ROUNDTABLE FORUM: MEDICAL TECHNOLOGY & DEVICES: 2000-12-04

ROUNDTABLE FORUM:
MEDICAL TECHNOLOGY & DEVICES
Round Table Interview - published 12/04/2000

DOCUMENT # LAG450

MARIOLA B. HAGGAR is President, General Partner and Portfolio Manager at
Haggar Concord Partners, L.P. She is also a Managing Director of Concord
International Invest-ments. Ms. Haggar was previously associated with
Salomon Brothers, and Deutsche Banc Alex. Brown. Prior to that she was
employed at Kemper Securities Group, Inc., L.F. Rothschild, Unterberg,
Towbin and began her career at Kidder Peabody & Co.  Ms. Haggar received
a BA in Biochemistry from Cornell University and an MPH with a focus in
Healthcare Finance from Columbia University.

BRUCE JACOBS is a Vice President at Deutsche Banc Alex. Brown covering
the medical device and hospital supply group. Mr. Jacobs is a CFA. He
received a BSE in Finance and Management from the Wharton School and
graduated Magna Cum Laude and received an MBA from Harvard Business
School. In his leisure he enjoys sports and traveling.

ANNE P. MALONE, CFA, is a Vice President at Salomon Smith Barney,
covering Medical Technology Industry. She was previously associated with
Bear Stearns & Company. Ms. Malone is a Chartered Financial Analyst and
a member of the New York Society of Security Analysts. She received a BA
in Finance, with a minor in Economics from St. Leo College.

FREDERICK A. WISE is a Senior Managing Director at Bear Stearns &
Company. Previously, he was associated with Kidder Peabody & Co. and
Forbes Inc. He earned both his Bachelor's and Master's degrees from the
Manhattan School of Music. A Chartered Financial Analyst, he is a member
of the NYSSA.  

Sector: Medical Devices

Moderator: Juliet Milkens

Stock Performance

TWST: Let's start with a review of the performance of the medical technology and devices stocks over the past 12 months. Anne, to what do you attribute the upturn in the stocks? Ms. Malone: At the beginning of the year one could choose between thinking (a) the stocks would benefit as a safe haven if technology turned, or if people turned against drugs; and alternatively, (b) underperform if they were associated with some of these same troubles. So I think the simple answer is there is a lot of money that needed to be put to work, and these stocks have delivered for the most part on their earnings. I sit here and every morning I listen to a technology analyst talk about an earnings miss, and those have been few and far between in this group that has good demand, good top- and bottom-line growth. So I'll say money flows into a high-quality defensive area is the driver. TWST: Rick, what in your view has been driving the medical technology and devices stocks in 2000, and how does the Bear Stearns Medical Technology Index look for the year? Mr. Wise: In 2000, medical technology and devices stocks in general showed great performance. Over the last 12 months my larger cap stocks are up an average of 25% by my calculation. Year to date that same group is up 21 1/2%. It's been a little tougher on the smaller cap side with several stocks under our coverage actually slightly down. In answering your question, I think it is important to go back 12 months to the November 1999 through March 2000 period. In my 12 years of experience in covering the medical device industry, this was one of the most challenging periods for these stocks. Another such challenging period was the first year of the Clinton administration when investors were concerned about healthcare reform. This time last year, nobody seemed interested in investing in the medical devices group since the investors were very focused on the dot-com revolution, biotech, genomics ' essentially anything NASDAQ and non-medtech. As a result, there were stocks with extraordinarily appealing valuations, which translated into perhaps one of the most attractive stock-picking times that I had seen in a long time. Obviously the attractive valuations changed significantly throughout the year, as the stocks appreciated meaningfully. TWST: Bruce, would you like to comment on the performance, and also will you highlight the better performers in your universe and tell us what contributed to the price increases for those stocks? Mr. Jacobs: To appreciate the performance of this group in 2000, I think one first has to look back to 1999. Last year was definitely a very challenging period of time for these companies, and accordingly stock price performance was not particularly impressive for the group. In my view, there were many reasons for the performance in 1999, at least one of which was the large number of acquisitions that occurred and the resulting integrations that followed that in some cases turned out to be quite challenging. Furthermore, we had some markets which for the first time looked as if they were maturing, such as the coronary stent market, which also made for a very difficult 1999. That said, as challenging as 1999 proved to be, it did set the stage for a nice return in 2000, which we have indeed seen. As I look across our medical technology coverage universe, it is primarily the larger cap stocks that have flourished this year, with gains in our large capitalization companies up in the mid- to high 20% range. Some of the leaders of that group in terms of percentage increase this year have been Abbott Labs (ABT), which was one of the companies that had probably the most difficult year in 1999, and has really come back very, very nicely. Another strong performer this year has been St. Jude Medical (STJ), which is being driven at least in part by optimism about its new defibrillator product. Finally, the other company in our universe that has had an extremely strong year is Applied Biosystems (PEB), formerly PE Biosystems, which has ridden the genomics wave and produced a very, very nice year for investors. TWST: Mariola, from the perspective of the buyside, which medtech stocks have best rewarded investors year to date, and how well has the group done compared to other sectors of health care in your fund? Ms. Haggar: The group overall has done quite well thusfar this year. Early in 2000, as we were entering an election year, we decided to overweight the portfolio in sectors such as medical devices, specialty pharmaceuticals and healthcare services. Medical device stocks were then, in my opinion, very undervalued. The relative multiples for some of these companies based on one-year-ahead earnings (at that time the year 2000 earnings), were either below or at best, equal to the market multiple. Since then, the multiples have gone up significantly. Now, the average premium to the S&P 500 based on one-year-ahead earnings is 36% for the large market cap medical technology companies. The mid-cap and the small cap stocks are more mixed and still may hold some bargains, but you really have to look at them on a stock-by-stock basis. One of the best medtech performers this year in the mid-cap category is MiniMed (MNMD), up 62% year to date and Waters (WAT), up 156% year to date. Among the larger positions in our portfolio this year have been Baxter (BAX), up 40%; Abbott, up 46%; Stryker (SYK), up 47%; and Medtronic (MDT), up 8%.

Earnings Surprises

TWST: Anne, have there been any surprises out of the third quarter earnings? Which companies have beaten the estimates and which, if any, have failed to meet the numbers? Ms. Malone: I don't think it was any surprise that in almost all cases the top line was going to be pretty tough. We had the euro to contend with. But if I go with surprise announcements, I'd say number one would be Baxter, in their conference call, lowering forecasts for next year based on the fact that they had decided not to fully hedge. Taking into account where the euro was, that was a little bit of a surprise. Second would be Stryker coming up with stronger than expected top-line growth, joining Medtronic as the only company with 10% revenue growth, when everyone else was coming up with single digits. So there aren't too many on the surprises and disappointments side. TWST: Rick, how about you? Were there any surprises among the recent earnings results? Mr. Wise: Actually Bruce summed it all up. I would say that moving beyond the specifics, which Anne stated very clearly, I think that the larger issue is that, and maybe I'll put it in the surprise category, investors are having a tough time accepting or coming to grips with the fact that we're not seeing as robust top-line growth in general, particularly from some of the bellwether stocks, as we might have hoped to see 12 months ago. This is a complicated issue but probably one of the things that we might talk about today: where is the growth and where is the accelerated growth going to come from for this industry? I think the issues in the third quarter specifically were currency and the magnitude of its impact on the companies' performance. It tended to be, in general, a little worse than I think most people expected. And we did see a number of companies, large and small, that lowered their earnings performance guidance going forward. Anne mentioned several companies, but I think you'd have to add Edwards Lifesciences (EW) to the list of names when talking about currency being a drag going forward. So dealing with the magnitude of negative currency impact was probably the biggest general surprise in the third quarter. TWST: Bruce, what surprised you about the third quarter results? Mr. Jacobs: For the most part, the results of our group were in line with our expectations. Probably the one surprise that has not been mentioned yet was Guidant (GDT), whose transition to a new stent product line caused an earnings hiccup in its 3Q00 results. My sense is that many investors are still struggling with how best to interpret the company's 3Q00 results, whether the issues truly are temporary or likely to persist perhaps beyond the third quarter.

Investment Approach

TWST: Moving on to the approach that each one of you takes to the industry, Bruce, how would you describe the approach that you take to investing in medical technology and devices at Deutsche Banc Alex. Brown? Mr. Jacobs: One of the things that I think investors at this time value as much as anything is strong earnings visibility. As mentioned earlier, there certainly have been a number of high profile earnings misses on the technology side, and we've had a couple on the device side as well. As a result, one of the things that we look for right now in terms of the stocks that are on our best idea list are companies that have high visibility going forward, certainly on the bottom line and if possible on the top line as well. The next obvious question is what drives companies that have visibility? It's typically those that are in the midst of new product cycles that are driving accelerating growth, as well as companies that have business models that lend themselves to being quite predictable. Finally, companies that have a healthy amount of earnings leverage in their income statement also tend to be quite predictable. Stryker is probably the best example of a company with very high earnings visibility. First, they've got one of the best, most disciplined management teams in the business. Second, they are operating in an environment, the orthopedics industry, which has shown a healthy growth acceleration of late. Finally, they have tremendous leverage in their income statement. As a result of these dynamics, we are very comfortable with Stryker's ability to drive 20% EPS growth reliably for the next several years or more. The other company at the top of our best idea list is Abbott, which also has very nice earnings visibility going forward, something I continue to believe will be highly valued by investors. TWST: Anne, what is key to the approach that you take to investing in medical technology, and what are the characteristics of the companies that you focus on? Ms. Malone: Would it scare everyone if I mentioned the use of darts? I think if you had to say one thing, it's identifying new product trends. There is obviously a lot of work that goes into that task, but with these companies we have to be so focused on pipelines to make sure that they're constantly feeding that top-line to keep it growing to leverage to the bottom line. But identifying new products really has to be compared to expectations and time frames and the potential for the market. That's where you're going to find the ability to identify a stock that's going to really move. How much is already expected? How much is already forecast? From there you must figure out how it can drive growth. You don't want to believe that a tail can wag the dog, but can it make a big difference to the company? Can it change the perception of a company that used to be a single-digit grower? And this must be done with a healthy dose of reality checks. So I think the simple answer would be identifying new product trends. I've found that I've had better luck this year, not so much with the sustainable growers, but really those change-of-perception stories, such as a Baxter or a St. Jude, which were considered dogs for so long, with management teams that were perpetually messing up good opportunities. Watching them identify a catalyst, being able to check it out and see it turn, those are the ones where we were able to get not only earnings expansion but multiple expansion, and those turned out to be the big winners for us this year. TWST: Mariola, tell us about the approach that you take to investing in medical technology and devices. Has your approach changed significantly since you moved to the buy side? Ms. Haggar: I would like to start with answering the last part of your question first. Yes, to some extent my approach certainly has changed. During my 18 years on the sellside, in the 1990s I followed big cap pharmaceutical companies, a very stable, uniform industry. In the 1980s I was a healthcare generalist and I followed device and biotech companies as well as other areas of health care. I can't really say that I have one specific formula for looking at various sectors of health care. I would say that my approach is really very opportunistic and varies depending on the sector. I now run a diversified healthcare fund. There is always competition for the investment dollar among different subsectors of health care. I do own what Anne called the change-of- perception stocks, or what I call the contrarian turnaround stories. I like the turnaround stories, but I typically do a lot of research to arrive at a certain level of comfort that a stock in fact has bottomed and that the turnaround is not too far away. I don't buy stocks only because they are cheap, because they can always get cheaper. In early 2000, my Baxter, Abbott and Stryker picks were all considered contrarian. But I also do buy the expensive, so-called momentum stocks in anticipation of positive events, such as Medtronic with several new product launches. When you are on the buy side, you realize the paradox that while most investors think of themselves as being long-term- oriented, they do not like to see a down quarter. Therefore, I have to look at the long-term as a series of positive short terms, and I do pay attention to quarterly catalyst events for a particular stock, and to what will make money work for the fund in a particular quarter. In general, I like to look for companies that are developing products which could open up whole new markets. It is actually amazing how many different medical conditions are now treated or will be treated with devices in the future, opening up huge potential new markets, such as: congestive heart failure (Medtronic's InSync and Guidant's Contak CD), epilepsy (Cyberonics' VNS), Parkinson's disease (Medtronic's Activa), atrial fibrillation (Medtronic's Jewel AF and AT500), diabetes (with companies like MiniMed trying to develop the artificial pancreas). There is really something very different and inspiring about devices companies today versus the way they were a decade ago. TWST: Rick, just tell us briefly about your approach to investing in medical technology. Do you see your approach changing at all over the next couple of years? Mr. Wise: My approach has typically been a contrarian approach. I was corrupted at an early analytical age by my mentor, who preened me as a value-oriented, special situations analyst, and I've never been quite able to shake that sensitivity to valuation or sort of down and out stocks, even though all of us essentially follow a growth stock universe. The thing that I find myself most excited about as an analyst, that I have the most fun doing is thinking about change. The change can be significant and dramatic or something small, but as long as I feel that it's not in the stock and people are perhaps overly focused on, near-term issues and not focused enough on the next positive issue that will be a driver of the stock, I enjoy trying to articulate that and recommending stocks on that basis. Several people have mentioned a number of these names already, but Abbott Labs was my stock pick of the year at Bear Stearns for 2000. There's essentially a new, younger generation management team coming in and making some tough decisions about old problems and tough, challenging decisions about how to invest more aggressively in the future. I felt all of these factors would help them move beyond some of the problems we saw them go through. With St. Jude, earlier in this year, as we got toward the end of 2000 I really felt people would be focused on their entry into the dual chamber implantable defibrillator market and that that would do terrific things for the stock, and thankfully it has, and Baxter similarly, among others. This is a volatile group of stocks. I've always been astonished at the sort of violent swings in price that we can see in short periods of time on both good and bad news. And since I tend to be more a buyer than a seller of stocks, I think there is tremendous opportunity when these stocks get oversold, which they often do, to take a longer-term point of view. And if one can be patient, one can make a lot of money.

New Products & Platforms

TWST: Anne, you emphasized the importance of identifying new products. What did you come away from the recent round of medical conferences with in terms of the new products and industry trends that will be important, at least over the next three to five years? Ms. Malone: I don't think I walked out of any of them thinking about anything new, but maybe feeling more comfortable with the thesis that I had gone in with. Not surprisingly, many of the new products ended up being cardiology-focused for the treatment of congestive heart failure or CHF. Obviously as a device analyst, I tend to be focused on that idea from a device perspective, but even at AHA one picked up on possible ideas for newer drug treatments, gene therapy, atrial fibrillation or AF. The whole idea of anti-restenotic products, whether that is a drug- coated stent or whether it's radiation (I have to admit my bias is toward coated stents), is that restenosis rates have been brought down with the stent and with how much further they can be lowered. Those are the top three that come to mind, as I said, just coming out of AHA. So I don't think the lightbulb went on there, but there was rather a confirmation that this is also what the medical community really seems to be focused on. TWST: Bruce, did the lightbulb go on for you at any of the recent conferences? Mr. Jacobs: I think much of what we saw at AHA was confirmatory of many of our beliefs. That said, the one area that I was perhaps even a little more enthusiastic about was drug-coated stents. Although there is certainly more work to do in the clinical arena, some of the early results have been extremely promising. But what is so interesting to me is that it does appear that drug-coated stents, if they work as promised, truly have the ability to be a game-changer in the coronary stent market. Specifically, one of the things that we learned from our conversations with physicians at AHA is that the physicians are willing to give up a lot in order to have a product that truly does prevent restenosis. That can mean, for instance, giving up on flexibility and deliverability, which is something that today is at the top of the list in terms of factors that drive a physician's choice of a stent. Clearly, it appears as if restenosis is enough of a vexing problem that if there is a coated stent that does work as advertised, there are few reasons to believe that it won't capture a very, very significant share of the total market. As a result, that would be the one area where I think our opinion got a little bit stronger. Beyond that, an additional area of focus for us, and frankly for everybody else on the Street, continues to be congestive heart failure and the treatment of the disease with resynchronization devices. Everything that we saw, again, supports our belief and that of many others that there is a very, very big potential for these devices. And companies such as Guidant and Medtronic certainly are at the forefront of tackling that opportunity. The last point I would make is that there was a considerable amount of work presented at AHA on a diagnostic marker called BNP, a cardiac marker that has shown some very nice promise in diagnosing heart failure in patients and also in staging the disease in patients. Best positioned to capitalize on this opportunity is a company that we follow called Biosite Diagnostics (BSTE), which has a BNP product that is under FDA review right now. I think if that product gets approved in a timely fashion, perhaps early next year, it has the potential to have a nice impact on this market, as it certainly will be able to, I believe, help diagnose patients with heart failure who may then be candidates for resynchronization therapy. TWST: Rick, were there any presentations or discussions of new products or platforms that, in your view, created interest within the medical community and among analysts and investors? Mr. Wise: Anne and Bruce did a great job of talking about the key issues. The major issues of the day and the next major market opportunities are for drug-coated stents and congestive heart failure. There are some other interesting smaller markets for using a covered stent-like device for treating AAA, which is abdominal aortic aneurysms. And there are other interesting things going on in the peripheral use of stents and peripheral applications, but these two markets are dwarfed by congestive heart failure. And I think all of us are trying to figure out, and are going to spend certainly the next six to 12 months trying to figure out exactly how big these opportunities are, when the commercial opportunity will really get under way, and the timing and the degree to which they will affect the cardiology companies involved. In no particular order, these would include Medtronic, Johnson & Johnson (JNJ), Boston Scientific (BSX), Guidant, and St. Jude, among others. One non-cardiology issue that I would mention relates to Bausch & Lomb (BOL). The company is hard at work on a new device called Envision, which is a small, almost tiny pellet-like product that is a delivery mechanism for putting drugs in the back of the eye to treat a variety of conditions including diabetic macular edema, posterior uveitis, among others that lead to blindness. Roughly 3 million people in the United States alone have these conditions. Bausch & Lomb is working aggressively with multiple clinical trials that are in their very early phases showing tremendous promise in treating these conditions. Even if the clinical trials are successful, I don't think we're going to really see any economic impact for Bausch & Lomb until probably 2003, although it could be sooner. Still, this is a major multi-billion dollar market opportunity that could potentially be very, very exciting. So I would just throw that into the hopper as well. TWST: Would this qualify as an unmet need? Mr. Wise: It definitely is an unmet need. People who have these conditions most times are treated systemically with drugs. The problem is that in order to get a sufficient concentration of that drug to the back of the eye, you have to deliver massive doses to the body, which would still be an insufficient amount, because of the protective nature of the brain. So very unpleasant treatments are offered, including actually injecting steroids directly into the eye. But these are painful, not sustainable treatments that just don't work well. Therefore, having a product that could deliver these drugs consistently over a multi-year period would be truly fantastic for a population of patients who are in desperate need of help. Can you imagine parents who can't see their children and people who can't go to work? It's not just elderly people, it's people of all ages. So it's a very serious unmet medical need.

Regulating Outlook

TWST: Moving on, if we may, looking out through 2000, 2001, have there been any regulatory changes that could have an impact on this sector in the US or in any of the overseas markets in which these companies do business? Anne? Ms. Malone: Regulatory changes in the United States, I think no. I think overseas sometimes. It's a little harder to predict what will happen in a given country. Probably the one that comes to mind, though, is continued, if you want to call it, regulatory pricing change over in Japan, which happens on a regular basis. I think that country, which in the past has always been willing to pay very high prices for devices, is going to see continued pressure on those prices. I think in the European countries those kind of happen in a haphazard fashion. So if you ask me to bet whether there will be some sort of regulatory pressure there over the next year, I'll say yes, although I don't think there is anything specific on the table. TWST: Anne, are these companies making inroads in other markets beyond Europe and beyond Japan, and if so, which product categories? Ms. Malone: The larger, truly global companies like the Abbotts and the Johnson & Johnsons, they're everywhere. You can go to India, you can go to Brazil, anywhere in Latin America, I'm sure you'll find a red Johnson & Johnson script on the baby powder. And even Baxter has gotten into some interesting markets such as China and Russia. But if you go down to what you might consider to be the less global names ' Medtronic, Guidant, perhaps St. Jude ' for the most part their markets tend to be Europe, North America, and Japan. But I'd say what we're finding is that the broader Asia-Pacific, including Australia and Latin America, though still small, is showing some pretty wild swings ' some years up, and then others down. Latin America, for instance, can be affected by currency. So yes, I think it is becoming a global marketplace, but for analysis purposes, the markets you first mentioned are the primary drivers here. TWST: Mariola, which companies have the greatest exposure to categories that have become increasingly competitive, or that may lack pricing power for other reasons? Ms. Haggar: First, may I chime in with a comment on your previous question about the regulatory changes? TWST: Of course. Ms. Haggar: I would like to mention that over the last 20 years, one thing that has been very interesting is the regulatory change in the United States. For example, in the early 1980s, there was very little research on using devices to deliver drugs to various sites of the body; even in such established areas as orthopedics, the companies were very reluctant to work on drug-coated implants, for example, because it was so difficult to work with the FDA in that area. The FDA couldn't decide whether it should treat the product as a drug or as a device, and the companies that have tried early on were typically bogged down at the FDA for years. Today, we have companies working on drug-coated stents such as Boston Scientific, Guidant and Cook; the FDA apparently will treat those as devices. I think that in the future we will see companies working on drug-coated orthopedic implants. Devices will be increasingly used to deliver drugs to specific sites in the body to avoid systemic side effects. I think this makes sense in many areas of medicine. Perhaps the most obvious being oncology and the less obvious being orthopedics. It makes sense to deliver drugs that stimulate bone growth directly to the bone. Drugs like bisphosphonates, such as Fosamax, have a very low bioavailability, i.e., less than 1% of the oral dose actually ends up in the bone. Moreover, they are rough on the esophagus, so one has to take the drug standing up with a full glass of water. Going back to your question of which companies compete in markets that have matured and are now more competitive, among the larger, more diversified companies, just about all of them have encountered competitive pressure in one area or another, such as in balloon angioplasty, coronary stents and/or pacemakers. The stronger companies such as Medtronic and Guidant, through an intensive research effort and acquisitions, have been able to continue to improve upon their product offerings, and continue to grow by introducing change in these markets through innovation. They're working on drug-coated stents to decrease the incidence of restenosis, more flexible stents for easier placement and so on. They have introduced smaller, lighter and smarter pacemakers, and they have been able to grow and capture market share in competitive markets. We have also seen companies, that have not been able to keep up with innovation to the same degree, like Becton, Dickinson (BDX) or C.R. Bard (BCR). These companies are now trying to change the negative market perception and refocuse their research. C.R. Bard has recently introduced an innovative device to treat GERD and Becton, Dickinson plans to introduce new glucose monitoring products.

Outlook for Stent Pricing

TWST: Bruce, how do you see the outlook for stent pricing? Can the newer generations of stents command higher prices? Mr. Jacobs: Until we get to drug-coated stents, my expectation is that it is likely to be much of the same, specifically, annual price decreases in the double-digit range, hopefully offset by some unit gains to keep the dollar value of the US market roughly flat. In terms of your question about new generations of stents driving price increases, I don't think that is likely to happen until we have drug-coated stents. With drug-coated stents, there is a great potential for some nice price premiums. In fact, the physicians with whom we have spoken have expressed a willingness to pay a significant premium for stents that have a much better restenosis profile. But I think in the absence of that, we're likely to see much of the same in stent pricing. Clearly, companies will continue to innovate and continue to bring out new generation stents. But, in our view, we've gotten to the point now where each advancement is only modestly incremental. I think the days of significant improvements in stent performance, and significant differentiation across companies, are coming to an end. Add that to the fact that we are also seeing new competitors enter the US market, I believe the best we can hope for prior to drug-coated stents is a flat market. TWST: Who are the competitors that are entering the US market? Mr. Jacobs: One example is Abbott Labs, which has an agreement with a UK company called Biocompatibles and a product called the BioDivysio stent. That product has just recently been approved and is expected to be on the market in the first half of next year. Additionally, although it's not a completely new product to the market, Johnson & Johnson's Bx Velocity stent is expected to be out on a rapid exchange platform next year, and I think that will alter the dynamics of the industry as well. Many doctors are anxious to see it on a rapid exchange platform, and some have admitted their usage of the stent could rise significantly on the rapid exchange platform. TWST: Rick, at the other end of the spectrum, which categories, and the companies associated with them, will have good pricing flexibility in 2001 and going forward? Mr. Wise: Before I answer that, maybe we can come back to the whole regulatory issue and focus on what's happening in Washington. Later, I'll answer your question. TWST: Of course. Mr. Wise: Generally, one has to believe that in this industry, the companies that will do well will be those that have the best pricing flexibility. The golden rule, it seems to me, is that if you can prove to doctors, insurers and patients (generally through clinical trials) that your product can address medical conditions that have either inadequate or no currently really outstanding therapeutic virtues, and do it better, faster and cheaper, you're going to have tremendous pricing flexibility, in addition to the opportunity to create possibly new markets as well. Each one of the top-flight companies in our universe is doing that, and the complex thing is that when you look at this group of companies as a whole, and I'm thinking here of the larger cap companies, none of them are pure plays in any one product or market per se. So when I point to Abbott's new age drug Kaletra that has a greater tolerability profile and more therapeutic benefits for AIDS patients, it has excellent pricing flexibility. When we look at Baxter's ability to launch, to expand its manufacturing capacity for Factor VIII, in a market that is woefully short of product, that product is going to do exceptionally well. And also we could go company by company and find products that have that pricing flexibility as well as plenty of products where there is no growth. There are commodity markets, mature markets. But I think as you would expect in any diversified portfolio, every company has to have areas of lower investment that are generating cash to fund the more rapidly growing businesses and products.

Reimbursement Changes

TWST: Back to you, Anne. To what extent are these companies directly affected by reimbursement changes coming out of Medicare, Medicaid and managed care organizations? How vulnerable are they directly? Ms. Malone: Well, the reimbursement issue is one of the primary differentiating risks, versus many other areas of health care. So medtech stocks are very vulnerable to it. You know, a large majority of the patients served by the orthopedic companies are Medicare recipients. So if Medicare decided to sweep in and lower prices, they would be incredibly exposed. That's a general statement. Specifically are there reimbursement changes coming down the pike that leave a certain sector of the medical device industry at risk in 2001? I have to admit none come to mind. There is always a question as to whether dialysis reimbursement should be changed for better or for worse and that would affect Baxter. But lowering it has never come to pass. So yes, they are exposed, but I don't see a specific risk in the United States. In an effort to keep confusing you by answering other people's questions, as well, on the pricing flexibility side, I would just mention that I think of it as applying to all of the companies that Rick said can adjust their mix. But these days, the flexibility on pricing is so slim for everyone and there's such intense pressure to keep delivering more for the same price, I don't really think of it so much as does anyone have flexibility but rather has someone emerged who can adjust that mix to work in their favor. TWST: Rick, you wanted to talk about what was happening in Washington. Would you go ahead? Mr. Wise: Sure, I just want to make sure that we didn't get off the regulatory, political reimbursement issue because I think it's important. Regardless of the outcome of the presidential election (I guess we're still waiting on that front), I think it's important to appreciate that I believe the medical device industry is in a little better shape perhaps than the drug industry. I don't think it is quite the political target that the pharmaceutical industry has made itself because of aggressive pricing increases. But perhaps in this just completed election, the big news in the House is what didn't happen. Because of the political composition of the House and the Senate, I think we're all relieved to hear that Pete Stark did not succeed Bill Thomas as Chairman of the House Ways and Means Committee. Pete Stark, in the early part of my career, was well-known for looking for Medicare fraud and abuse and was a thorn inside the FDA and was a real factor in slowing down product approvals. There didn't seem to be any significant changes in the Senate Health Committee either. I think that you've got some important guys on the Committee who've basically been advocates for the medical device industry. I wonder whether a Bush administration might be a touch more favorable on the margin for the industry in that (HCFA) the Health Care Financing Administration might be a little weaker or maybe have a more restrained regulatory reach with Bush in the White House, which might be ' again, at the margin ' a plus. But some of the things that I'm certainly watching are the whole issue of clinical oversight and direct to consumer marketing. Those are some of the things that are on the watch list in the new legislative session. There seems to be a lot of talk about the need for greater human subject protection in clinical trials; that could be a concern for the industry if it slows down the development of new products and the moving of new products through the whole clinical trial process. In general, there's nothing dramatic, but I still think there are issues to watch. I will mention one last potentially positive thing. Based on communication with our contacts in Washington, the general improvement in FDA review times in recent years, the last five years, as opposed to the prior five have in general been quite pleasing. Now my sense is the agency has turned its focus toward overall device development times, perhaps looking for ways to speed up the clinical trial process. So that might actually turn out to be a plus. So those are my thoughts there. TWST: Bruce, what are you looking to Washington for? Mr. Jacobs: My hope is that not too much changes. I think the device companies are in a reasonably favorable environment right now. And, as was mentioned earlier, we don't quite have the laser focused attention on the medical device sector that there is on the pharmaceutical space. There are lots of reasons for that. I think one is that medical devices typically represent a much smaller piece of the cost pie. When one looks at healthcare reform, clearly there's a focus on lowering costs in the healthcare system. Fortunately, many of our companies manage to stay under the radar screen of reformers. I think also the fact that many of these devices are in many cases not reimbursed directly, but rather as part of the procedure also helps. As a result, there is just not as much focus on them. Lastly and perhaps most importantly is the fact that one can make a very good case in many instances that the devices that are out there today are not expanding the healthcare pie but they're shrinking it. Many devices save costs by either making procedures less invasive or getting people out of the hospital more quickly, or both. As a result, I think we have a fairly favorable outlook for the regulatory environment going forward, both on the reimbursement front and also on the regulatory front. Clearly, those are risks that will always be in place for these companies. You always have to worry about getting through the FDA. You always have to worry about potential cost and reimbursement. But, generally, I think the environment is pretty favorable and we hope it stays that way. TWST: Mariola, is there anything you'd like to add here? Ms. Haggar: The only thing that I would add is that for other healthcare sectors in my portfolio, such as pharmaceuticals, biotechnology or healthcare services, regulation and what is being debated in Washington on medical reimbursement is very important. But I think that for medical devices the reimbursement cycles are also market-driven. It depends on where managed care stands in the pricing cycle; since most people are covered by managed care, managed care organizations pay for most surgical procedures and the devices that are used in these procedures. This year, managed care entered a very good pricing cycle. With premium increases in the range of 8% to 10% for 2000, and it looks like they are going up to double digits, perhaps 10%-12% in 2001, for the first time in a long while. Therefore, the managed care organizations can reimburse hospitals and other healthcare providers at better rates. That, combined with approximately $30 billion in 'the Medicare givebacks' to hospitals and HMOs, proposed in the BBA2, should result in less pressure from hospitals on suppliers. I certainly do not believe that hospitals, which have suffered financially for a long time, will give all of that back, and that device companies will be able to raise prices in maturing markets like stents or defibrillators, but I think there certainly should be less downward pressure on pricing. How long can this good premium pricing cycle for managed care last? Corporations have been doing well because of a strong economy. If the economy holds up, I think that this strong premium pricing can continue into 2002. On the other hand, if the economy slows down significantly, then corporations will likely refuse to pay such high premium increases to managed care. TWST: And that will impact these companies? Ms. Haggar: Absolutely. It is a chain effect, in 'the medical food chain,' so to speak. TWST: Anne, is there anything you'd like to add here? Ms. Malone: No, I think it's been covered pretty well. Growth Sectors TWST: Let's move on to the growth characteristics that the different categories will demonstrate over the next one to three years and longer term over the next five to 10 years. Anne, will you highlight the categories that you believe do posses the ability to really grow over this period? Ms. Malone: If I look at it broadly, I'd cast my vote for cardiology and neurology. Obviously, we have an aging population that smokes and drinks and eats far too much butter, and so many of the cardiology problems are really effects of poor quality of life. Luckily I cover a number of companies that put an awful lot of R&D into new products and we are a society that wants to pay for them. So as we talk about coated stents AF, CHF, you name it, there is more and more being focused on. I think of cardiology as a broad idea of either trying to improve the plumbing or to improve the electrical system. That's here and now. Neurology will be a bigger area further out. It really is much more of a pioneering effort right now. I think of this area as encompassing the spine all the way into the brain, going after things like aneurysms with less invasive devices, or treating Alzheimer's with drugs and devices. TWST: Which companies are most closely associated with neurology and what are the products that are going to drive growth for the companies in those areas? Ms. Malone: That's just the point ' as a frontier, there are not a lot of major companies focused there yet. So I think what you're going to see is the natural life cycle of an area like this. You'll probably see more of the innovation come out in small, private companies that will eventually go public or get bought by the larger ones. An example of an established company that is looking there is Boston Scientific with its Target division. They've been working for some time on a less invasive approach to treating aneurysms, or bulges, in the vessels of the brain. Then there is Medtronic, which has really made a much larger bet with the purchase of Sofamor Danek and with the work they've done internally. They have made a couple of different efforts. First, there is deep brain stimulation for treating Parkinson's and central tremors, which involves a pacemaker-like device that can stimulate the thalamus and try to cure some of the problems there. Second, there is an implantable drug pump that can help with intractable pain that runs up and down the spine. These are the two companies that immediately come to mind, in addition to some of the smaller companies. But I think what you'll see is a food chain idea ' smaller companies will come up with the newer ideas in the biotech and medical device area, and the larger companies will come up with broader device therapies. And the drug companies will chip in as well. TWST: I'm assuming that this is a very large market opportunity there. Ms. Malone: With the stress on the word 'opportunity.' TWST: Mariola, which do you see as the strong growth areas going forward, and which companies and which products are going to be most important for those areas? Ms. Haggar: I certainly would agree with Anne about cardiology, especially in the case of congestive heart failure. From the perspective of time, I see a technological revolution in devices almost as big as in biotechnology. Most of the new markets that upcoming devices are promising to open up are in the areas of unmet medical needs. In congestive heart failure, no one is going to treat class I, class II or class III patients with implantable devices, but for class IV patients, half of whom die within a year, there is a tremendous unmet need to prolong life. The preliminary data indicates that you can prolong life by as much as two years for these class IV patients. A very interesting, albeit small (only about 500 patients) study was just published in the American Journal of Cardiology and it showed a two-year increase in survival for patients implanted with these devices. Likewise, in neurology, I think late-stage Parkinson's patients will benefit from Medtronic's Activa, which is awaiting approval in the US. Also, Cyberonics (CYBX) has a device for the treatment of epilepsy. All of this looks extremely promising. I also think that one of the areas of tremendous potential growth for devices in the future will be in the treatment of diabetes. The idea of creating an artificial pancreas, which combines an implantable insulin pump with continuous blood glucose monitoring, is not new, but is only now becoming a reality with MiniMed's progress. I think that could become a revolutionary way of treating diabetics. Yet another potential area of growth is the emerging market for public access defibrillators (PADs). PADs are the small, easy to use portable defibrillators that we already see on airplanes and in most major airports, and that are now being placed in most police cars, major skyscrapers, shopping malls, etc. There are only a few ways to play the PAD market, since few companies have that kind of product. One of them is Medtronic, which acquired a portable defibrillator through its acquisition of Physio-Control. Another is Agilent (A), a spin-off from Hewlett-Packard (HWP), which in turn is now spinning off the medical devices part of its business to Philips (PHG). There are also some smaller companies, such as ZOLL Medical (ZOLL). These would be some of the future growth areas that come to mind, but there are many other opportunities that I believe will arise from the migration of the device companies into drug delivery. TWST: One follow-up question, Mariola. In diabetes, are there any other companies besides MiniMed that are doing work in this area? Ms. Haggar: Well, there are a lot of small device companies that have been working on continuous blood glucose monitoring with various degrees of success, such as Cygnus' (CYGN) GlucoWatch and Disetronic's device, for example. MiniMed is, in my opinion, the best external and implantable insulin pump company. The pulmonary delivery of insulin is another example of using devices to deliver medications, with companies such as Inhale Therapeutic Systems (INHL), Aradigm (ARDM) and Alkermes (ALKS) involved in that. What is very interesting is that all of the device companies that are working to deliver pharmaceuticals or biologics command much higher multiples. It is an interesting strategy of how to build a device company with a biotech multiple. TWST: Moving on to you, Rick, which categories would you highlight as the ones that show the greatest promise going forward? What are the products, and which companies are associated with the products that will be most prominent in those categories? Mr. Wise: I second Mariola's initial reaction to the question, which is it's hard to know where to start because inside virtually every one of these companies are interesting opportunities. The basic reality here is that, especially if we just focus on the United States and forget about international opportunities, the population is growing, aging, and abusing itself in a variety of ways. Whether it's with McDonald's, cigarettes, someone who doesn't believe much in exercise or the people out there exercising too much, hurting their joints and needing replacements, the opportunities for these companies are significant. I think that everyone has done a really great job of touching on most of the significant areas, but you have to figure, from a device perspective, that the cardiology opportunity is vast. There are huge populations of people who have diseases that these devices are going to be able to address. There is a congestive heart failure opportunity, depending on how you slice it. Certainly it should far exceed $8 billion; it could easily be a multibillion-dollar annual market. I talked earlier about the Bausch & Lomb Envision technology. I think there is some possibility that will become a platform technology that could address other eye conditions. I also wonder, in a larger sense, whether that kind of platform technology can deliver drugs to the rest of the body over time. I want to address a general thought about that, which is something everybody has touched on a little bit, Mariola most specifically. This increasing marriage of devices and drugs, or biotech compounds and elements, is something that I think we're going to see more and more. This is where the device provides either a delivery system or some physical or structural element as well as a drug, a growth factor, or a gene on the tip of a catheter. That would be on a site-specific or area-specific basis, which would help in treating specific diseases in a more concentrated way and that enables patients to get better faster and cheaper. Who's going to benefit from all of this? That's both an easy question and hard question because, again, we have to speak generally about this. Abbott, J&J and Medtronic are three outstanding companies ' as well as Guidant and Baxter ' that are investing heavily in the future with an array of incredibly promising products. It's not always clear where the future begins, but I think there's a lot of promise in this group. TWST: Do you see these companies investing in the future through their in-house R&D or through acquiring smaller companies that may have platforms or products that they would like to add to their portfolio? Mr. Wise: That's an important question, and one that I'd answer slightly indirectly by referring to the question you asked earlier about what are the changes I've seen in recent years, or in my case a decade or so, with this group. I think that one of the many interesting changes is that the mid-tier or mid-cap companies have disappeared. Increasingly, this industry has become a barbell industry with the big guys on one end and the tiny, little guys on the other. The big guys have a huge investment in infrastructure and the ability to conduct clinical trials, handle regulatory issues and sell, distribute and market contracts. But they are desperate for growth; they're desperately trying to innovate. So all of them are spending generously, by and large, on R&D and investing in the future internally. But if there is absolutely an ongoing need to consolidate, you should look at the smaller companies that are doing interesting things clinically, that either the large guys couldn't conceive of or couldn't accomplish, and put these two things together. So consolidation in this industry will continue and is a substantial portion of the innovation that will come from outside the company. Johnson & Johnson said quite recently that when they look at their roughly 10% top-line growth over the last 10-20 years, 2 percentage points of that growth have come from acquisitions on a fairly consistent basis. So I think that gives you some flavor for what is possible. TWST: Bruce, I'm afraid we didn't get to you to ask you what your favorite categories are, or the category that you think is going to show the strongest growth going forward. Will you answer that question, and then go on to comment on consolidation? Mr. Jacobs: It may not be the sexiest or fastest growing segment, but I do think that investors will be focused on the orthopedic markets in the coming years. We have seen a very nice resurgence in growth in that market, which certainly has been helped by the aging of the population. The industry also appears to be benefiting from a much more favorable pricing environment that has partly been a result of all of the industry consolidation, which seems to have stabilized things in this sector. We think it's very realistic to see roughly double-digit type of growth out of this sector, and certainly even faster growth in some of the rapidly growing segments such as the spinal area. I think there are a couple of interesting ways to play this sector, and Stryker is one that we have mentioned a couple of times today. There is also Biomet (BMET), which is a very innovative company that is growing nicely as well. So that would be the one sector that I would add to the list. In terms of acquisitions, I think it's very likely that they are going to continue to be a big part of this industry. Some of the smaller companies are incredibly innovative, very nimble, and, in many cases, able to capitalize on new markets before the big guys can. As a result, there is no shortage of acquisition targets out there. With the kinds of multiples at which some of the larger companies, such as Medtronic, Guidant, Stryker and others, are trading, I think it's very realistic to expect that acquisitions will certainly continue. I think that the acquisitions we will see will continue to be the kind that help companies build scale within existing markets. An example is Guidant's acquisition of Intermedics, which allowed it to build its pacemaker business up. Also, there will be acquisitions that take companies into entirely new areas, such as Medtronic and Abbott have done with several of their acquisitions.

Industry Consolidation

TWST: Anne, is consolidation the theme that investors should be focusing on for 2001 or 2002? Ms. Malone: I think you would be hard-pressed to find a year when any given medical device analyst doesn't talk about consolidation. I think that's just an ongoing theme. If our larger companies want to keep getting larger, they always have to make a decision about buying versus building and which makes more sense, in terms of the time it would take to bring a product to market, the investment that would have to be made, and what sort of intellectual property is already out there. So I think it's ongoing. While we were all thinking that the big would buy the small, the big ended up buying all the mid! We saw US Surgical, Mallinckrodt, and Sofamor Danek ' a great lineup of mid-cap companies ' disappear. So I think consolidation will happen; it is a constant theme because the companies are constantly looking to fill that pipeline. TWST: Mariola? Ms. Haggar: I think that the question has been pretty well covered. I totally agree with everything that has been said; consolidation is an ongoing process and it will continue over time, as it always has, in the device area.

Investment Outlook

TWST: Rick, what are you telling investors today? At current prices, is this a good time to buy medical technology and devices stocks? Mr. Wise: I have actually been sending an aggressively cautionary message, but for the last three weeks or so I've been getting sick of hearing myself say that it's hard to generalize about this group. But you have to keep saying it; it is hard to speak about all stocks and companies. If this group is characterized by anything, it's characterized by volatility. It seems to me that we've been through a sustained, wonderful period of performance by some of the better companies. That makes me anxious and I feel that from a portfolio or top-down point of view, investors have been treating the medical device group as though it is a safe haven. In the larger scheme of things I suppose it is, but it's a volatile safe haven. It seems to me that we're talking about a period of time when the group has generally performed exceptionally well. So I've been a little concerned about valuation, although I think we're all quite positive about the long-term prospects of the group. I feel that some of the more exciting, new product markets or areas won't emerge for a while here. I think the next big thing, post-stents, is congestive heart failure, but the true commercial market reality for them is more like a 2002 and beyond story. I'm a little concerned short term, given the valuations and expectations, that some of these stocks might take a rest for a while. TWST: Bruce, what have you been telling investors? Mr. Jacobs: Our message is that it's hard to generalize in this group, as it is a very heterogeneous group of stocks. In terms of stock selection, you have to look at each individual company because, as I said, it is very difficult to generalize across the industry. One of the things we have been emphasizing is the value of high earnings visibility. Then one has to ask how much is reasonable to pay for predictability, as some of the more predictable companies are trading at as much as twice their earnings growth rate or more. That fact all the more highlights the need to be selective in this market, and to pick your opportunities carefully. Stock selection also very much depends on one's time horizon. There are companies such as Guidant and Medtronic that we've talked quite a bit about today, and I think all of us here would agree that two or three years down the road, the stocks are going to be considerably higher than they are now. So if one's investment horizon is that long, then I think those both make perfectly fine investments. If you're worried about the next couple of quarters that may be a different story, depending on which stock you're looking at and at what valuation. So this is a market where people not only have to be selective, but have to pick their entry points very carefully because there is a lot of volatility, which creates both issues and opportunities. TWST: Anne, what are you telling investors? Ms. Malone: I feel as though six, nine or 12 months ago I always had something on the tip of my tongue when someone said, 'What's your favorite idea?' Maybe I had a story that was really being misperceived and we could point out an opportunity. I think now the good stories have been identified and rewarded, and the questionable stories have been identified as such. What I'm trying to say is that at one point, regarding the safe haven or security blanket idea where people have parked money, I probably will not be able to predict when the tide will pull back toward other areas. What I want is for people who are putting money to work to put it into real stories. So try to identify the ones where the earnings estimates are more likely to go up than down, but be prepared for that tide tripping back out. TWST: Mariola, have you been and are you continuing to look at these stocks as a safe haven? Ms. Haggar: Yes, they have been a safe haven. I do believe that if we continue to see the signs of an economic slowdown with the negative profit warnings in technology and other industries, they will continue to be perceived as a safe haven. But having said that, I do think that the valuations of a lot of medtech stocks are now quite high. As I mentioned earlier, many of the medtech companies were trading at or below the market multiple earlier this year, and now they are trading at a significant premium. However, I do consider many of these companies, including Medtronic, Stryker, Biomet, and Abbott, as solid long-term core holdings, and I would not want to incur significant short-term capital gains. The dilemma is that it is difficult to find a stock that you would feel brave enough at current valuation levels to add to the portfolio today. Among the large cap companies, the only one that is still reasonably valued is Baxter, especially after the recent correction caused by the potentially greater than expected impact of currency translation on next year's earnings. But from a longer-term perspective, currency usually cancels itself out, and as long as the underlying organic growth continues to accelerate, which I believe is the case with Baxter, I think we will see the multiple continue to creep up over time. Multiple creep-up is how I would best characterize this stock's future. I do not think it will ever make tremendous leaps, like MiniMed or even Abbott did, where a single product or drug like Kaletra can capture people's imagination. But I do think that Baxter is one of these evolutionary long-term stories, where the organic earnings growth rate will continue to accelerate over time. TWST: So Mariola, tell us, are you brave enough to put new money into Baxter today? Ms. Haggar: Yes, I still would buy Baxter.

Stock Recommendations

TWST: Anne, I guess you've made it clear that we shouldn't ask you for your three best investment ideas. Ms. Malone: I'd have to make up the third, and maybe I'd have to pull it out of another industry. Under the thesis that I was talking about, when the tide rolls out, I still want to be in some of the names where I think the story is real. If you pushed me on three, I'd go with St. Jude and Baxter for numbers that could still go higher, with the caveat we already talked about, the euro. I might say J&J as the security blanket idea, and as I watch Medtronic decline by almost another 10% as we're speaking, that might suddenly get on the radar screen in another 10 minutes if this keeps up. TWST: Anne, what's the most compelling reason to buy St. Jude today? Ms. Malone: We should discuss valuation, but I join Baxter and St. Jude at the hip, because if I go through my investment recommendations, those two stand out as having potential for upside revision, and I think everyone hasn't signed onto the story. While I agree 100% with everyone here that Medtronic is a fabulous company, I think we all agree that there are only a few people living under a rock who don't know about it. With St. Jude, there's a new product coming ' a dual chamber defribillator. It's a $1 billion market opportunity that they'll enter, and that can leverage to the bottom line. So a company that has only been a single-digit grower can be a double-digit grower and surprise a few people. TWST: Are there any risks here that investors should be alerted to? Ms. Malone: Of course. Whenever you're entering a market where you have two very strong competitors like Medtronic and Guidant, you always have to be worried about market acceptance of the third product on the market. St. Jude in the past has made a living out of taking opportunity and somehow missing it. So it would be, do they have enough inventory to supply the market if need be. Pricing can always be an issue. Simply put, if the thesis is the dual-chamber ICD can make a difference in their growth pattern, then the risk lies in the acceptance of that product in the market, or the supply of it. TWST: Rick, you've put out a cautionary note, you told us about that. But nevertheless, are there any stocks that you could still recommend to investors? Mr. Wise: I guess the answer, in no particular order, is some of the names we already focused on such as Baxter and Becton, and we recently initiated coverage with a buy on Edwards Lifesciences. All three of them are, to varying degrees, a little contrary. I think that Anne touched on the Baxter issues. I think the Baxter story operationally is one of seven or eight years now of steady operational and financial improvement. Disappointingly, they have not managed to deliver as consistently as I would have liked and I suspect others would have liked on a quarter-to-quarter basis. But on an annual basis, they basically, gradually, steadily have moved this company in a more positive direction, and top-line growth, excluding currency, is the fastest we've seen since the mid-1990s. Top-line growth has steadily increased since the mid-1990s, as has EPS growth. And I think the fundamental drivers of the business, again excluding currency, are in good shape. So with the Factor VIII story still playing out, at the earliest kind of stage, the company is generating a substantial amount of cash, and the business is in pretty good shape. It seems to me that, particularly in the $75 to $80 range, where we may head before this particular session is over, it seems like an attractive area. I believe Baxter can certainly be a $90 to $100 stock over the next year. Becton, Dickinson we recently upgraded, and it's had a nice move. I've never, ever recommended Becton, Dickinson. I should have, I suppose, several times. But it's been really a laggard throughout the entire time I've covered the industry. I'm interested in the stock now because I think it will be helped by key new members of management, particularly an outstanding new Chief Financial Officer, John Considine. I think the company is in good shape to get back on track to produce what maybe will be more sustainable, predictable financial performance. They've recently announced a number of strategic programs that I think are the first of what I believe will be a number of steps to achieve that. They're discontinuing distributor incentive programs, they're eliminating staff and corporate positions, they're trying to reduce volatility with a hedging program. And again, I think that's the first of a number of actions we'll see. This doesn't resolve every issue, I want to make that clear. But I think that the management is working very hard to get our expectations beaten down; I think everybody's on the same page. This is a stock that not a lot of people are focused on or believe in, with very good reason. It's definitely a show-me situation. But if they are successful, in the right kind of environment, I certainly think this could be a $50 to $60 stock, if not in 12 or 18 months, over the next couple of years, with limited downside. I'd much rather buy it in the mid-$20s today, and there's no particular rush here, but it's one I like a lot. Last would be Edwards Lifesciences, which we recently upgraded. My colleague, Jeremy Chase, is covering this. But I think that the story is very straightforward. The stock at $14 is essentially where it was at the time of the spin-off from Baxter, I believe in April of this year. And you have an excellent management team that is demonstrably doing everything they can to accelerate growth, to make good decisions. They've taken some tough steps to get rid of some underperforming assets. They're a significant cash generator, and I think they'll use that cash to pay down debt and to make selected technology acquisitions. I think that following the third-quarter modest operational disappointment, the stock got knocked down from $25 to $14. I think that we have pretty sustainable, achievable numbers going forward. And maybe most interesting of all to me is that this is profoundly the cheapest stock on an EBITDA and cash EPS basis in the universe. So despite the fact that there's not much top-line growth ' or should I say more strongly, virtually no top-line growth ' this seems like a very interesting idea for a volatile, scary market. TWST: What business is Edwards Lifesciences in? Mr. Wise: They're in the cardiology business, basically. Roughly 40%-45% of their sales come from tissue valves. They are the market leader in tissue heart valves, and they compete with Medtronic and St. Jude. The rest of their businesses are more mature ' they have large market shares in some mature niche markets like hemodynamic marking devices. These businesses are, as I said, mature, slow growing, but also stable and require very little investment. TWST: Bruce, what's on your buy list? Mr. Jacobs: My three best ideas right now are Abbott, Stryker, and Biosite Diagnostics. On Abbott and Stryker, I think one has to be selective in terms of an entry point, and our view is that both of those stocks are attractive below $50 per share. In both instances, the valuations are certainly not inexpensive relative to their growth rates, but I think that is a reflection of the high earnings visibility, something quite compelling in uncertain market environments. On the small cap side, I very much like Biosite Diagnostics, which I mentioned earlier. Biosite has a novel product for detecting congestive heart failure, and they're also in the midst of a new product cycle with another cardiology platform for diagnosing heart attacks. Additionally, the company also has a little bit of a genomics play embedded in it through a business they call Biosite Discovery, where they are hoping to find a major pharmaceutical collaborator before the end of the year. In sum, Biosite is a stock that I think has some very nice catalysts in front of it over the next couple of quarters and could be considerably higher than it is today. TWST: Bruce, what do you particularly like about Stryker, and what's the compelling reason to buy it today? Mr. Jacobs: The reason to buy Stryker is that it is probably the best- managed company of all the companies in my coverage universe. They are a leader in the orthopedic space, which, as I mentioned earlier, will be an attractive area over the next couple of years. They are certainly benefiting from, and in fact helping to drive, those positive growth trends. And the company is coming off the acquisition of Howmedica, which they made back in 1998, which they have put together quite well with their main business, and in doing so they have created some pretty significant critical mass in this market. But importantly, they also have significant opportunities to improve the company's overall profitability, and I think Stryker is very well positioned to sustain its 20% bottom-line earnings on revenue growth in the 8% to 12% range, because of the leverage that they have in the income statement. And that comes not only from the gross margin line, but also from operating expense reductions as well as reductions in interest expense as they pay down debt. So to the extent that people are looking for a safe haven in this space, Stryker will certainly be that in terms of its ability to deliver earnings as expected at the 20% growth clip. TWST: Anne, Rick is recommending Becton, Dickinson, and he says that this is the first time that he's done so. What's your thinking on Becton, Dickinson? Ms. Malone: Right now we are in the research phase on that one, so I don't think it's fair for me to comment on that one. TWST: What about Abbott, Anne? Ms. Malone: You know, it's made a great comeback. And it's been, I think, appropriately revalued. At $29, people thought the world was coming to an end when it hit that bottom in late January. I think it is exciting to have a new CEO at Abbott, born and bred there, to give it new lifeblood. The challenge becomes at what point do you take advantage of a lower-priced opportunity and also give appropriate value to the changes that are coming? So this is a very long way of saying that Abbott is a quality core company, but I think the price right now doesn't give a lot of opportunity for new money. TWST: Mariola, what would it take for you to look more positively at Becton, Dickinson? Ms. Haggar: This is a very good question, especially, because I have known John Considine for years in my previous life as a pharmaceutical analyst following American Home Products (AHP), and I think the world of him. I do believe that he will improve communication with analysts and the perception of predictability of earnings for that company. He did the same, with Tom Cavanagh, for American Home Products in the 1990s. I do respect him, and that is the reason why Becton is now such a tempting idea. However, one question that is still on my mind is whether one should buy a big, complex company on the reputation and strength of one single individual. I still need to do a lot more research on whether this company's strategy and technology are truly changing to effect an acceleration of growth in the future, and what kind of catalyst events I can expect that would propel the stock further beyond the recent bounce. TWST: Bruce, do you look at Becton at all? Mr. Jacobs: Yes, I do, and I think the others have made very solid points about Becton. That said, we are still in what I would call the watchful waiting mode with Becton. I truly believe that they have some very strong franchises. The company has had, though, a very difficult period over the last one to two years in terms of its ability to execute on its financial goals. And I'm not quite over the hump in terms of believing that they indeed have finally set expectations at a level that is not only achievable but perhaps beatable. While there are certainly some pretty good analogies between Becton today and Abbott 12 months ago, which had a nice run after a very difficult period of time, my only issue with Becton is finding exactly what the catalyst will be in the upcoming quarters to drive future growth. Not being able to find these catalysts is what has kept me on the sidelines on this one. TWST: Rick, do you have any recommendations among the small caps, or are there any that you'd like to highlight where there could be a milestone that would serve as a catalyst for the stock in the coming year? Mr. Wise: Small caps have been a challenge, and I think it's a very gentle word for what I really feel, which I suspect you couldn't print in a family newspaper. This has been a very tough period for the last couple of years, and the stocks that I have liked have been successful from time to time, but they've also been astoundingly volatile, as opposed to just volatile, as I discussed in the larger cap group. So I might mention Intuitive Surgical (ISRG) today, if somebody were interested in investing in early-stage technology that has, I think, tremendous promise long term, but from an earnings point of view it can only promise to lose money for a while until the technology matures. TWST: Just give us a brief profile of Intuitive Surgical. Mr. Wise: Intuitive Surgical makes a robotic-like surgical instrument that essentially enables surgeons to perform surgery more precisely, more exactly than they would in a normal open surgical procedure. Essentially the surgeon looks through a monitor and has a direct, normal visualization; the surgeon then puts his or her hands into an instrument that enables them, with exquisite, minute precision, to perform very delicate surgery. This is not only an instrument, this is something that, if its potential is realized, as I believe it can be and possibly will be long term, could actually improve the surgeons' skills, and enable them to do ever more exquisitely refined, elegant surgery, more accurately, more quickly. And it is a revolutionary product that I would describe as, in a way, the next step down in the minimally invasive surgery revolution. So it provides better instruments for the surgeon and, in effect, it actually improves the surgeon by eliminating issues such as hand tremor in these delicate, tiny procedures. I think there are going to be enormous potential opportunities for this technology in almost every single surgery, whether it's cardiology or urology procedures ' virtually anything. But there's an enormous educational and developmental process. This is a mult-year evolution, and the company has gotten off to a very strong start in placing systems, and I'm very optimistic long term. TWST: Mariola, would you look at a company like this, or is early-stage technology not something that you normally look at? Ms. Haggar: I would definitely look at early technology. I do not have any major restrictions on the market capitalization or even on how thinly the stock is traded. I can buy anything and everything as long as it is health care and as long as it makes sense to me. I do own some early technology companies in my portfolio and I look forward to reading Bruce's report on Biosite Diagnostics and Rick's on Intuitive Surgical. In terms of small market capitalization medical device companies, the ones that I find interesting are those crossover type of 'chimeras,' those that are really device companies, but the market looks and trades them like biotech companies because they typically deliver recombinant proteins, like Alkermes. TWST: They're frequently thought of as drug delivery companies, aren't they? Ms. Haggar: Yes, they are device companies that deliver drugs, vaccines or biologics but they trade with the biotech companies. TWST: Anne, I don't think that you look at the smaller caps, do you? Ms. Malone: No, mid- and large caps. TWST: Are there any mid- and large caps where you think there could be a milestone over the next year that could serve to create interest in the stocks? Ms. Malone: So kind of what's on our watch list, if I could rephrase the question? TWST: Go ahead. Ms. Malone: I guess one that I watch, looking for signs of that comeback, would have to be Boston Scientific ' I can't say that I expect it, but just looking for signs of life, that company's had a lot of troubles. And a mid-cap name, I guess it almost falls under small cap, is STERIS (STE), a $1 billion market cap. STERIS is in the sterilizer business, and they would join that club of companies that have seen the stock price come down dramatically over the last couple of years, have seen a management change, have taken a restructuring, and we're waiting to see if they can get the company back on course. So those would be the two. I can't say that I expect the milestone, but I'm really ardently looking for one. TWST: Rick, any other small caps that you'd like to mention? Mr. Wise: No, Intuitive is the one I'd mention today. TWST: Bruce, how about you? Mr. Jacobs: I would reemphasize Biosite Diagnostics, which I've mentioned before. Additionally, one other company that has had a little bit of a difficulty of late is Aspect Medical (ASPM), which has an exciting product for consciousness monitoring, but has run into some competitive issues that have impacted their performance. That said, I still believe the company has a bright future ahead of it, and those who can take a long-term perspective will still be rewarded. Finally, we like Dionex Corporation (DNEX), which is an underfollowed story but one building momentum in the separations industry. Additionally, they just made an acquisition which should help accelerate the company's growth rate. TWST: Thank you. (JM) Note: Opinions and recommendations are as of 11/25/00. MARIOLA B. HAGGAR Haggar Concord Partners, L.P. 667 Madison Avenue 18th Floor New York, NY 10021 (212) 451-3470 BRUCE JACOBS Deutsche Banc Alex. Brown 101 Federal Street 15th Floor Boston, MA 02110 (617) 261-3604 ANNE P. MALONE Salomon Smith Barney 388 Greenwich Street New York, NY 10013 (212) 816-7539 FREDERICK A. WISE Bear Stearns & Co. 245 Park Avenue New York, NY 10167 (212) 272-4265 Copyright 2000 The Wall Street Transcript Corporation All Rights Reserved

The Wall Street Transcript (TWST) interviews are published verbatim, and TWST does not in any way endorse or guarantee the accuracy of any information or opinions expressed herein and all opinions are subject to change without notice. Nothing herein constitutes a solicitation to buy or sell any securities. TWST interviews with CEOs may include include "forward-looking statements", which are based on factors that involve risks and uncertainties. Actual results may differ materially from those expressed or implied. TWST shall have no liability whatsoever for any trading losses arising out of use of this information. Copyright 1999 Wall Street Transcript Corporation. All Rights Reserved.