Article & Journal Resources

Unit Looks to Expand
In Emerging Markets
As U.S. Business Slows

By LEILA ABBOUD

Philips Electronics NV's medical-equipment division has been a growth engine in recent years. But this year, it hit a speed bump: budget-conscious U.S. officials.

The federal government, concerned about ballooning U.S. health-care spending, beginning this year cut its Medicare reimbursement for out-of-hospital scanning procedures such as X-rays, CAT scans and MRIs. In large part because of the change, Philips's medical division, which had been pegged to grow at 6% a year, is now expected to grow no more than 3% to 4%, as hospitals and outpatient clinics postpone buying expensive medical scanners.

Half of the company's medical business comes from the U.S. The company's trimming of its forecast caused its stock to drop 12% from €30.33 ($43.54 at current exchange rates) on the day of the announcement in October, though it has regained some ground since then. In Friday's trading in Amsterdam, Philips shares fell 2%, or 60 European cents, to €30.11 apiece.

Competitors General Electric Co. and Siemens AG have also been affected and have said sales in their medical businesses would be mostly flat this year. But GE and Siemens have large units in other areas, including aviation, infrastructure and construction, to compensate for the slowdown. As a result, GE and Siemens are forecasting overall revenue growth of 10% or more, while Philips expects overall revenue to grow 5% to 6%.

To offset the slowdown in the U.S. imaging market, Philips is stepping up its efforts in fast-growing emerging markets. The company is also pushing into businesses aimed at medical procedures that appeal directly to consumers and are less dependent on government-reimbursement policies -- one reason behind its deal disclosed Friday to buy Respironics Inc., a U.S. maker of sleep and respiratory products focusing on the U.S. home health-care market, for €3.6 billion.

The company's approach differs from that of GE and Siemens, which seem to be willing to ride out the short-term slowdown in the U.S. The two companies declined to comment.

"We're trying to diversify our health-care portfolio to move into the home," said Stephen H. Rusckowski, who runs the company's Philips Medical Systems division. "We see it as a way we can differentiate ourselves from our competitors."

Philips's medical division was supposed to cure the ills that had begun to plague the 116-year-old company. When Chief Executive Gerard Kleisterlee took over six years ago, the company's big brand-name business of making compact-disc players and TV sets was getting crushed by cheaper Asian competitors, while its computer-chip division was hemorrhaging cash following the bursting of the Internet bubble.

Mr. Kleisterlee retooled the company to make health care the new center of its business, along with its fast-growing lighting division. He won over investors by arguing that focusing on higher-margin products in health and lighting would deliver strong long-term growth.

But the slowdown in the medical business has exposed the pitfalls of betting on health care. Although health-care spending increases every year, it isn't always easy to translate that big promise into profits. Since governments spend so much on health care, their policies have an outsize impact on sales of drugs, devices and treatments. Companies like drug maker Pfizer Inc. and insurer Aetna Inc. are accustomed to managing the risk of reimbursement policies, but Philips is new to the game.

Mr. Rusckowski predicted that the difficulties in the U.S. market would continue for at least an additional six to 12 months. But he was confident that medical sales would eventually rebound. "What happened in 2007 was a slowdown in one specific country, but it doesn't change our long-term expectations for the medical marketplace," he said.

Mr. Rusckowski described a confluence of factors that led to the slowdown. First, the U.S. government ratcheted down the amount it pays each time a patient on Medicare gets a scan or X-ray at a medical clinic outside the hospital. Although the reimbursement for in-hospital scans didn't change, some hospital administrators began to worry that the new lower rate would eventually be expanded to hospitals and backed off purchasing new equipment, said Mr. Rusckowski.

In addition, a new generation of CT scan machines was due to be released by GE, Siemens and Philips in mid-November, so hospitals stopped spending in anticipation of the new technology. Spending on CT scanners was down 20% this year.

Lastly, medical research has focused increased skepticism on devices that open clogged arteries, called stents. That led to a drop in operations to insert stents, lowering demand for equipment for catheterization labs where the operations are performed. Philips is a leader in catheterization lab equipment. Mr. Rusckowski said new studies that reach different conclusions on the issue have since been released and doctors would have to debate the best treatment options.

Scott Geels, an analyst at Sanford C. Bernstein & Co., said despite the downturn, he still believed that medical was a promising high-growth market for Philips. "This is a glitch that will work itself out with time," he said.

Philips's medical division grew 8% to €6.3 billion in revenue in 2005 and 6% to reach €6.7 billion in revenue in 2006. Mr. Geels is forecasting 2% growth and €6.85 billion in revenue this year; Philips's guidance is for 3% to 4% growth on the year.

The medical division accounted for about 40% of Philips's €1.2 billion in earnings before interest, taxes and amortization in the first three quarters of 2007, with lighting contributing 40%, and the rest coming from consumer electronics and household appliances. The overall company reported net income of €2.78 billion during that period.

As part of its efforts to reach emerging markets, Philips signed a joint venture in China with Neusoft, a software and medical technology firm, to design new low-cost imaging equipment tailored for poorer economies and bought an X-ray company in Brazil called VMI-Sistemas Médicos in June.

Philips is also building a consumer health-care business to sell things including home health monitoring and disease-management software. Philips can pitch these products or services directly to patients or their family members who help with their medical care. For example, its Lifeline business connects elderly people to call centers at the push of a button to allow them to live independently.