(FORTUNE Magazine) – Way back in 1949, Earl Bakken, the co-founder of Medtronic, outlined his 100-year plan. His company then was nothing more than a hospital-equipment repair shop, and the notion of implanting electrical devices in the human body evoked Frankenstein-ish images. Bakken believed such devices were the future: He envisioned gadgets to help heal every part of the body. Within a few years the rapid advance of cardiac medicine gave him his chance: He engineered the first battery-powered pacemaker.

Fifty years later Wall Street has come to regard Medtronic as a kind of medical miracle. In eight years at the hands of its fourth CEO, Bill George, Bakken's baby has morphed into a $4-billion-a-year giant whose market value has exploded from $3.6 billion to around $40 billion, as earnings have grown at a 26% annual rate. Its stock now sells at a 60% premium to the S&P 500. Medtronic's name is synonymous with pacemakers, and the company has achieved a pace of innovation that is nothing short of incredible: About 70% of its revenues come from products introduced within the past two years. So dominant is Medtronic in its field that analyst David Gruber at Lehman Brothers labels it "the best medical-device company in the world." Some on Wall Street call it the "Microsoft of the medical-device industry."

With a vast demographic tide flowing in Medtronic's favor, it's easy to think the company has it made. An estimated 65% of the growing number of people over age 65 suffer from some form of cardiovascular disease, and there are no miracle cures for the myriad ailments that afflict the aging heart. For many diseases there may never be a cure--which is why Medtronic exists. "Medtronic doesn't cure anyone. We help them live with their disease," says George.

Yet Medtronic wants--and needs--to do more than tick along with the aging population. Built into its culture is the desire to implant itself into markets far beyond the heart. Medtronic has little choice but to try: It must find new ways to grow in order to sustain its stock price. Pacemakers have been around a long time, and the boom days are over; most analysts estimate 4% annual growth in the coming years. In 1998, Medtronic's revenues grew just 7%, and its profits before charges grew 12%. Since such numbers aren't good enough to support a premium stock price, Medtronic has embarked on a high-risk expansion. "This company is growth driven. They'll do it anyway they have to," says analyst Kurt Kruger at Bank of America. CEO George is more blunt: "Either we're totally transformed or we're slipping back."

George's quest has led Medtronic into a lot of different areas all at once. It is furiously developing new cardiac-care products that go beyond pacemakers. And using its expertise in implanting things that help the body's electrical system, Medtronic is implanting pacemaker-like devices to stimulate other parts of the body, most notably the spine and the brain.

The riskiest part of George's strategy is the use of Medtronic's high-priced stock to buy much of the growth the company needs. In the past year or so, Medtronic has spent around $9 billion to swallow six major companies. Medtronic now supplies devices and surgical tools for everything from spinal operations to ear, nose, and throat procedures. Revenues have jumped from $2.6 billion in fiscal 1998 (Medtronic's year ends in April) to $4.1 billion in 1999, and are expected to reach $5 billion in 2000. The company is clearly optimistic about its acquisition binge: At a recent analysts' meeting, management said that Medtronic's earnings could grow by several percentage points more than they had previously thought--as much as 18% to 20% a year.

There's a lot of skepticism on Wall Street about this strategy--far more than Medtronic is used to facing. "I have some real questions about this company, and I think there's a problem with the valuation," says Allen Gillespie, the director of research at Gotham Capital Management. Medtronic's stock is off some 20% from its high last February. What has rattled investors' confidence is that Medtronic's cash flow has contracted dramatically in fiscal 1999, from $685 million to $455 million, and the company's biggest acquisition--its $4.3 billion purchase last January of stent-maker Arterial Vascular Engineering--has gone badly off course. Sally Yanchus, the portfolio manager of Scudder's health-care fund, calls the deal a "disaster," and few disagree. Lately Wall Street is asking bigger questions, such as how much opportunity Medtronic really has in new markets and whether the growth it has bought will be worth the price. "This is a company that has gone from doing no major acquisitions to doing a string of massive ones, and I haven't yet met a company that didn't screw that up," says a former investment banker.

No one could have predicted how badly the Arterial Vascular deal would turn out, but it raised eyebrows from the start. The stent market (stents are tiny medical scaffolds that keep diseased or damaged arteries open so that blood can flow) is extraordinarily competitive. Product cycles are mercilessly short, and surgeons have no reason to stay loyal to suppliers--they will change brands instantly if a better stent comes along. In 1998, after trying and failing to develop a successful stent business, Medtronic President Art Collins admitted that its position was "untenable," and his comments on the fierce competition in stents left some thinking that Medtronic would keep clear of a market that analyst Kurt Kruger at Bank of America calls a "barroom brawl."

Collins says that he never said that Medtronic wouldn't get into the stent business. George adds that the structure of the market changed, making it necessary. In many hospitals, purchasing committees rather than individual physicians were making product decisions; unless Medtronic could present a complete line of surgical gear, it risked being left out. "We can't have gaping holes," says George, who adds that Medtronic was facing pressure from Guidant, its archrival in the pacemaker business, because it couldn't offer stents. Guidant is a $2-billion-a-year medical device maker in Indianapolis.

Medtronic's rationale might have been more convincing had the deal turned out better. At the time Medtronic acquired it, Arterial Vascular was a top coronary stent maker, with roughly 30% of the $1.9-billion-a-year market. But within months competitors brought out superior stents, and demand for Arterial's products plunged; about six months after the purchase, Arterial's market share had shrunk to around 10%. Largely because of Arterial's problems, Medtronic was forced to announce in February that it would miss earnings estimates. "They didn't understand what they were getting into," says Kruger. Analyst David Lothson at Paine Webber estimates that the Arterial Vascular debacle has cost Medtronic shareholders some $10 billion in purchase price and lost market value.

Believing that Medtronic's management can deliver on its growth strategy now requires a leap of faith, even though George and his team are highly regarded. "Medtronic's management are not pussycats, not by any stretch of the imagination," says John Schroer, a portfolio manager at Invesco. And Medtronic has always fought the odds. In 1949, Bakken, a young electrical engineering grad student, and his brother-in-law, Palmer Hermundslie, founded Medtronic in a 600-square-foot garage in Minneapolis. The company's first home was warmed by a potbelly stove (which can't have been pleasant in the icy Minnesota winters). In the first month of operations, the partners repaired exactly one piece of equipment and grossed $8. It wasn't until the mid-'50s that a local doctor asked Bakken to design a device to help a failing heart. In 1957, Medtronic produced the first pacemaker, a bulky monster that a patient had to wear externally, strapped around his shoulders. Wires led from the box through the chest wall to the heart. The box featured knobs prominently labeled "voltage" and "pulse rate" for the doctor to adjust.

Even though the contraption saved lives, the notion of sticking something in someone's body and shocking vital parts with electrical current sounded even more repellent then than it does today. Critics predicted that the pacemaker market would never exceed 10,000 people.

Today, Medtronic pacemakers are implanted in about 250,000 people every year, and the technology has proved remarkably able to evolve with the times. The basic idea is still to supplement the body's electrical system, yet just about everything else about the product has changed. It has shrunk to the size of a small stopwatch--and packs uncanny intelligence, which lets it sense when your heart is doing fine on its own and when it needs help. It can be fully implanted in the body yet does not require major surgery. A surgeon cuts a four-inch slit under the clavicle bone, creating a pocket for the pacemaker. Then an insulated wire with a silicon tip is fed through the subclavian vein to the inner wall of the heart.

Advances in technology and medical science have given Medtronic opportunities to extend "cardiac rhythm management" beyond pacemakers. Its latest major products, which hit the market in the 1990s, are defibrillators, which rein in a speeding heart rate. The devices incorporate software that is even more complex than that of pacemakers, and their circuitry puts personal computers to shame. Medtronic's latest defibrillator has 13 million transistors, vs. seven million in the Intel Pentium II; the company produces the circuits at its own chipmaking facility.

Sophisticated as such products are, Medtronic must battle to maintain its dominance. Pricing pressures are intense, and manufacturers race to one-up each other in R&D. Because lives (and careers) require that a doctor use the best technology, a lag in a product introduction can chop a company's market share in half almost overnight. George says that at any time, Medtronic has five generations of products in development. Medtronic's most recent defibrillator, introduced just four months after its predecessor, was already 35% smaller.

What excites investors and physicians most about cardiac care is a big, untapped opportunity--devices to treat chronic heart failure (CHF), a condition in which the heart is unable to pump blood effectively. Typically caused by a complicated mix of interrelated problems, all of which must be treated concurrently, CHF is the second-most-common cause for hospitalization (childbirth is No. 1) and the only form of heart disease that is on the rise. In the U.S. alone, an estimated five million people suffer from it; there are almost half a million new cases each year. Scientists have had to make major strides in understanding how the heart works in order to even begin meeting the challenge; both Medtronic and Guidant are filing for approval from the FDA in the first half of 2000 for first-generation CHF products. Lothson at Paine Webber says that successful CHF devices could be a major factor in expanding the cardiac rhythm management market from $4.5 billion a year at present to $11 billion by 2005.

Medtronic is betting it can be as successful in neurology as it has been in cardiology. Treating neurological problems fits Medtronic's mission of "meeting unmet medical needs" (a mantra among employees), and there are no truly effective palliatives for many of those disorders, including Parkinson's disease, Alzheimer's, and epilepsy. Already, Medtronic products address problems like severe incontinence (an implanted device sends pulses to the sacral nerves in the lower back, which control bladder function). In the future Medtronic hopes to have a device that will sense a coming seizure in an epileptic and send a signal that stops it in its tracks. "Areas associated with neurology are going to be what cardiology was in the '90s," says Joe Bossong, an analyst at Needham.

Over the next few years the product that will shape perceptions about Medtronic's potential in neurology is Activa, a therapy for controlling the tremors associated with Parkinson's. The brainchild of a French neurosurgeon, Activa is a sort of pacemaker for the brain. An insulated wire lead is surgically implanted deep within the brain's communication center, the thalamus. Using an extension wire that runs under the skin, it connects to a pulse generator implanted near the collarbone. The results have been dramatic: Patients stop shaking and can function normally. But Medtronic is still awaiting FDA approval for Activa as a treatment for all the symptoms of Parkinson's, and the device is controversial. Many people, including surgeons, aren't thrilled by the idea of implanting something in the brain. "Medtronic has a lot more convincing to do and a lot more clinical data to show," says Ken Kam, a portfolio manager at Firsthand Funds.

These opportunities may pay off in the future--but Medtronic needs growth now. So just as it did with Arterial Vascular, it is spending heavily to acquire fast-growing market leaders. It paid about eight times sales, or $800 million, for its most recent target, Xomed, a Jacksonville company that makes surgical products to treat ear, nose, and throat disorders. Medtronic paid about the same multiple, or $3.6 billion, for Sofamor Danek, a Memphis maker of products for spine and cranial surgery.

With the painful exception of Arterial Vascular, there's no question that Medtronic's acquisitions are topnotch companies. Sofamor Danek, for instance, has more than a 50% share in a market that is growing at around 30% annually. But critics wonder what these businesses have to do with Medtronic's core capabilities and whether they are worth the price. George, who claims to believe that straying outside your corporate capabilities is a recipe for disaster, insists that the businesses mesh. For example, he argues that Sofamor is a natural match because Medtronic already makes spinal cord stimulation devices to treat intractable back pain, and it's pretty difficult to separate the brain from the spine. Analysts agree that the Medtronic name brings its new family members a certain luster. But product synergies? A skeptical Cole Lannum, a portfolio manager at Putnam, says that's a stretch: "Boy, you really have to wonder what ear, nose, and throat surgery has to do with electrophysiology."

The larger issue for investors is that there's no way to know how big Medtronic's new markets will be. For example, in the neurology business, developing a product that wins the FDA's approval is just the first step. Then Medtronic must persuade physicians to accept it, prove to insurers that the benefit outweighs the cost, and create a market that doesn't yet exist. From today's vantage, it's hard to believe that any of Medtronic's new businesses will be as big as cardiac care, which according to Kam represents 20% of the revenues and 50% of the profits of most hospitals. Given the unexploited opportunities in cardiac care, perhaps Medtronic should have stuck to what it knew best.

Even in the near term there's little question that Medtronic is facing challenging times. There are murmurs that the defibrillator market is slowing, which would make it next to impossible for Medtronic to meet analysts' expectations. And if its cash flow does not rebound in the next quarter, the skeptical voices will get very, very loud.

Not surprisingly, Medtronic defends its strategy. Just as with pacemakers, a new market could be 500 times bigger than anyone expects. Says Warren Watson, who is in charge of some of Medtronic's neurological ventures business: "You never find out how large a group is until the therapy that helps is there. Then they come out of the woodwork." George points out that his new, diversified Medtronic is more balanced. Before it made its acquisitions, pacemakers accounted for about 50% of sales; now they account for about 30%. Says Michael Bonsignore, Honeywell's CEO and a new Medtronic board member: "Medtronic's new growth strategy is a different game. It remains to be seen how successful it will be, but we've all gone into it with our eyes wide open to the risks."

True believers like Kruger, who says that "there's never going to be another company like Medtronic," are willing to bet that it will once again work its magic. "They understand the business better than we do. They've got the poker hand, and we don't see all the cards yet," he says. Medtronic's hand may or may not turn out to be good; for now, the only thing that's certain is that its cards are no longer all hearts.