We are in the midst of the fourth quarter earnings season and it is once again time to review the players in the worldwide medical devices market. The US still holds the leading position with almost one-third of the market share. However, emerging economies like Brazil, Russia, India and China - collectively known as the BRICs - are fast coming up in the medical devices space and are attracting a lot of attention. These emerging economies are seeing an increasing uptake of medical devices due largely to growing medical awareness and economic prosperity. Expansion in emerging markets, especially those with double-digit annual growth rates, represents one of the best potential avenues for growth in 2013 and beyond. On the flip side, the MedTech industry is currently plagued by several issues including the 2.3% medical device excise tax, pricing concerns, hospital admission and procedural volume pressures, Medicare reimbursement issues and regulatory overhang. Percutaneous intervention (angioplasty) volumes continue to be relatively flat in the US, Japan and Europe, with improvement not expected anytime soon. In spite of several uncertainties resulting in constrained capital spending, the past year also witnessed significant M&A deals including acquisitions of Switzerland-based Synthes Inc. by Johnson & Johnson (JNJ) for a whopping $19.7 billion, Gen-Probe Inc. by Hologic (HOLX) for $3.8 billion and Agilent Technologies' (A) acquisition of Danish cancer diagnostics company Dako for $2.2 billion. Another trend that we have been observing of late is the divestment of non-core business segments. For example, in early January, Abbott Laboratories (ABT) separated its research-based pharmaceuticals business by creating a new company, AbbVie (ABBV), to allow the two separate entities to perform in a more focused manner. In January, diagnostic testing company Quest Diagnostics (DGX) divested its OralDNA Labs salivary-diagnostics business to Access Genetics. The sale of the company's HemoCue diagnostic products business is also in the works. This would enable the company to refocus its attention on its core diagnostic information services. Moreover, Johnson & Johnson is currently looking for opportunities to sell or spin off its Ortho Clinical Diagnostics business. In November last year, Becton, Dickinson and Company (BDX) divested its Discovery Labware sub-segment (excluding Advanced Bioprocessing capability) to Corning (GLW) for $730 million. In May, Smith & Nephew (SNN), through an agreement with Essex Woodlands, completed the disposal of its Clinical Therapies business, to the newly formed Bioventus LLC, in which it will retain a 49% investment. Healthcare products maker Covidien (COV) is on track to spin off its pharmaceuticals business into a standalone public company by mid-2013. Earnings Numbers Before getting into the core discussion, let us brief some of the significant earnings releases so far. Johnson & Johnson's fourth quarter 2012 earnings came ahead of expectations, though revenues were just shy of the Zacks Consensus Estimate. Another medical device major St. Jude Medical's (STJ) fourth-quarter earnings and revenue came ahead of expectations. The still-choppy U.S. defibrillator market remains an overhang on St. Jude and we expect the same to affect the performance of its peers Boston Scientific (BSX) and Medtronic (MDT), though Boston Scientific's results earlier today came inline with expectations. Other major earnings reports by industry players include the earnings and revenue beats by Stryker Corporation (SYK) and positive earnings surprise but a revenue miss from Quest Diagnostics. We believe that the overall soft industry trends leading to low volume growth was a dampener for Quest. We expect this challenging scenario to adversely affect Quest Diagnostics' peer Laboratory Corporation of America (LH) as well, which is scheduled to release its fourth-quarter and fiscal 2012 results on Feb 8, 2013. A look at the Zacks Earnings ESP (Expected Surprise Prediction - read: Zacks Earnings ESP: A Better Method) in the table below shows that companies like Becton Dickinson and Hologic are likely to beat the Zacks Consensus Estimate this quarter. M&A Activity Wary of an uncertain economy, MedTech companies have resorted to the acquisition route to harness their strength and diversify their offerings. Apart from the massive takeovers by Johnson & Johnson, the other major deals inked in recent times in the MedTech space include six successive acquisitions by Covidien exceeding $1.2 billion. In late December the company again entered into a definitive agreement to acquire Fremont, California-based medical device company, CV Ingenuity. After strengthening its Cardiac Rhythm Management (CRM) portfolio with the acquisition of Cameron Health, Boston Scientific recently purchased Rhythmia Medical in Massachusetts and Minnesota-based BridgePoint Medical (in October). While the former strengthens the company's foothold in the rapidly growing electrophysiology ablation business, the latter brings in a catheter-based system to treat coronary chronic total occlusion. Moreover, the company currently plans to acquire Vessix Vascular, which has developed the percutaneous radiofrequency balloon catheter technology for the treatment of hypertension. AngioDynamics (ANGO) continues to expand its base on the back of acquisitions and strategic alliances. The latest in its kitty, the Navilyst acquisition will effectively double the company's existing market share in the vascular access market. In Nov 2012, the neurovascular division of Stryker acquired Surpass Medical (for $135 million) to expand its Complete Stroke Care portfolio. Surpass' mainstay, the CE-Marked NeuroEndoGraft family of flow diverters is an attractive addition to the company's product line. In order to expand into the large and lucrative market for drug-coated balloons, C.R. Bard (BCR) purchased Lutonix Inc. in December. The worldwide peripheral vascular market for drug-coated balloons is forecast to hit roughly $1 billion annually over the next ten years. Further, the acquisition of Neomend will allow Bard to expand into another $1 billion market for surgical specialties offerings. Low global penetration and demand outstripping supply provide a positive long-term thesis for investing in the blood processing and supply chain management industry. With the acquisition of the transfusion medicine business of Pall Corporation (PLL), Haemonetics (HAE) has entered the $1.2 billion whole blood collection market. Haemonetics is also in the process of acquiring Hemerus Medical that develops technologies for the collection of whole blood, and processing and storage of blood components. The acquisition is expected to close in 2014. Also noteworthy is women's health giant Hologic's acquisition of Gen-Probe in August. In addition, Cooper Companies (COO), a global medical products player acquired Denmark-based Origio to beef up its women's health franchise. Trends over the recent past reflect focus on the diagnostics space. A prime example is that of Agilent Technologies entering into the Diagnostics and Genomics space through the acquisition of cancer diagnostic company Dako. The acquisition is intended to augment Agilent's portfolio and build a global market share to better fight its major peers, especially Teradyne (TER), Thermo Fisher Scientific, Inc. (TMO) and Danaher Corp. (DHR) in this space. In November, Danaher acquired IRIS International, a leading manufacturer of automated in-vitro diagnostics systems and consumables and a provider of high-value personalized medicine solutions. While Thermo Fisher Scientific strengthened its Specialty Diagnostics business with the acquisition of One Lambda, a leading player in the field of transplant diagnostics, Life Technologies' (LIFE) three recent tuck-in acquisitions -- Compendia Bioscience, Navigenics and Pinpoint Genomics -- will bolster its diagnostics franchise. Moreover, Life Technologies has several agreements with pharmaceutical players such as Bristol-Myers Squibb (BMY) to shore up its companion diagnostics franchise. In the light of the discussion above, 2012 has thus been a big year for mergers and acquisitions in the MedTech space. According to the American Council for Capital Formation's (ACCF) report, effective Jan 2013, capital gains tax rate increased to 20% from 15% earlier. The MedTech giants, being fully aware of this expected increase, accelerated their acquisition strategy in 2012. Despite the bleak prognosis, we do not expect the M&A trend to slacken going forward. We expect a significant pickup in in-licensing activities and collaborations for the development of pipeline candidates. Several MedTech majors struggling in their core businesses are looking to explore potential emerging therapies through collaborations and alliances. Emerging Markets Another avenue of growth for the MedTechs is the huge untapped potential of the emerging markets. An aging population, rise in wealth, government focus on healthcare infrastructure and expansion of medical insurance coverage make these markets a happy hunting ground for global medical device players. The focus on emerging markets is all the more significant given the saturation and uncertain growth in the developed markets of US, Europe and Japan. Companies like Medtronic, Boston Scientific, Thermo Fisher Scientific and Life Technologies are all vying to expand their presence in the BRICs and other emerging markets. These companies are also looking to establish their manufacturing facilities abroad. According to a recent McKinsey & Co. report, health-care spending in China has more than doubled from $156 billion in 2006 to $357 billion in 2011. It is expected to grow to $1 trillion by 2020. China is also setting up proper health insurance coverage that should boost the healthcare sector. It is expected that within the next decade, China will be the biggest healthcare market in the world, outpacing the US. Among the other BRIC members, Brazil is currently the largest health care market in Latin America, covering almost one-fourth of the population. Though India has one of the largest and fastest growing health-care markets in the world, it is considered to have the least developed health-care infrastructure and spends relatively little on health care. In order to reverse the trend, during the 12th Plan (2012-2017), the Indian government planned to spend 2.5% of its GDP (up from 1.2% earlier) on healthcare and raise it to at least 3% by 2022. Given the huge potential in these regions, Johnson & Johnson has set up manufacturing and R&D centers in Brazil, China and India. While it has been doing business in China for more than 25 years, it established a new innovation center in the country in 2011. The Guangzhou Bioseal Biotech deal marked the company's first MedTech acquisition in China. The company is expected to expand further in China on the back of the Synthes acquisition. Medtronic, on the other hand, is targeting 20% of its revenues from emerging markets by fiscal 2015-16. After setting up its Innovation Center in Shanghai, the first outside the US and Europe, last September, the company decided to acquire China Kanghui Holdings for $816 million. The acquisition would strengthen its orthopedic franchise in the country. Boston Scientific is aiming to increase its below-average market share in the $700 million combined drug-eluting stent market in China and India, which is growing sharply at 20%. The company plans to invest $150 million in China over the next 5 years to build a local manufacturing operation. Life Technologies expects emerging markets to contribute $1.6 billion to revenues in 2015, up from just $188 million in 2007, representing a CAGR of 30%. In the third quarter of 2012, the company acquired Genewindows, a distributor covering the Invitrogen brand reagent portfolio. In October 2012, the company entered into a strategic partnership with Sino Biological, a Chinese biotechnology company and a license and supply agreement with Singapore based VelaDx. Thermo Fisher is also expanding its presence in emerging markets. It expects to garner 25% of total revenues from the high-growth Asia-Pacific region and emerging markets by 2016, up from 19% in 2011 and 10% in 2006. Healthcare Reform: MedTech Tax Woes The Government-mandated health care reform in the US - the Patient Protection & Affordable Care Act (aka "ObamaCare") - has already started impacting the financial results of medical device companies. The reform has led to a less flexible pricing environment for these companies and has increased pricing pressure across the board. As per the mandate, beginning 2013, device makers will have to pay this tax on sales of certain products. With the first tax installment due by the end of this month, many of the nation's medical devices players are bracing themselves for the impact of this tax. The companies are either trying to relocate outside the US or reduce operations in order to weather the 2.3% tax burden. They are undertaking various restructuring initiatives to counter costs associated with the implementation of the new tax. Earlier this month, the Medical Device Manufacturers Association (MDMA) released a statement expressing its disappointment with the failure to repeal the medical device tax in the fiscal cliff deal. According to the MDMA, the outlay has already been felt across the country in the form of an adverse impact on R&D investment, job cuts and higher prices for customers impacting the overall quality of patient care. OPPORTUNITIES We continue to have a Neutral outlook on large-cap medical device stocks. While the companies will keep facing challenges like pricing pressures, declines in procedural volume from economic uncertainties and sluggish growth in the CRM business, increased M&A activities, focus on emerging markets and product approvals in latent areas could help reduce the impact. Better pipeline visibility and appropriate utilization of cash should increase confidence in the medical device sector. Zacks Rank #2 (Buy) stocks in the MedTech sector include Johnson & Johnson (JNJ) and Edwards Lifesciences (EW) among others. In our universe, we see growth potential in companies dealing with promising technologies. In this respect, both these companies represent a value proposition. In spite of several core market challenges, the big three medical device players -- Medtronic, Boston Scientific and St. Jude Medical (STJ) -- are striving to gain share in the ICD market through several new product launches. The big three are also exploring new avenues of growth beyond the mature pacemaker and ICD markets. With gradual stability in the ICD market, they should be able to revive their top line. Beyond the MedTech majors, we are optimistic about the Zacks #2 Ranked orthopedic devices player Zimmer Holdings Inc. (ZMH). The percentage of the population over age 65 in the US, Europe, Japan and other regions is expected to nearly double by the year 2030. In the US, the oldest baby boomers are now approaching retirement age. We believe the orthopedic giants will stand to benefit from this aging demography. Among the scientific instrument makers, Thermo Fisher Scientific (TMO), a Zacks Rank #2 stock, has been successfully expanding operating margins over the past few quarters on the back of operational efficiency. Its rival Life Technologies (LIFE) has the same rank based on its strong position in the life sciences market and momentum of its Ion Torrent franchise. We are also positive on Cooper Companies (COO), another Zacks Rank #2 stock, based on factors such as margin expansion, acquisitions, product line expansion and geographical reach as well as share buybacks. CHALLENGES AND WEAKNESSES Apart from the medical devices excise tax discussed earlier, the US medical device industry is facing several challenges in the form of depressed volumes, pricing pressure, currency headwinds and a complicated regulatory system. While the debt crisis in Europe remains unresolved, economies throughout the world are trying to come to terms with myriad challenges. Consequently, procedural volumes in the US have been hit by a high unemployment rate, which has resulted in the expiry of health insurance as well as a decline in enrollment in private health plans. Governments across several European countries have taken up measures to curb spending on devices, which is taking a toll on utilization. Volume headwind is likely to linger as unemployment continues to influence procedure deferrals. Players in the medical device space are also experiencing pricing pressure of varying degrees. Companies are witnessing global pricing pressure in the CRM business and in some cases in stents. Adding to the risk is the foreign exchange headwind (stemming from the strengthening of the US dollar) as medical device companies derive a chunk of revenues from overseas markets. Medical device makers are also expected to contend with margin pressure given the sustained pricing headwind. Last but not least, the highly regulated US medical device industry is hampered by stringent and complex procedures leading to approval delays. This sometimes demotivates companies, deterring them from investing in product development. In fact, according to a report based on a survey of over 200 medical technology companies, the US FDA takes a significantly high time to review compared to its European counterpart. Coming to the weakest link in the MedTech sector, we recommend avoiding names that offer little growth/opportunity over the near term. These include companies for which estimate revision trends for 2012 and 2013 reflect a bearish sentiment. These are Abbott Laboratories (ABT), Patterson Companies Inc. (PDCO), a distributor of dental, companion-pet veterinarian, and rehabilitation supplies, MGC Diagnostics Corporation (MGCD), a provider of non-invasive cardio respiratory diagnostic systems and Invacare Corporation (IVC), which provides medical equipment and supplies for non-acute care environment. All these companies carry a Zacks Rank #5 (Strong Sell). Also, cloud-based services provider athenahealth Inc. (ATHN) currently retains a Zacks Rank #5 as doubts linger around its proposed acquisition of Epocrates Inc. (EPOC). Further, pricing compressions on hips, knees and spine products, which impaired the performances of several orthopedic companies, remain a key concern, at the macro level. We remain skeptical about companies including Wright Medical Group (WMGI).