neurological disorders—including Parkinson's disease, essential tremor, and dystonia—with powerful results. In coming years, Medtronic plans to release similar gadgets to relieve symptoms of obsessive-compulsive disorder, depression, and epilepsy. "My biggest challenge in neuro is trying to figure out what not to do," William Hawkins, Medtronic's president and CEO, said in an interview at its Minneapolis headquarters.

This enthusiasm for neuromodulation comes as annual sales growth in Medtronic's cardiac rhythm unit has slowed from 24 percent in 2003 to just 2 percent in the past fiscal year. But neuromodulation is indeed promising: Parkinson's alone afflicts roughly 1.5 million Americans, with 60,000 new cases diagnosed each year. "We think that there is more headroom for growth in the neuromodulation space than any other part of Medtronic," says Hawkins. He expects the unit to generate revenue growth of 13 to 15 percent annually over the next five years, compared with cardiac rhythm disease management's projected growth rate of 5 percent to 7 percent.

Surgery. Medtronic sees the potential of neuromodulation in patients like Jerry Wildenauer of St. Paul, Minn. Wildenauer, a chiropractor, was diagnosed with early-onset Parkinson's disease in 1996. In the years since, the degenerative neurological disorder—triggered by the death of brain cells—turned his limbs rigid and slowed his movements, making a task as simple as retrieving change from his pockets a tedious chore. Meanwhile, medications he took came with powerful side effects, including profound exhaustion.

So in 2004, Wildenauer opted to undergo deep brain stimulation, a therapy that employs an implantable device to send electrical signals to the brain in an effort to restore normal function. It took doctors almost eight hours to drill into his skull, embed the Medtronic-made gadget in his chest, and connect electrode-tipped wires to just the right targets in his brain. Weeks later, Wildenauer had a second device implanted on the left side of his brain. The results were dramatic. "It was like they threw a switch, and my body just totally relaxed for the first time in years," says Wildenauer, now 56. Just like that, he reclaimed many of the abilities that Parki nson's had stolen from him, such as playing the guitar and dancing with his wife.

William Marks, a physician at the University of California, San Francisco Medical Center who specializes in movement disorders, calls DBS a "revolution" in neurology: "It can really substantially improve [symptoms] to the point where [with] many patients, you don't even know that they have Parkinson's."

Fears. Yet the challenges to neuromodulation's growth as a treatment are stiff. The DBS procedure and device cost about $60,000 (although they are often covered by insurance). The brain is less understood than the heart, and brain surgery is lengthy, complicated, and invasive. "Putting a probe in someone's brain is a major operation," says Sara Michelmore, an analyst at Cowen & Co. Given people's fears about brain surgery, how can Medtronic make physicians and patients more willing to undertake the procedure?

It's yet another challenge for a company that traces its family tree to 1949, when two brothers-in-law started repairing medical devices in a Minneapolis garage. Soon they were making products of their own. After Medtronic released the external, battery-powered pacemaker in 1957, things really took off. The device, the size of a paperback book, was held outside the body but used wires to send electrical impulses to the heart to restore normal rhythms—a groundbreaking development for cardiac arrhythmia sufferers. (DBS applies similar principles to the brain.)

Over the next several years, Medtronic's pacemakers became more advanced. Soon, the devices were tiny enough to insert into patients. Another cardiac blockbuster came in 1993 with the release of an implantable defibrillator. Medtronic's profits ballooned. Net earnings jumped from $119 million in 1990 to $1.1 billion in 2000. Over the same period, the value of its shares surged 20-fold. Today, the company has a market value of $60 billion.

Slowdown. But as Medtronic's size swelled and the pacemaker and implantable defibrillator markets matured, the company's growth sputtered. Annual revenue growth declined to 10 percent in the past fiscal year from twice that in 2003. Earnings grew just 6 percent, to nearly $3 billion, after rising 16 percent in 2003. Medtronic's stock price moved sideways. Hawkins was promoted to his current perch last August.

Medtronic has branched further outside its core cardiac arena than its top competitors—Boston Scientific and St. Jude Medical—and is currently the only company with a commercially available DBS device. Beyond neuromodulation, Medtronic produces devices to treat diabetes, spinal disorders, and other cardiac conditions. "The key to their future growth is to hold serve in their key markets where they have dominant market share...and then try to drive greater market growth and pick up market share in areas like neuro," says Gregory Simpson, an analyst at Stifel Nicolaus.

The company recently cut 1,100 jobs but added positions to faster-growing divisions, such as neuromodulation. Still, the cardiac rhythm unit, which pulled in nearly $5 billion of revenue for fiscal year 2008, dwarfs neuromodulation, which did $1.3 billion in sales. Simpson says he's confident that Medtronic will be able to maintain dominant market share in cardiac rhythm and should meet its goals for neuromodulation.

Epilepsy on deck. But Medtronic will need more patients to undergo brain surgery. It's moving to make DBS devices smaller and more effective while investing in less invasive surgical technologies. Also, the company is seeking government approval to use DBS to treat some patients with obsessive-compulsive disorder, plans a clinical trial of DBS for depression this year, and hopes to introduce a DBS treatment for epilepsy as early as 2010. "Innovation is the lifeblood of our company," Hawkins says.

Citigroup analyst Matthew Dodds expects DBS to remain a treatment of last resort. "It is very invasive," he says. "If you have intractable epilepsy or you have intractable depression, you'll get it done." Still, in part because Medtronic has other powerful therapies—such as spinal stimulation for chronic back pain—Dodds expects the neuromodulation unit to grow 13 percent a year over the next four years.

Jaimie Henderson, director of stereotactic and functional neurosurgery at Stanford University School of Medicine, thinks DBS procedures will become increasingly common: "There have been enough stories about it on the news that it is no longer a strange concept."

While Medtronic hopes Henderson is right, it is also pursuing growth through its diabetes and spinal units while looking to expand overseas sales. But it's the graying U.S. population and its need for Medtronic's products that could hold the most promise. "We're in a plethora of chronic diseases," Hawkins says. "So as the population ages, there's tremendous headroom for growth in this company." With opportunities like that, Medtronic—on the verge of 60, a baby boomer itself—isn't planning on retiring anytime soon.