ANALYSIS-Medtronic faces struggle to mend spine business

* Decline in spine procedures threatens turnaround plans

* Back surgery under scrutiny from insurers, government

By Susan Kelly

CHICAGO (Reuters) - Medtronic Inc is facing an uphill battle to revive its struggling spine device business, with insurers taking a harder look at whether surgery is the best way to treat lower back pain and fewer patients undergoing elective procedures in the weak economy.

Analysts are raising new concerns about deteriorating demand for spinal fusion and other back surgeries just as Medtronic, the biggest maker of the devices, is completing a three-year overhaul of its business with a new product lineup that aims to deliver growth on par with the industry.

"There are two issues for Medtronic going forward. One is the challenge of stemming their share loss and catching up to market growth. And second, the market itself is slowing," said Bernstein Research analyst Derrick Sung.

The spine unit, with $3.5 billion in annual sales, is second only to Medtronic's industry-leading heart rhythm device franchise of pacemakers and implantable defibrillators.

In recent years, the spine business stumbled as a raft of smaller rivals with lower-priced offerings proliferated in the fusion market. Medtronic also had trouble integrating Kyphon -- maker of the kyphoplasty treatment for fractures of the vertebrae caused by osteoporosis -- which it acquired in 2007.

More setbacks ensued, including a pair of studies that cast doubt on the benefit of vertebroplasty, a procedure similar to kyphoplasty, and a Department of Justice crackdown on hospitals accused of overbilling Medicare for kyphoplasty operations.

A warning from the U.S. Food and Drug Administration and a separate DOJ probe hurt Medtronic's biological bone growth stimulation product Infuse, which is under scrutiny for its use in cervical spine surgeries for which it is not approved.

"Given its size within the company, the spine business has been the problem child for management," said Edward Jones analyst Aaron Vaughn.

Medtronic's spine product sales rose a sluggish 2 percent on a constant-currency basis in the fiscal year ended in April.

At an analyst meeting in June, the company highlighted a series of new products in its core fusion and kyphoplasty lines it said would help the business return to market growth rates it pegged in the upper single digits. Medtronic is also seeking FDA approval for a new biological called Amplify.

Now, analysts are citing evidence of further declines in spine procedure volumes across the industry that threaten to derail Medtronic's prospects for a turnaround of its business.

J.P. Morgan analyst Michael Weinstein cut Medtronic shares to a "neutral" rating from "overweight" this week, citing increased resistance by insurers to approve spine procedures. He forecast flat spine sales for Medtronic in fiscal 2011 and 2.7 percent growth for the industry overall.

Johnson & Johnson, Synthes Inc, Stryker Corp and Zimmer Holdings Inc, he noted, all reported lower U.S. sales of certain spine devices in the second quarter.

"Spine market growth has fallen off precipitously," Weinstein wrote.

Bernstein's Sung said last quarter marked the first time spine companies said they were seeing a slowdown in procedure volumes, in addition to pressure on pricing.

CONTROVERSIAL PROCEDURE

Spinal fusion surgeries, in which two or more vertebrae are fused together, have grown 10 percent a year for the past decade, Bernstein said. The popularity of the procedure has risen, despite a lack of clear clinical evidence it effectively alleviates lower back pain.

The lack of compelling evidence for the procedure has led to greater scrutiny by both government and private payers alike.

"There is a lot of controversy about the use of spinal fusion surgery for lower back pain and a lot of the payers are starting to focus on this," Sung said.

UnitedHealth Group Inc, for example, initiated this spring a review of spine surgery requests it said is expected to reduce the number of "unnecessary" procedures.

Comparative effectiveness research has been funded through the U.S. healthcare reform bill that will examine the clinical evidence on spine surgeries and could further limit their growth if results show a lack of benefit, analysts said.

Morningstar analyst Debbie Wang said the next few quarters will tell whether Medtronic's revitalized product line can help it withstand price pressures and catch up to the competition.

"Right now it is coming down to a share fight. With everything we've seen about doctor visits falling off, Medtronic is going to be fighting for a smaller pool of patients," she added. (Reporting by Susan Kelly; editing by Andre Grenon)