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Krause Fund Research Spring 2016 Healthcare Recommendation: HOLD Analysts

Taylor Wingert Adam Busta taylor-wingert@uiowa.edu adam-busta@uiowa.edu

Alex Junk Manman Tai alex-junk@uiowa.edu manman-tai@uiowa.edu

Company Overview St. Jude Medical Inc. (STJ) is a global medical device company involved in developing, manufacturing, and distributing cardiovascular medical devices for the management of chronic pain and movement disorders. The company was founded in 1976 and is headquartered in St. Paul, Minnesota, with its principal geographic locations found in the United States, Europe, and Asia Pacific. Since 2013, St. Jude has acquired four companies including Thoratec, NeuroTherm Inc., Endosense SA, and Spinal Modulation Inc.37 Stock Performance Highlights 52 week High $80.84 52 week Low $48.83 Beta Value 1.212 Average Daily Volume 2.03 M Share Highlights Market Capitalization $16.64 B Shares Outstanding 283.67 M Book Value per share $14.26 EPS (ttm) $3.07 P/E Ratio 17.98 Dividend Yield 1.79% Dividend Payout Ratio 37.74% Price per share (as of 4/18/2016) $58.65 Company Performance Highlights ROA 6.86% ROE 20.90% Sales $5.54 b Financial Ratios Current Ratio 1.32 Debt to Equity 158.14 Profit Margin 15.88%

St. Jude Medical, Inc. (NYSE: STJ)

April 19, 2016

Current Price $ 58.65

Target Price Range $ 58 - $ 66

STJ Lags Competition

• M&As and R&D investments are both catalysts for growth in the health care sector. STJ has consistently invested more in R&D as percentages of sales than their two biggest competitors. STJ acquired Thoratec in 2015, and the company is better off strategically with this acquisition and is offering more comprehensive products for heart failure patients. • STJ underwent a “business realignment plan” over the past five years. They incurred over $160 million in costs for these realignment plans and have yet to realize these gains.43 • STJ has not come up with a tissue heart valve product yet and is losing market share in the heart valve space. They currently only offer mechanical valves. • The launching of the MRI-safe CRT-D product early next year would provide an opportunity for STJ to gain market share back in their CRM division which was down nearly 10% in 2015. • The Affordable Care Act will have a material impact on revenues. The focus has shifted from fee-for-service to fee-for-value. STJ’s CardioMEMS device is one of their best selling products in the CRM market, and they have had trouble receiving reimbursement from private insurers. One Year Stock Performance

Source: Yahoo Finance33

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Economic Analysis For our economic analysis of the health care sector, our team determined the following five economic variables as the most significant: unemployment, gross domestic product (GDP), government changes, interest rates, and demographics. Unemployment Unemployment is an economic factor in the health care sector that significantly affects who demands health care, whether or not there will be enough supply to meet demand, and who is qualified and willing to pay for health insurance. Only 55% of adults make use of preventive health care options while only approximately 50% of adults choose to take advantage of general health care.3 Today’s critical preventive health care resources include mammograms, pap tests, colorectal cancer (CRC) scope exams, prostate-specific antigen (PSA) tests, digital rectal exams, annual checkups, and seasonal influenza vaccinations.3 With STJ in the medical equipment and supplies industry, demand for preventive health care can affect the demand health institutions have for STJ’s products required for these preventive tests. Therefore, the demand for preventive care is critical to STJ’s success. The correlation between the unemployment rate and rate of preventive health utilization is also significant, with a one percentage point increase in unemployment leading to 0.0196 (1.58%) fewer preventive health care resources used by the population.3 This relationship shows that during periods of low unemployment, more preventive health care resources are likely to be utilized, and more patients, hospitals, and health institutions will demand medical equipment and supplies from STJ. The correlation between the unemployment rate and preventive health care use while controlling for the availability of health care services is also worth noting. A one percentage point increase in the unemployment rate results in a decrease in average state health care employment by 760 jobs, indicating that there are relevant signs of cyclicality in the health care sector.3 In addition to the patients who need STJ’s products, health care employment is also directly tied to the demand of STJ’s products and is a critical variable in the health care system. The unemployment rate also has significant connections to health insurance. Health insurance helps the population receive proper medical attention and helps pay for this medical attention. Individuals without health insurance

are normally in worse condition in comparison to those with health insurance. The Patient Protection and Affordable Care Act (PPACA) was passed in 2010 in an effort to change this imbalance, raising public health insurance qualifications while encouraging employer-provided health insurance.7 A negative relationship also exists between the unemployment rate and probability of having health insurance. For adult males, a rise in unemployment by one percentage point equates to a 1.67 percentage point decrease in the probability of having health insurance from any source, a 1.00 percentage point decrease in the chance of having company-paid health insurance, and a 1.44 percentage point decrease in the probability of the individual buying health insurance protection independently.7 Consequently, the unemployment rate is a key factor in health insurance protection. Individuals without health insurance will be less likely to afford STJ products. More importantly, STJ products will not be able to reach the uninsured population, further limiting their value and use. Large fluctuations in the unemployment rate can also provide many positive and negatives for the healthcare sector. The Great Recession from December 2007 to June 2009 caused the US unemployment rate to soar from 5.0% to 9.5% as illustrated below.7

Source: Periodot47 This 4.5% increase equated to 9.3 million citizens (7.1 million men, 2.2 million women) aged 18-64 years old losing health insurance over the course of the Great Recession.7 Therefore, the issue with unemployment and health insurance is that the population does not necessarily control whether they are insured. The unemployment rate dictates the economic conditions that determine whether or not employers can provide insurance or if the population can independently afford

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insurance. The following graph demonstrates the sharp rise in the percentage of uninsured correlated with the unemployment rate throughout the duration of the Great Recession.

Source: Center for American Progress Action Fund53 During the post-recession period, the percentage of uninsured also continued to rise, but the increase was not as sharp as during the recession. Another observation is that the uninsured rate slightly rose after ACA enforcement, meaning that the Affordable Care Act did not change the relationship between unemployment and health care as much as government would have liked. However, the effects of the ACA were also likely masked by the post-recession recovery that was still occurring during ACA approval. The sharp drop in the uninsured did not occur until the end of 2013, when the percentage significantly dropped over one year as shown below.

Source: Gallup48 Since the Great Recession, the economy has made a considerable comeback. The following graph shows that

job creation has been on the rise since 2010, boosting the economy and steadily decreasing the unemployment rate. STJ ranks below Medtronic and Boston Scientific Corporation in many product categories so the addition of more jobs in health care will only help spur demand for its medical equipment. An additional and useful metric is the Insured Unemployment Rate (IUR) defined as the percent of the labor force eligible to receive unemployment insurance benefits.24 An increase in unemployment stems from an increase in IUR. The IUR has steadily dropped since 2008, and the unemployment rate is expected to follow suit.24 Our team believes the unemployment rate will stay relatively stable the next two years, slightly increase in 2018, and then decrease back to 5.0%. While the ACA transitions the healthcare system from fee-for-service to fee-for-value55, hospitals should see less volume. Due to the required enrollment however, more individuals may receive the necessary medical attention provided by STJ’s medical equipment and supplies.

Source: Forbes49 Gross Domestic Product (GDP) Gross Domestic Product (GDP) is a commonly used economic metric that measures the market value of all goods and services produced. Around 17.5% of GDP spending in America came from health care. The following graph demonstrates that in comparison to other countries, the US clearly spends the most on health care and is well above the rest of the world. In recent years, legislative reform like the Affordable Care Act (ACA) as well as the Great Recession have had tremendous

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influence on health care spending. The timing of the ACA implementation and the economic recovery has complicated the relationship between GDP and health expenditures, most notably from 2013 to 2015. Health care spending grew 4.5% from 2013 to 2014 due to coverage expansions from the Affordable Care Act. Health care spending grew 5.5% in 2015, representing the largest increase in spending since 2007.5 As of July 2015, approximately 8.4 million Americans are estimated to have acquired health insurance through the ACA.4 This enrollment is good news for STJ as they continue to develop medical devices for adults and the baby boom generation.

Source: The Wall Street Journal50 Excess health spending growth adjusted for GDP and inflation from 1965 to 2011 is illustrated by the following graph. From 1965 to 2011, inflation adjusted GDP explained 85% of the variation in health care spending.2 Changes in health care spending frequently lag behind changes in real GDP and are usually more extreme, with a 1% change in real GDP leading to a 1.49% change in health care spending.2 This relationship indicates that health care spending grows faster than the economy and benefits STJ and the medical equipment and supplies industry in most respects. From 1997-2002, real GDP grew 3.4% on average, and from 2001-2003, health spending grew 8.8% on average. From 2007-2012, real GDP only grew 0.8% on average, and health care spending fell and averaged approximately 4.2%. From 1960-2011, health care spending has grown 2.6% faster than GDP.2 The relationship between GDP growth and health expenditures complicates the corresponding effects. An increase in health care expenditures as a percent of GDP helps the health care sector and STJ yet burdens the US government with significant expenses including Medicare, Medicaid, and social security expenses that account for a majority of the government budget.

Source: KFF2 Actual and projected growth in health care spending according to components of GDP and inflation are illustrated by the following chart. Health care expenditures are predicted to increase 6% per year on average for the next 10 years due to ACA expansion and an aging demographic.6 The corresponding increase in expenditures with an older population is key for STJ because many of their products are directed to the older population that will require medical equipment. Increased expenditures can expose the health care industry to increased government supervision. A rising concern for policy makers and economists has been the disproportionate amount of GDP allocated to health care. Even though the US is devoting too many resources to health care compared to many other developed nations, the health care system in the United States is among the poorest performers on different health care metrics.25 The ACA is expected to decrease the number of people without health insurance in this country by 30 million before 2023, creating market opportunities for the entire health care sector along with STJ and the medical devices industry.8 In terms of overall GDP growth, our expectations are GDP will grow around 2.6% in 2016 and will slowly decrease to 2% by 2020.3 Our analyst team believes GDP will be fairly consistent over the next five years.

Source: KFF2

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Government Changes The US government has been very influential on the health care sector with the power to create, manipulate, and revise the regulations associated with the health care system. The regulations affect the revenue and costs of STJ. The most recent influential legislation in health care occurred in 2010 when the Patient Protection and Affordable Care Act (PPACA) was enacted. The result of this legislation increased the amount of Americans enrolled in health insurance plans. 11.7 million Americans are expected to have enrolled during the 2015 enrollment period.17 The ACA enactment has resulted in a decrease in the number of uninsured Americans as represented by the following graph. About 11.4% of Americans were uninsured in 2015, down from 14.6% in 2008.17 As of July 2015, 8.4 million Americans are estimated to have acquired health insurance through the expanding ACA. As more and more Americans receive insurance, government regulations will undoubtedly become stricter due to a tighter money supply.4

Source: White House51

Supplementing the ACA are new costs enforced on companies in the health care sector that offset generated income from more Americans paying for health insurance.10 Health care spending grew 5.5% in 2015, becoming the largest increase in spending since 2007. Future costs that will impact the healthcare sector include the Cadillac Tax of January 2018, a planned excise tax of 40% to employers who provide their employees with high-cost health benefit plans.16 The goal of the tax is to try and eliminate excess health care spending. The tax will also be used to help pay for ACA expansion. On top of the 2.3% tax on most of STJ’s medical devices, the Cadillac tax could further limit STJ from offering its employees large health benefit plans in the future which would have a negative effect on the company.

Source: Centers for Medicare and Medicaid Services As time passes, health spending at both the state and local levels will increase. Due to ACA coverage expansions and premium subsidies, state and local governments are projected to account for 47% of health spending by 2024, an increase of 4% from 2013.15 The ACA is expected to decrease the number of individuals without health insurance in the US by 30 million before 2023. Around 19.1 million people are also projected to register for Medicare during the next eleven years. Medicare spending is projected to grow at 7.4% from 2015 to 2022 due to a growth in enrollment from the aging population.8 An increase in Medicare spending will have positive effects on STJ’s product line as many of their products are intended for use by the aging population. However, stricter regulations, tighter budgets, and a focus on quality for care providers could hurt STJ. Lastly, the result of the 2016 presidential election could affect the future forecast for government regulations within the health care sector. There are some candidates who desire to further advance the ACA while other candidates may look to repeal the ACA in order to pursue alternative health care reform. The election result will signal to STJ where the health care system and industry is likely headed. Interest Rates The health care sector relies heavily on capital for renovations and operations. Companies usually have high levels of debt in their financial statements because of their capital dependence, and the debt includes loans with both fixed and variable rates. Debt is often refinanced when interest rate environments are low because the lower cost of capital leads to more profitability.21 STJ has managed to take advantage of low interest rates as the company has successfully acquired Thoratec, NeuroTherm Inc., and two other companies in the past few years. STJ’s strong current ratio in the industry also shows they are capable of paying off debt. The following

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graph illustrates historical performance of the target and effective federal funds rates.

Source: Market Realist52 The effective federal funds rate is expected to reach 1% by the end of 2016 and 4.5% by 2020.23 While we believe the expectations of a 1% rate will hold true, the stagnant and projected decrease in GDP growth along with global uncertainty will move the rate below 1% by 2020. STJ should continue to take advantage of these low rate opportunities for future acquisitions and company expansions. Demographics As the population ages, additional medical care is needed. The baby boom generation is heading into retirement, and Medicare enrollment is set to grow by an average of 1.6 million people per year.1 As a result, STJ can expect to see an increase in sales from a good majority of their product categories. Medical costs per person are highest at approximately 80 years old excluding expenditures associated with long-term and home health care. Males aged 19-34 have the lowest per-person medical costs for men, and females aged 0-18 years have the lowest per-person medical costs for women. Health care expenditures associated with long-term care and home care increases exponentially beyond 65 years of age. The correlation between age and health care holds in that the older the individual, the higher the expenditures associated with health care treatment. The three dominant factors that mediate this positive relationship are high medical costs associated with death and the increasing likelihood of death with age, increasing long-term and home care with age among the very elderly, and the severity of diabetes-related complications with age.11 The following graph illustrates the rise in the percentage of 65 year olds and above working-age population since 2000.1 This rate is expected to quickly rise during the next 20 years, and we believe this demographic shift will strain

the cost of employer health insurance. In particular, employers will have fewer young and “cheap” employees and more older and “expensive” employees. However, we believe STJ will take advantage of the growing population over 65 years old and find first-mover advantages within the industry.

Source: PBS Newshour1 Capital Markets Outlook Our analyst team believes the health care sector is a safe investment with great opportunity due to the current state of the economy, the steady and increasing demand for medical attention, and government required enrollment from the Affordable Care Act. The population aged 65 and older is expected to grow over the next several years so STJ needs to be ready strategically to enhance their product line to meet this demand and take advantage of this opportunity. Approximately 19.1 million people are also projected to register for Medicare during the next eleven years, with 11.7 million Americans estimated to have enrolled in 2015. Consequently, Medicare spending is forecasted to grow at 7.4% from 2015 to 2022 in order to match this enrollment.8 Lastly, we believe the unemployment rate will remain steady at 5.0% over the next few years, leading to more job creation in the health care sector to meet increased demand. Although STJ is struggling in a few areas of their business, we believe they are still positioned to grow market share in the medical equipment and supplies industry.

Industry Analysis Industry Description STJ competes within the medical equipment and supplies industry, a component of the healthcare sector focused on the diversified manufacturing and distribution of medical products. The industry includes a variety of products that

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are used to both diagnose and treat millions of patients.35

Medical products can be classified into 2 primary categories. Conventional devices are easy to manufacture, have narrow margins, and are price sensitive. High-technology products are better suited to demand a premium as long as the competition has not yet caught up to the technology. The manufacturing of conventional products yields narrow margins. As a result, companies rely on high sales volume in order to generate revenue. The sale of conventional products is a steady stream of income for most firms that provides funding for continued research and development expenses. Reputable firms often have long-term supply contracts with institutional healthcare providers. Devices within this category of medical equipment include surgical apparel, traditional wound dressings, kits, trays, and a wide array of other products. Barriers to entry are limited, allowing easy access to new entrants and initiating intense competition. Nearly all high-technology products yield high margins until competitors catch up, which is inevitable given the weakness of patents in the medical device industry. These products face limited competition and usually command price premiums if they have established clinical effectiveness. High technology devices are subject to a more substantial approval process from the FDA as well as a longer patent process. Some examples of products that fall into the high-technology category are cardiovascular implants, orthopedic devices, wound care, various surgical instruments, and some in vitro diagnostic tests. The following graph demonstrates the segments of the medical equipment and supplies industry as well as their percentage share of the available market.

Source: IBIS World 32

Recent Developments and Industry Trends The industry is segmented into different products/services, and the market share for each is demonstrated in the figure below.

Source: IBIS World 32 St. Jude is involved in the manufacturing of cardiovascular, neuromodulation & spinal, and patient recovery devices. The health care equipment and supplies industry has largely underperformed the healthcare sector in recent years. From 2011-2014, the S&P 1500 Health Care Equipment and Supplies Index was up 77.8% compared to 115.7% for the Health Care Sector. The health care equipment and supplies industry has recently had to adjust to new health care reform. The Affordable Care Act has shifted the entire industry toward value-based health care with increased regulatory pressures and resource constraints.29 The reform could continue to negatively impact the industry as health care institutions are required to conduct operations within a tighter budget and abide by stricter regulations. Markets and Competition Competitive Landscape and Major Players Throughout the medical device industry, research and development (R&D) spending is rising as companies try to design innovative equipment in order to remain competitive. The table on the following page illustrates the R&D expenses of the top medical device companies as a percentage of total sales from the fourth quarter of 2014 through the third quarter of 2015. In terms of sales, the only firm that has invested more in R&D than St. Jude Medical is Edward Life Sciences.

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Source: Yahoo Finance33 Medtronic, which has the highest market cap, spends the most money on R&D expenses accounting for 18% of all R&D spending within this industry. Medtronic maintains a significant amount of cash both in terms of total cash and cash/share. This gives the company more flexibility in their operations and could be very useful if they were looking to acquire another company. Cash also provides a cushion in case of a market downturn, and their market cap helps their leverage with health care service providers. All of the companies included in the following graphic have current ratios greater than one, signifying that they are all capable of covering short-term liabilities with short-term assets. Specifically, Medtronic and Edwards Lifesciences are both in much better shape than their competitors with ratios greater than three.33

Source: Yahoo Finance33

STJ maintains a strong financial position amongst competitors in the medical device industry as demonstrated in the table. STJ’s return on assets (ROA) and return on equity (ROE) ratios are higher than most of their peers. These statistics demonstrate that STJ is efficient and productive with their capital and equity. STJ’s strong current ratio provides indication that they have the ability to pay off their debt. A high current ratio is often seen as an advantage when paying off debt resulting from acquisitions or similar opportunities.36 Porter’s Five Forces Analysis Threat of Competition: High Small companies often have nothing to lose when it comes to the development of a cutting edge product that replaces an existing technology. They are flexible with their operations and maintain relationships with researchers. At times, it is very easy for a small firm to raise capital from a venture capitalist for the research and development of a new product. However, they need assistance in bringing their product to market once it has been approved. Due to this and the risk and time associated with developing medical technology, smaller companies usually get bought out at some point in the early stages of medical device launches. Larger companies are usually the end suppliers for most medical devices. Threat of New Entrants: Low The conventional device category is highly competitive with low profit margins. Developing relationships and obtaining long-term contracts with hospital chains and other large-scale providers is the key to success in this category. Alternatively, the high-technology category requires a significant amount of research and development (R&D) and is highly regulated, also making entry difficult.31 Threat of Substitutes: Moderate Conventional devices tend to be commodity-like by nature, therefore making these products easily replaceable. Companies compete for market share in this space by increasing volumes, cutting costs, and obtaining long-term contracts. Firms competing for conventional product market share include Johnson & Johnson, GE Healthcare, and Medtronic. High-technology devices are better equipped to withstand the threat of substitutes due to the use of patents to offer intellectual protection. However, patents require a significant amount of resources such as time and money for development which limits the impact of patents in the medical device industry. Power of Suppliers: Low

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Conventional devices are very competitive on pricing and require large-scale operations. Highly technological products can be sold at more of a premium until the competition catches up. Power of Buyers: Moderate The conventional devices category is dominated by large companies that have been able to cut costs, scale manufacturing, and build long-term relationships with large-scale medical service providers. These service providers often belong to group purchasing organizations (GPOs) that negotiate contracts. By combining providers into groups, these organizations have more leverage in their agreements. GPOs are able to obtain significant price discounts for the providers in exchange for a minimum number of products ordered. The role of GPOs has strengthened in recent years due to cost cutting initiatives by the service providers. Additionally, the Affordable Care Act has concentrated the power of insurance companies and Medicaid/Medicare, resulting in more bargaining power. Highly technological products, on the contrary, give more leverage to the suppliers.34 Physicians oftentimes have preferences for certain products without much consideration of cost. Surgeons are very particular when it comes to the products that they select to use. Continuous improvements to old technology and the introduction of new products are very important for medical device companies to appeal to surgeons and physicians.34

Catalysts for Growth and Change R&D and M&A Companies within the medical device industry rely on research and development as well as mergers and acquisitions to gain access to the latest technological advancements. R&D funding is critical to remain innovative. Companies with a higher percentage of sales dedicated to research and development are better equipped to remain relevant and develop advanced medical products. Mergers and acquisitions are beneficial for both companies involved. Large firms usually acquire the new technology, which maintains or increases their market share. Small firms benefit because large firms devote substantial resources to acquire and build their business. Additionally, large firms have more leverage, maintain established relationships with service providers, and are often better at the production and sale of products. STJ acquired Thoratec, the leader in innovative heart pumps, for $3.4 billion in 2015.1 The acquisition helps STJ by growing their market share in the cardiovascular subsector and expanding their product expertise in heart pumps specifically.30 Growth in Chinese and Indian Markets

The United States and the European Union are massive markets; however, the growth rates for these markets have normally remained stable between 3-5%. Developing countries provide opportunities for growth. China’s large population and economic growth makes them a primary target for US medical device exports.30 Key Investment Positives/Negatives Key Investment Positives

• Aging Population The increase in population of individuals aged 65 and older results in the expanding demand for medical devices and equipment. Growing demand allows companies more pricing power, therefore leading to revenue growth, increase in sales volume, and additional contracts.

• Government Regulation Government funded programs such as Medicare and Medicaid ensure that there will always be a level of demand for medical equipment and supplies. Additionally, enrollment requirements stemming from the Affordable Care Act will give more individuals access to healthcare, therefore increasing product demand.46

• Interest Rates The Federal Reserve has preserved the fed funds rate between 0% and 0.25% since the end of 2008. The maintenance of this low interest rate has made growth through R&D and M&A much easier within the medical device industry. It also affects manufacturers’ cost of capital projects, stock repurchases, and dividends.

Key Investment Negatives

• Regulation Strict regulation and tough competition make it difficult for new competitors to enter the market. If new competitors create a breakthrough product, larger corporations are capable of buying those competitors out. This option is beneficial for both parties involved.

• Protective Patents Patent specifications are stricter for the biotechnology industry than for medical devices, leading to greater odds of litigation. Technological advancements also render products out-of-date prior to patent expiry.

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Company Analysis Company Overview St. Jude, Inc. (STJ) is a global medical device company engaged in development, manufacturing, and distribution of cardiovascular medical devices for the management of chronic pain and movement disorders.37 The company was founded in 1976 and is headquartered in St. Paul, Minnesota, with its principal geographic locations found in the United States, Europe, and Asia Pacific. Since 2013, STJ has acquired four companies including Thoratec, NeuroTherm Inc, Endosense SA, and Spinal Modulation Inc. STJ is also a leader in research and development in their industry. These two factors demonstrate STJ’s commitment to growth, especially outside of the United States where 53% of their current business is done.39 Beginning in 2011, STJ also began a “business realignment plan” that included restructuring business segments, centralizing SG&A activities, and optimizing manufacturing and supply chain operations. STJ has yet to realize any of the gains from the efficiency improvements.43 Products and Markets STJ has a portfolio of product offerings broken down into three main divisions and seven business segments. The three divisions are cardiac rhythm management, cardiology, and neuromodulation.41 STJ has seven business segments that include: ICD systems, atrial fibrillation systems, vascular products, structural heart products, neuromodulation products, and products stemming from the acquisition of Thoratec.44 The CRM business consists of around 46% of their total sales and is critical to their success.37 CRM includes the Implantable Cardioverter Defibrillation (ICD) and Pacemaker business segments. In 2015, CRM sales decreased nearly 10%, so there is cause for concern on the future of STJ in their largest product category.43 CRM is also highly competitive with a substantial amount of R&D required to remain relevant.41 STJ is committed to investing back in the company with extremely consistent R&D expenditures as percentages of sales. Over the past several years, they have averaged around 12.5% of net sales on R&D.44 Many of STJ’s recent R&D projects have involved MRI-safe cardiac rhythm products. Medtronic and Boston Scientific have already rolled out MRI-safe resynchronization therapy pacemakers (CRT-P)

and have received approval for their MRI-safe resynchronization therapy defibrillators (CRT-D), so STJ is already behind the competition on these type of products.40 STJ expects their CRT-Ps to be launched this year, and their CRT-Ds are expected to be launched early

next year.37 After these products are launched, STJ should see sales improve in their CRM division. Neuromodulation involves the stimulation of the nervous system using electrical signals. The market is extremely difficult to enter in the United States because product development takes a very long time and is incredibly expensive. Regulatory approvals and patents are also a difficult process when entering the neuromodulation market. STJ has been developing neuromodulators for relieving chronic spinal pain that do not need to be recharged and their CEO expects these to be launched soon.55 Our group believes STJ has a lot of room to grow in the neuromodulation business segment. STJ is also expected to release a leadless pacemaker later this year that will help generate growth. The acquisition of Thoratec allowed STJ to provide the most comprehensive portfolio of products for advanced heart failure patients that should lead to more physicians preferring their products. The portfolio of products now includes mechanical circulatory support devices, an area where Thoratec led. This market is particularly popular in Europe, where STJ estimates 125-130 million in revenue alone.56

Source: Thomson One37 Competition STJ’s two main competitors are Medtronic Inc. and Boston Scientific Corporation. These two companies compete with STJ in all three of their divisions.41 A chart with the market share for each company in each of the three divisions is displayed below.

Company CRM Cardiology NeuromodulationSTJ 27.62% 7.08% 9.01%MDT 19.39% 31.15% 41.62%BSX 52.99% 23.10% 10.78%

Market Share

Source: Yahoo Finance33

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STJ has seen a decrease in sales in their largest business segment over the past year. They have yet to receive FDA approval of a low-voltage CRM device, and the market is beginning to prefer these low-voltage alternatives. STJ was late to receive approval in Japan compared to their competitors in this space, and they were able to regain market share back. STJ’s CardioMEMS device is one of their best selling products in the CRM market, and they have had trouble receiving reimbursement from private insurers. The issue is the concept of fee-for-service versus fee-for value. STJ’s CEO believes this is a result of the transition of government regulation over the past few years.55 Boston Scientific received approval for their Emblem device, a device that physicians believe will take market share from STJ and Medtronic in the ICD market. The device that Boston Scientific has introduced is smaller, has better battery life, and allows for remote patient monitoring.54 The market has also shown preferences for tissue heart valves instead of mechanical valves, and STJ seems to be having a hard time adjusting. They have been losing heart valve market share due to this.44 Our group believes STJ will have to introduce a tissue valve in 2017 to remain competitive. STJ seems to be lagging with the development of new products in certain categories. Production and Distribution Production STJ owns about 75% of their manufacturing facilities, and their facilities are located in nine different states as well as Brazil, Puerto Rico, Cost Rica, Sweden, and Malaysia.43 STJ has 75% of their property, plant, and equipment (PP&E) located in the United States, and they also have advanced technology centers in Texas, Minnesota, California, China, Belgium, and Japan.44 Distribution, Suppliers, and Leases STJ uses a direct sales force in the United States, Japan, and throughout the rest of the world to market their products, and the company uses independent distributors in Japan and Asia. In the United States, STJ uses group purchasing organizations (GPOs), independent delivery networks (IDNs), and other accounts such as the Veterans Administration for group purchasing decisions for providers of health care. These relationships are normally bound with long-term contracts, making it difficult for entry into the market. STJ’s customers include CVS Caremark Corporation, Express Scripts Inc., Walgreen Co., Tenet Healthcare Corporation, and Davita Inc.41 STJ has numerous suppliers of their raw materials, and these relationships can be unstable and terminated in a short period of time. STJ leases facilities and equipment through operating lease agreements that includes 83 out

of 100 sales and administrative offices. They are currently set to owe $122 million toward operating leases in the future that are non-cancellable.44 Government Regulation The Patient Protection and Affordable Care Act (PPACA) will impact the operations and strategy of STJ moving forward. It is still hard to determine whether the ACA will have a positive or negative impact. The ACA has already imposed a tax of 2.3% on most medical devices sold in the United States in an effort to improve health care quality and decrease costs. Any decrease in volume of patients due to improved quality will adversely affect the business. On the other side, many more people are required to enroll in a health care program, which could also benefit the operations of the business.44 Health care institutions are required to conduct operations within a tighter budget and abide by stricter regulations so it is very difficult to tell yet whether the Affordable Care Act will benefit or hurt St. Jude. Business Process Improvements In 2011, STJ began a restructuring plan that realigned the CRM business. They disposed of some manufacturing and R&D operations in Europe and finished the project in 2013. In 2012, STJ began a “business realignment plan.” The company centralized information technology, human resources, legal, and marketing. There were many termination costs and write-offs associated with this plan that ended up being costly. The vision of this realignment was to accelerate growth, reduce costs, and utilize economies of scale. STJ incurred over $100 million in expenses due to severance and also had inventory/asset write-off and restructuring costs. In 2014, St. Jude implemented a “Manufacturing and Supply Chain Optimization Plan” to reduce costs, centralize vendor relationships, and create more efficient distribution processes. The company realized over $60 million in expenses due to contract terminations and information technologies that are no longer used.43 Catalysts for Growth STJ’s sales have been declining in their largest division, but the company still has plenty of opportunity for growth. Opportunities for St. Jude include the following:

• The launching of the MRI-safe CRT-D product early next year would provide an opportunity for STJ to gain market share back in their CRM division. Due to the strong contractual relationships STJ has in place, they should not have trouble entering this market. Launching a tissue heart valve would also allow St. Jude to gain market share back.

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• The acquisition of Thoratec should provide a spark to STJ’s product line. Thoratec develops, manufactures, and markets proprietary medical devices for heart failure patients. STJ has not realized any of the benefits of this acquisition yet. The company is better off strategically with this acquisition and will be able to offer more comprehensive products for heart failure patients.56

• Research and Development (R&D) is a critical metric for all health care companies due to the competitive environment and the importance of patents. STJ has consistently dedicated 12% of sales to R&D which is more than all four of their main competitors historically.

• STJ underwent a “business realignment plan” over the past five years and have not realized the gains on these improvements but have incurred a significant amount of expenses.43

Key Investment Positives and Negatives

• STJ has invested an average of 12.42% of their sales in R&D per year since 2005 which is much higher than most of their competitors. The combination of STJ’s R&D investment and low payout ratio (32.37%) compared to competitors signal they are focused on internal growth.

• STJ has not come up with a tissue heart valve product yet and is losing market share in the heart valve space. They are also losing market share in their cardiac rhythm management division because they have yet to offer a low-voltage alternative, and they are having difficulties adjusting to fee-for-value instead of fee-for-service.

• STJ is dependent on volume with many of their product lines, and the Affordable Care Act will have an impact on volume. The company could therefore be negatively impacted by the ACA. However, increased enrollment could help offset the decrease in volume. It seems the ACA has been hurting more than helping STJ since its implementation.

Valuation Analysis Our group has decided to issue a “hold” recommendation for STJ because we do not necessarily like the outlook of the cardiac rhythm division for them, but we do believe that they have yet to realize many of the benefits stemming from their supply chain and operations projects. STJ also invests heavily in research and

development compared to their competitors, a strategy in the long run that should separate themselves in an industry that is very competitive. We also believe that the current climate we are in as a demographic with the aging population of baby boomers will benefit STJ over the next decade. Revenue Growth In order to project overall revenue growth for STJ, we separated sales into their seven product categories. We then computed historical growth rates for each category and also computed each category as a percentage of overall sales. Our inputs for revenue growth were growth rates for each of the seven categories for all six years in our model. These growth rates dictated the year’s sales for that category. The growth rates were based on revenue growth rate estimates from analysts, STJ’s Form10k, and from our own projections for the individual categories. We believe STJ will continue to struggle in their CRM division, but not nearly the 10% loss they took in 2015. STJ is expected to launch leadless pacemaker systems this year that will generate demand and revenues later this year.56 We expect the pacemaker division to grow 7%. We expect their neuromodulation segment to grow around 10% due to their new spinal product that will not have to be recharged. Their products received from the acquisition of Thoratec will also provide a spark in revenue in 2016 because they are equipped to dominate the advanced heart failure market. Our economic outlook also had an impact on our estimates. We predict that the economy will have a small downturn in 2018 due to global economic uncertainty and slow GDP growth. We forecasted revenue growth rates until 2021 when we believe STJ will reach a steady state. STJ is already in the maturity stage of the company life cycle. The acquisition of Thoratec will have an impact on revenue growth, and we believe that six years is enough time to allow revenues from Thoratec’s product category to stabilize. Profit Margins STJ’s gross margin has been consistently around 75% historically. We estimated our COGS as a constant percentage of sales based on historical percentages so our gross margin is constant as well. We forecasted items such as SG&A expense and other expenses as a percentage of revenues based on historical percentages. The historical percentages were fairly consistent so we are confident in our expense projections. Their profit margins are usually around 15%. Our profit margins are a little more pessimistic partly because of our interest rate expense projections as well as the negative growth in STJ’s main product category and the competitive

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environment in the medical device industry. Amortization expense was calculated using a historical amortization rate of amortization as a percentage of intangible assets. Research and Development (R&D) STJ does a great job at reinvesting back in the company through research and development. We used a historical average of their R&D expense as a percentage of sales from 2005-2015 to get our projection for the next six years. Due to STJ’s consistency in their R&D figures, we are extremely confident in our R&D projections. Capital Expenditures Property, plant, and equipment (PP&E) was forecasted assuming constant PP&E purchases of $100, which was much less than STJ’s purchase amount in 2015. STJ normally purchases between $175 and $220 million worth of PP&E each year, and the company’s purchases have been decreasing over the past three years. Because of St. Jude’s current cash constraints, we think they will be required to cut back on PP&E purchases. Other Key Assumptions Long-Term Debt LTD was forecasted as a percentage of non-cash assets based on the percentage in 2015. With the acquisition of Thoratec, we felt 2015 was the most reflective of the current state of long-term debt. Common Stock Repurchases We obtained common stock repurchasing information from their 10K. Interest Rate Expense Our analyst team forecasted interest expense by multiplying the cost of debt by the sum of current and long-term debt. Dividend Payments STJ has been consistently increasing dividends by $0.08 per year. We assumed they will continue to increase dividends by this amount. Weighted Average Cost of Capital (WACC) Our analyst team arrived at a WACC of 7.68% utilizing a capital structure of 70.93% equity and 29.07% debt. The cost of equity and cost of debt were calculated as follows: Cost of Equity Our group utilized the Capital Asset Pricing Model (CAPM) approach to calculate the cost of equity. We assumed a risk-free rate equal to the yield on the 30-year US Treasury bond because we felt this number best

reflects the market’s future expectations and contains a lot of forward-looking economic data. For beta, we used Bloomberg to determine the average of the 1-year, 2-year, 3-year, 4-year, and 5-year weekly and monthly raw betas. Our group found this beta to be accurate because the 5 raw betas used all seemed to stabilize around the average of these betas and contained no outliers. Lastly, for the Equity Risk Premium (ERP), our group used Damodaran’s implied equity risk premium of 5.5%, as this premium matched our forecast horizon well. Using these estimates, our group arrived at a cost of equity of 9.29%. Cost of Debt For the cost of debt, our group utilized the Yield-to-Maturity (YTM) of STJ’s bond set to mature on April 15, 2043.We believe this figure was best to use because it accurately matches our forecast horizon. Using this yield along with a marginal tax rate of 12.30%, our group arrived at a cost of debt of 3.75%. Valuation Models Discounted Cash Flow and Economic Profit Model Using the DCF and EP models, we obtained identical prices of $66.35 per share for STJ. This price was driven from our value driver estimates for NOPLAT, FCF, and EP. Key inputs included the CV growth rate, CV return on invested capital (ROIC), the WACC, and the cost of equity. The price was then adjusted for year-to-date. Dividend Discount Model (DDM) The DDM model discounted future dividend payments and the projected CV price based on STJ’s future P/E ratio and EPS. This model gave us a price of $39.60. Our group believes this price is reasonable because STJ has very consistent dividend payment increases of $0.08 per year. Relative Valuation In our relative valuation model, our group compared relative P/E multiples of several competitors of STJ. We also compared price/sales and price/book based on the ratios of STJ’s competitors. We used the averages of STJ’s main competitors to compute what STJ’s theoretical price should be. For the relative P/E ratio, we multiplied the average P/E of their competitors by STJ’s EPS in both 2016 and 2017 to arrive at prices of $30.26 in 2016 and $36.16 in 2017. Similarly, for price/sales, we multiplied the average of STJ’s competitors by STJ’s revenue/share to calculate prices of $74.12 and $80.70 in 2016 and 2017, respectively. For price/book we multiplied the average of STJ’s competitors by STJ’s equity/share to get prices of $52.68 and $50.30 in 2016

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and 2017, respectively. Our group believes that the P/E ratio is the most relevant for health care companies. Sensitivity Analysis For our sensitivity analysis, we wanted to see how much our most influential assumptions changed the price based on minor changes in these assumptions. We compared the equity risk premium against the beta, the WACC against the CV growth rate, COGS against SG&A, and the cost of debt against the PV of leases/PP&E ratio. Beta was one of our toughest assumptions because of all the different options for calculating beta. The price ranged from $53.01 to $84.40 by incrementally changing beta from 1.412 to 1.012. Our group settled on a beta in the middle of those two values by running several regressions of St. Jude’s price against the S&P 500 price for one, two, three, four, and five years as well as weekly and monthly for each. The beta of 1.212 was in the middle of the extremes of these calculations and seemed like the right choice. The WACC was also a choice for a few of the sensitivity tables. The WACC was used to discount cash flows in both our DCF and EP models, so this figure can sway the price quite a bit. Overall, our target price ended up being between $58 and $66 with STJ currently trading at $58.65.

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Important Disclaimer This report was created by students enrolled in the Applied Equity Valuation (6F:112) course at the University of Iowa. The report was originally created to offer an internal investment recommendation for the University of Iowa Krause Fund and its advisory board. The report also provides potential employers and other interested parties an example of the students’ skills, knowledge and abilities. Members of the Krause Fund are not registered investment advisors, brokers or officially licensed financial professionals. The investment advice contained in this report does not represent an offer or solicitation to buy or sell any of the securities mentioned. Unless otherwise noted, facts and figures included in this report are from publicly available sources. This report is not a complete compilation of data, and its accuracy is not guaranteed. From time to time, the University of Iowa, its faculty, staff, students, or the Krause Fund may hold a financial interest in the companies mentioned in this report.

St. Jude Medical, Inc.Revenue Decomposition

Fiscal Years Ending Dec. 31 2013 2014 2015 2016E 2017E 2018E 2019E 2020E 2021E (CV)SalesCardiovascular Medical Devices 5,501 5,622 5,541 5,809 6,136 6,032 6,274 6,494 6,652

GrowthCardiovascular Medical Devices -0.04% 2.20% -1.44% 4.83% 5.64% -1.70% 4.02% 3.50% 2.43%

Net SalesICD Systems 1,741 1,746 1,582 1,487 1,517 1,471 1,493 1,508 1,523 Atrial Fibrillation Products 957 1,044 1,096 1,206 1,266 1,203 1,275 1,338 1,379 Pacemaker Systems 1,042 1,047 941 1,007 1,047 1,016 1,041 1,062 1,083 Vascular Products 704 709 716 737 760 744 759 774 790 Structural Heart Products 631 639 595 577 586 574 586 597 609 Neuromodulation Products 426 437 475 523 580 586 630 674 701 Thoratec Products - - 136 272 381 438 490 540 566 Net Sales 5,501 5,622 5,541 5,809 6,136 6,032 6,274 6,494 6,652

Percentage of Net SalesICD Systems 31.6% 31.7% 28.8% 25.6% 24.7% 24.4% 23.8% 23.2% 22.9%Atrial Fibrillation Products 17.4% 19.0% 19.9% 20.8% 20.6% 19.9% 20.3% 20.6% 20.7%Pacemaker Systems 18.9% 19.0% 17.1% 17.3% 17.1% 16.8% 16.6% 16.4% 16.3%Vascular Products 12.8% 12.9% 13.0% 12.7% 12.4% 12.3% 12.1% 11.9% 11.9%Structural Heart Products 11.5% 11.6% 10.8% 9.9% 9.5% 9.5% 9.3% 9.2% 9.2%Neuromodulation Products 7.7% 7.9% 8.6% 9.0% 9.5% 9.7% 10.0% 10.4% 10.5%Thoratec Products - - 2.5% 4.7% 6.2% 7.3% 7.8% 8.3% 8.5%Sum - - 100.7% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0%

GrowthICD Systems -2.49% 0.29% -9.39% -6.00% 2.00% -3.00% 1.50% 1.00% 1.00%Atrial Fibrillation Products 6.57% 9.09% 4.98% 10.00% 5.00% -5.00% 6.00% 5.00% 3.00%Pacemaker Systems -1.68% 0.48% -10.12% 7.00% 4.00% -3.00% 2.50% 2.00% 2.00%Vascular Products 3.10% 0.71% 0.99% 3.00% 3.00% -2.00% 2.00% 2.00% 2.00%Structural Heart Products 0.71% 1.27% -6.89% -3.00% 1.50% -2.00% 2.00% 2.00% 2.00%Neuromodulation Products - 2.58% 8.70% 10.00% 11.00% 1.00% 7.50% 7.00% 4.00%Thoratec Products - - - 100.00% 40.00% 15.00% 12.00% 10.00% 5.00%

St. Jude Medical, Inc.Income Statement

Fiscal Years Ending Dec. 31 2013 2014 2015 2016E 2017E 2018E 2019E 2020E 2021E (CV)Net sales 5,501$ 5,622$ $ 5,541 $ 5,809 $ 6,136 $ 6,032 $ 6,274 $ 6,494 $ 6,652 Cost of Sales:

Cost of sales before special charges: 1,529 1,597 1,706 1,832 1,884 1,828 1,871 1,912 1,941 COGS 1,311 1,376 1,488 1,560 1,648 1,620 1,685 1,744 1,786 Depreciation 218 221 218 272 237 208 186 168 154

Special charges 45 56 39 54 57 56 58 60 62 Total cost of sales 1,574 1,653 1,745 1,886 1,941 1,884 1,929 1,972 2,002

Gross profit 3,927 3,969 3,796 3,923 4,195 4,148 4,345 4,521 4,650 Selling, general and administrative expense 1,805 1,856 1,878 2,028 2,143 2,106 2,191 2,268 2,323 Research and development expense 691 692 676 721 762 749 779 806 826 Amortization of intangible assets 79 89 116 247 219 195 173 154 137 Purchased in-process research and development charges - - - 8 9 9 9 9 10 Special charges 301 181 96 129 136 134 139 144 147

Operating profit (loss) 1,051 1,151 1030 790 926 955 1,054 1,140 1,207 Interest income (5) (5) (3) - - - - - -Interest expense 81 85 103 274 266 264 253 248 246Other (income) expense 191 3 2 11 12 12 12 13 13Other expense, net 267 83 102 285 278 275 265 260 258

Earnings before income taxes and noncontrolling interest 784 1,068 928 505 648 680 788 879 948Income tax expense 92 113 62 62 80 84 97 108 117

Net earnings before noncontrolling interest 692 955 866 443 568 596 691 771 831Less: Net loss attributable to noncontrolling interest (31) (47) (14) - - - - - -

Net earnings attributable to St. Jude Medical, Inc. 723$ 1,002$ 880$ 443$ 568$ 596$ 691$ 771$ 831$ Net earnings per share attributable to St. Jude Medical, Inc:

Basic 2.52$ 3.52$ 3.11$ 1.62$ 2.14$ 2.31$ 2.76$ 3.15$ 3.48$ Diluted 2.49$ 3.46$ 3.07$ - - - - - -

Cash dividends declared per share: 1.00$ 1.08$ 1.16$ 1.24$ 1.32$ 1.40$ 1.48$ 1.56$ 1.64$ Weighted average shares outstanding:

Basic 287.0 285.0 282.2 273.3 265.2 257.7 250.9 244.6 238.9

St. Jude Medical, Inc.Balance Sheet

Fiscal Years Ending Dec. 31 2013 2014 2015 2016E 2017E 2018E 2019E 2020E 2021E (CV)ASSETSCurrent Assets:

Cash and cash equivalents 1,373 1,442 667 459 408 215 126 144 204Accounts receivable, less allowance for doubtful accounts 1,422 1,215 1,237 1,456 1,538 1,512 1,573 1,628 1,667Inventories 708 784 909 759 802 788 820 849 870Deferred income taxes 229 291 264 224 237 233 242 251 257Other current assets 178 182 188 217 229 225 234 243 249

Total current assets 3,910 3,914 3,265 3,116 3,214 2,974 2,996 3,114 3,246Property, Plant and Equipment:

Land, building and improvements 651 709 729 744 770 796 822 848 874Machinery and equipment 1,674 1,616 1,597 1,662 1,720 1,778 1,836 1,894 1,952Diagnostic equipment 474 450 441 461 477 493 509 525 541

Property, plant and equipment, at cost 2,799 2,775 2,767 2,867 2,967 3,067 3,167 3,267 3,367Less: accumulated depreciation (1,389) (1,432) (1,447) (1,719) (1,956) (2,164) (2,350) (2,518) (2,673)

Net property, plant and equipment 1,410 1,343 1,320 1,148 1,011 903 817 749 694Goodwill 3,524 3,532 5,651 5,651 5,651 5,651 5,651 5,651 5,651Intangible assets, net 911 851 2,226 1,979 1,760 1,565 1,392 1,238 1,101Deferred income taxes, net 116 113 132 129 136 134 139 144 147Other assets 377 454 470 430 455 447 465 481 493

TOTAL ASSETS 10,248$ 10,207$ 13,064$ 12,453$ 12,228$ 11,673$ 11,460$ 11,376$ 11,332$ LIABILITIES AND SHAREHOLDERS' EQUITYCurrent Liabilities:

Current debt obligations 62 1,593 1,163 1,163 1,172 1,079 1,010 1,001 1,006Accounts payable 247 151 201 258 272 268 278 288 295Dividends payable 72 77 82 89 92 95 97 100 102Income taxes payable 32 60 201 30 38 40 47 52 56Employee compensation and related benefits 312 292 309 317 335 329 343 355 363Accrued expenses and other current liabilites 655 493 517 563 595 585 608 629 645

Total current liabilities 1,380 2,666 2,473 2,420 2,504 2,395 2,383 2,425 2,467Long-term debt 3,518 2,273 5,229 5,059 4,986 4,833 4,781 4,738 4,694Deferred income taxes 240 240 738 314 331 326 339 351 359Other liabilities 706 784 582 681 719 707 736 761 780Total Liabilities 5,844 5,963 9,022 8,474 8,541 8,262 8,238 8,275 8,300Commitments and Contingencies - - -

Shareholders' EquityCommon stock and additional paid-in capital 249 147 176 176 176 176 176 176 176Unearned compensation - - - - - - - - -Retained earnings 3,936 4,225 4,211 3,804 3,511 3,236 3,046 2,926 2,856Accumulated other comprehensive income (loss) 46 (173) (345) 0 - - - - -Total shareholders' equity before noncontrolling interest 4,231 4,199 4,042 3,980 3,687 3,412 3,222 3,102 3,032Noncontrolling interest 173 45 - - - - - - -Total shareholders' equity 4,404 4,244 4,042 3,980 3,687 3,412 3,222 3,102 3,032

TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY 10,248$ 10,207$ 13,064$ 12,453$ 12,228$ 11,673$ 11,460$ 11,376$ 11,332$

St. Jude Medical, Inc.Cash Flow Statement

Fiscal Years Ending Dec. 31 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015OPERATING ACTIVITIES

Net earnings before noncontrolling interest 393 548 538 353 777 907 826 752 692 955 866 Adjustments to reconcile net earnings before noncontrolling interest to net cash from operating activities:

Depreciation of property, plant and equipment 76 94 198 202 213 244 296 196 218 221 218 Amortization of intangible assets 54 73 - - - - - 88 79 89 116 Amortization of debt discount (premium), net - - 34 50 - 1 (5) (11) (6) (5) (2)Inventory step-up amortization - - - - - 9 30 - 4 5 30Contigent consideration fair value adjustments - - - - - - - - 1 22 (87)Payment of contingent consideration - - - - - - - - - (27) -Stock-based compensation 1 70 55 53 60 70 76 69 65 71 160Cash settlement of accelerated equity awards - - - - - - - - - - (74)Excess tax benefits from stock issued under employee stock plans - (29) (98) (49) (26) (17) (9) (1) (15) (21) (24)Investment impairment charges - - 25 13 8 5 - - - - -Gain (loss) on sale of investments - - (8) - - (5) - (14) (13) (3) (22)Loss on retirement of long-term debt - - - - - - - - 161 - -Purchased in-process research and development charges 179 - - 319 6 12 4 - - - -Special charges (12) 35 - - - - - - - - -Deferred income taxes 5 (11) (19) (50) (14) (34) (65) (77) (124) (87) (37)Other, net - - 42 88 12 17 78 106 75 84 30Changes in operating assets and liabilities, net of business combinations:

Accounts receivable (139) (55) (92) (92) (39) (123) (55) 13 (100) 112 (39)Inventories (24) (77) 4 (74) (104) 42 10 13 (99) (102) (39)Other current and noncurrent assets 12 (18) (5) (20) 10 (30) 48 4 13 (70) (4)Accounts payable and accrued expenses 69 (29) 49 68 (65) 164 39 29 31 (60) (25)Income taxes payable 100 48 143 84 31 12 14 168 (21) 120 (28)

Net cash provided by operating activities 716 649 866 946 869 1,274 1,287 1,335 961 1,304 1,039INVESTING ACTIVITIES

Purchases of property, plant and equipment (159) (268) (287) (344) (326) (305) (307) (280) (222) (190) (186)Business combination payments, net of cash acquired (1,776) (39) (12) (490) (130) (679) - - (292) (147) (3,252)Proceeds from sale of investments 153 - 13 - - 8 - 19 10 7 30Other investing activities, net (30) (19) (20) (37) (35) (105) (30) (52) (18) (9) (37)

Net cash used in investing activities (1,811) (326) (306) (871) (491) (1,081) (337) (313) (522) (339) (3,445)FINANCING ACTIVITIES

Proceeds from exercise of stock options and stock issued, net 126 77 187 166 126 152 302 119 443 135 139 Excess tax benefits from stock issued under employee stock plans - 29 98 49 26 17 9 1 15 21 24 Common stock repurchased, including related costs - (700) (1,000) (300) (1,000) (591) (809) (992) (833) (476) (500)Dividends paid - - - - - - (205) (284) (282) (303) (322)Issuances (payments) of commercial paper borrowings, net - - - - (19) 26 247 321 121 75 (285)Borrowings under debt facilities 3,378 4,949 8,046 968 11,110 940 78 - 2,092 250 3,772 Payments under debt facilities (3,196) (4,487) (8,724) - (10,374) (620) (78) - (1,659) (50) (925)Payments of debt issue costs and commitment fees 660 (655) 1,200 (1,205) - - - - (17) - (33)Purchase of call options - - (101) - - - - - - - -Proceeds from the sale of warrants - - 35 - - - - - - - -Purchase of shares from noncontrolling ownership interest - - - - - - - - - (344) (173)Payment of contingent consideration - - - - - - - - - (128) -Other financing activities, net - - - - - (10) - 22 (137) (7) (5)

Net cash used in financing activities 968 (786) (259) (322) (131) (86) (456) (813) (257) (827) 1,692Effect of currency exchange rate changes on cash and cash equivalents (27) 8 9 (5) 9 - (8) (1) (3) (69) (61)

Net increase (decrease) in cash and cash equivalents (153) (455) 310 (253) 256 107 486 208 179 69 (775)Cash and cash equivalents at beginning of period 688 535 80 389 136 393 500 986 1,194 1,373 1,442Cash and cash equivalents at end of period 535$ 80$ 390$ 136$ 393$ 500$ 986$ 1,194$ 1,373$ 1,442$ 667$

St. Jude Medical, Inc.

Fiscal Years Ending Dec. 31 2016E 2017E 2018E 2019E 2020E 2021E (CV)

Net Income 443$ 568$ 596$ 691$ 771$ 831$ Plus Adjustments for Non-Cash Operating Expenses:

Depreciation 272 237 208 186 168 154Amortization of Intangible Assets 247 219 195 173 154 137Deferred income taxes (381) (2) 1 (2) (1) (1)

Plus Changes in Working Capital:Accounts receivable (219) (82) 26 (61) (55) (40)Inventories 150 (43) 14 (32) (29) (21)Other current assets (29) (12) 4 (9) (8) (6)Other assets 40 (24) 8 (18) (16) (12)Accounts payable 57 15 (5) 11 10 7Dividends payable 7 3 3 3 3 2Employee compensation 8 18 (6) 13 12 9Income taxes payable (171) 8 2 6 5 4Accrued expenses and other liabilities 46 32 (10) 23 21 15Other Liabilities 99 38 (12) 28 26 19

Net cash provided by operating activities 567 974 1,024 1,015 1,061 1,100INVESTING ACTIVITIES

Purchases of property, plant and equipment (100) (100) (100) (100) (100) (100)Net cash provided by investing activities (100) (100) (100) (100) (100) (100)FINANCING ACTIVITIES

Common stock repurchased, including related costs (500) (500) (500) (500) (500) (500)Common stock issued 0 0 0 0 0 0Changes in Long-Term Debt (170) (74) (152) (53) (43) (44)Accumulated other comprehensive income 345 0 0 0 0 0Dividend payments (350) (361) (371) (381) (391) (401)Current debt obligations 0 9 (93) (69) (9) 5

Net cash provided by financing activities (675) (925) (1,117) (1,003) (943) (940)Net change in cash (208) (51) (193) (89) 18 60Cash beginning of period 667 459 408 215 126 144Cash ending of period 459$ 408$ 215$ 126$ 144$ 204$

Projected Cash Flow Statement

St. Jude Medical, Inc.Common Size Income Statement

Fiscal Years Ending Dec. 31 2013 2014 2015 2016E 2017E 2018E 2019E 2020E 2021E (CV)Net sales 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00%Cost of Sales:

Cost of sales before special charges 27.79% 28.41% 30.79% 31.54% 30.71% 30.31% 29.82% 29.45% 29.17%COGS 23.83% 24.48% 26.85% 26.85% 26.85% 26.85% 26.85% 26.85% 26.85%Depreciation 3.96% 3.93% 3.93% 4.68% 3.86% 3.46% 2.97% 2.59% 2.32%

Special charges 0.82% 1.00% 0.70% 0.93% 0.93% 0.93% 0.93% 0.93% 0.93%Total cost of sales 28.61% 29.40% 31.49% 32.46% 31.64% 31.24% 30.75% 30.37% 30.10%

Gross profit 71.39% 70.60% 68.51% 67.54% 68.36% 68.76% 69.25% 69.63% 69.90%Selling, general and administrative expense 32.81% 33.01% 33.89% 34.92% 34.92% 34.92% 34.92% 34.92% 34.92%Research and development expense 12.56% 12.31% 12.20% 12.42% 12.42% 12.42% 12.42% 12.42% 12.42%Amortization of intangible assets 1.44% 1.58% 2.09% 4.24% 3.57% 3.23% 2.76% 2.37% 2.06%Purchased in-process research and development charges - - - 0.14% 0.14% 0.14% 0.14% 0.14% 0.14%Special charges 5.47% 3.22% 1.73% 2.22% 2.22% 2.22% 2.22% 2.22% 2.22%

Operating profit (loss) 19.11% 20.47% 18.59% 13.59% 15.09% 15.83% 16.79% 17.55% 18.14%Interest income -0.09% -0.09% -0.05% - - - - - -Interest expense 1.47% 1.51% 1.86% 4.71% 4.34% 4.37% 4.03% 3.82% 3.69%Other (income) expense 3.47% 0.05% 0.04% 0.19% 0.19% 0.19% 0.19% 0.19% 0.19%Other expense, net 4.85% 1.48% 1.84% 4.90% 4.53% 4.56% 4.23% 4.01% 3.89%

Earnings before income taxes and noncontrolling interest 14.25% 19.00% 16.75% 8.69% 10.56% 11.27% 12.56% 13.54% 14.25%Income tax expense 1.67% 2.01% 1.12% 1.07% 1.30% 1.39% 1.55% 1.67% 1.75%

Net earnings before noncontrolling interest 12.58% 16.99% 15.63% 7.62% 9.26% 9.88% 11.02% 11.88% 12.50%Less: Net loss attributable to noncontrolling interest -0.56% -0.84% -0.25% - - - - - -

Net earnings attributable to St. Jude Medical, Inc. 13.14% 17.82% 15.88% 7.62% 9.26% 9.88% 11.02% 11.88% 12.50%

St. Jude Medical, Inc.Common Size Balance Sheet

Fiscal Years Ending Dec. 31 2013 2014 2015 2016E 2017E 2018E 2019E 2020E 2021E (CV)ASSETSCurrent Assets:

Cash and cash equivalents 24.96% 25.65% 12.04% 7.90% 6.64% 3.56% 2.01% 2.21% 3.06%Accounts receivable, less allowance for doubtful accounts 25.85% 21.61% 22.32% 25.07% 25.07% 25.07% 25.07% 25.07% 25.07%Inventories 12.87% 13.95% 16.40% 13.07% 13.07% 13.07% 13.07% 13.07% 13.07%Deferred income taxes 4.16% 5.18% 4.76% 3.86% 3.86% 3.86% 3.86% 3.86% 3.86%Other current assets 3.24% 3.24% 3.39% 3.74% 3.74% 3.74% 3.74% 3.74% 3.74%

Total current assets 71.08% 69.62% 58.92% 53.64% 52.38% 49.30% 47.75% 47.95% 48.80%Property, Plant and Equipment:

Land, building and improvements 11.83% 12.61% 13.16% 13.16% 13.16% 13.16% 13.16% 13.16% 13.16%Machinery and equipment 30.43% 28.74% 28.82% 28.61% 28.03% 29.48% 29.26% 29.17% 29.35%Diagnostic equipment 8.62% 8.00% 7.96% 7.94% 7.77% 8.17% 8.11% 8.09% 8.14%

Property, plant and equipment, at cost 50.88% 49.36% 49.94% 49.36% 48.35% 50.85% 50.48% 50.31% 50.62%Less: accumulated depreciation -25.25% -25.47% -26.11% -29.59% -31.87% -35.88% -37.46% -38.78% -40.18%

Net property, plant and equipment 25.63% 23.89% 23.82% 19.76% 16.48% 14.97% 13.02% 11.53% 10.44%Goodwill 64.06% 62.82% 101.99% 97.29% 92.10% 93.69% 90.07% 87.02% 84.96%Intangible assets, net 16.56% 15.14% 40.17% 34.08% 28.69% 25.95% 22.18% 19.06% 16.55%Deferred income taxes, net 2.11% 2.01% 2.38% 2.22% 2.22% 2.22% 2.22% 2.22% 2.22%Other assets 6.85% 8.08% 8.48% 7.41% 7.41% 7.41% 7.41% 7.41% 7.41%

TOTAL ASSETS 186.29% 181.55% 235.77% 214.39% 199.28% 193.53% 182.64% 175.19% 170.37%LIABILITIES AND SHAREHOLDERS' EQUITYCurrent Liabilities:

Current debt obligations 1.13% 28.34% 20.99% 20.02% 19.10% 17.89% 16.10% 15.41% 15.12%Accounts payable 4.49% 2.69% 3.63% 4.44% 4.44% 4.44% 4.44% 4.44% 4.44%Dividends payable 1.31% 1.37% 1.48% 1.53% 1.50% 1.57% 1.55% 1.54% 1.54%Income taxes payable 0.58% 1.07% 3.63% 0.51% 0.62% 0.67% 0.74% 0.80% 0.84%Employee compensation and related benefits 5.67% 5.19% 5.58% 5.46% 5.46% 5.46% 5.46% 5.46% 5.46%Accrued expenses and other current liabilites 11.91% 8.77% 9.33% 9.69% 9.69% 9.69% 9.69% 9.69% 9.69%

Total current liabilities 25.09% 47.42% 44.63% 41.66% 40.81% 39.71% 37.98% 37.34% 37.09%Long-term debt 63.95% 40.43% 94.37% 87.10% 81.25% 80.13% 76.19% 72.96% 70.57%Deferred income taxes 4.36% 4.27% 13.32% 5.40% 5.40% 5.40% 5.40% 5.40% 5.40%Other liabilities 12.83% 13.95% 10.50% 11.72% 11.72% 11.72% 11.72% 11.72% 11.72%Total Liabilities 106.24% 106.07% 162.82% 145.88% 139.19% 136.97% 131.29% 127.42% 124.79%Commitments and Contingenciees - - -

Shareholders' EquityCommon stock and additional paid-in capital 4.53% 2.61% 3.18% 3.03% 2.87% 2.92% 2.81% 2.71% 2.65%Unearned compensation - - -Retained earnings 71.55% 75.15% 76.00% 65.48% 57.22% 53.65% 48.54% 45.05% 42.94%Accumulated other comprehensive income (loss) 0.84% -3.08% -6.23% - - - - - -Total shareholders' equity before noncontrolling interest 76.91% 74.69% 72.95% 68.51% 60.09% 56.57% 51.35% 47.76% 45.58%Noncontrolling interest 3.14% 0.80% - - - - - - -Total shareholders' equity 80.06% 75.49% 72.95% 68.51% 60.09% 56.57% 51.35% 47.76% 45.58%

TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY 186.29% 181.55% 235.77% 214.39% 199.28% 193.53% 182.64% 175.19% 170.37%

St. Jude Medical, Inc.Value Driver Estimation

Fiscal Years Ending Dec. 31 2012 2013 2014 2015 2016E 2017E 2018E 2019E 2020E 2021E (CV)NOPLAT Computation

Net Sales 5,503 5,501 5,622 5,541 5,809 6,136 6,032 6,274 6,494 6,652 - Cost of Goods Sold 1,249 1,311 1,376 1,488 1,560 1,648 1,620 1,685 1,744 1,786 - Depreciation 196 218 221 218 272 237 208 186 168 154 - Research & Development Exp 676 691 692 676 721 762 749 779 806 826 - SG&A 1,803 1,805 1,856 1,878 2,028 2,143 2,106 2,191 2,268 2,323 - Amortization of intangible assets 88 79 89 116 - - - - - -- Purchased in-process R&D charges - - - - - - - - - -+ Implied Interest on Operating Leases 5 5 4 5 7 3 3 3 3 3

EBITA 1,496 1,402 1,392 1,170 1,234 1,350 1,351 1,436 1,511 1,565 Less: Adjusted Taxes

Income Tax Expense (benefit) 253 92 113 62 62 80 84 97 108 117+ Tax Shield on Implied Lease Interest 1 1 0 1 1 0 0 0 0 0- Other Income 12 33 10 13 35 34 34 33 32 32

Adjusted Taxes 242 60 103 50 28 46 50 65 77 85Plus: Change in Deferred Tax Liabilities

Current Year DT Liabilities 323 240 240 738 314 331 326 339 351 359- Current Year DT Current Assets 220 229 291 264 224 237 233 242 251 257- Current Year DT Long-Term Assets 130 116 113 132 129 136 134 139 144 147

= Net DT Liabilies for Current Year (27) (105) (164) 342 (39) (42) (41) (43) (44) (45)Previous Year DT Liabilities 392 323 240 240 738 314 331 326 339 351

- Previous Year DT Current Assets 225 220 229 291 264 224 237 233 242 251- Previous Year DT Long-Term Assets - 130 116 113 132 129 136 134 139 144

= Net DT Liabilites for Previous Year 167 (27) (105) (164) 342 (39) (42) (41) (43) (44)Net Change in DT Liabilities (Current-Previous) (194) (78) (59) 506 (381) (2) 1 (2) (1) (1)NOPLAT 1,060 1,264 1,229 1,626 825 1,302 1,302 1,370 1,433 1,479

Invested Capital ComputationOperating Current Assets

Normal Cash 133 133 136 134 141 148 146 152 157 161Accounts Receivable 1,349 1,422 1,215 1,237 1,456 1,538 1,512 1,573 1,628 1,667Inventory 610 708 784 909 759 802 788 820 849 870Other Current Assets 178 178 182 188 217 229 225 234 243 249

Operating Current Assets 2,270 2,441 2,317 2,468 2,573 2,718 2,672 2,779 2,876 2,946Operating Current Liabilities

Accounts payable 254 247 151 201 258 272 268 278 288 295 Dividends payable 68 72 77 82 89 92 95 97 100 102 Income taxes payable 142 32 60 201 30 38 40 47 52 56 Employee compensation and related benefits 299 312 292 309 317 335 329 343 355 363 Accrued expenses and other current liabilites 482 655 493 517 563 595 585 608 629 645

Operating Current Liabilities 1,245 1,318 1,073 1,310 1,257 1,332 1,316 1,373 1,424 1,461Net Operating Working Capital 1,025 1,123 1,244 1,158 1,316 1,386 1,355 1,406 1,453 1,485

+ Net PPE 1,425 1,410 1,343 1,320 1,148 1,011 903 817 749 694+ PV of Operating Leases 112 86 109 167 74 74 74 74 74 74+ Other Assets 400 377 454 470 430 455 447 465 481 493+ Intangible Assets, Net 804 911 851 2,226 1,979 1,760 1,565 1,392 1,238 1,101- Other liabilities 529 706 784 582 681 719 707 736 761 780

Invested Capital 3,237 3,201 3,217 4,759 4,267 3,966 3,637 3,418 3,233 3,067

Value DriversROIC = 28.2% 39.1% 38.4% 50.5% 17.3% 30.5% 32.8% 37.7% 41.9% 45.8%

Beginning IC ÷ 3,761 3,237 3,201 3,217 4,759 4,267 3,966 3,637 3,418 3,233NOPLAT 1,060 1,264 1,229 1,626 825 1,302 1,302 1,370 1,433 1,479

EP = Beginning IC * (ROIC-WACC) 772 1,016 984 1,379 459 974 997 1,091 1,170 1,231Beginning IC 3,761 3,237 3,201 3,217 4,759 4,267 3,966 3,637 3,418 3,233ROIC 28.2% 39.1% 38.4% 50.5% 17.3% 30.5% 32.8% 37.7% 41.9% 45.8%WACC 8% 8% 8% 8% 8% 8% 8% 8% 8% 8%

FCF = 1,585 1,300 1,213 84 1,317 1,602 1,631 1,589 1,618 1,645NOPLAT 1,060 1,264 1,229 1,626 825 1,302 1,302 1,370 1,433 1,479+ Beg IC 3,761 3,237 3,201 3,217 4,759 4,267 3,966 3,637 3,418 3,233- Current IC 3,237 3,201 3,217 4,759 4,267 3,966 3,637 3,418 3,233 3,067

St. Jude Medical, Inc.Weighted Average Cost of Capital (WACC) EstimationEquity (Re)

Beta 1.212Risk-Free Rate (R f ) 2.62%Equity Risk Premium (ERP) 5.50%Cost of Equity (R e ) 9.29%

Current Share Price $56.42Current Shares Outstanding 283.67Market Capitalization $16,005

Debt (Rd)Pre-Tax Cost of Debt 4.28%Marginal Tax Rate 12.30%After-Tax Cost of Debt (R d ) 3.75%

Market Value of Debt (Current Debt Obligations + LTD) 6,392Capitalized Operating Leases 167

Enterprise Value $22,564Equity Weight 70.93%Debt Weight 29.07%

WACC = 7.68%

St. Jude Medical, Inc.Discounted Cash Flow (DCF) and Economic Profit (EP) Valuation Models

Key Inputs: CV Growth 2.43% CV ROIC 45.8% WACC 7.68% Cost of Equity (Re) 9.29%

Fiscal Years Ending Dec. 31 2016E 2017E 2018E 2019E 2020E 2021E (CV)

DCF ModelNOPLAT 825 1,302 1,302 1,370 1,433 1,479ROIC 17.3% 30.5% 32.8% 37.7% 41.9% 45.8%Change in Invested Capital (Δ IC) (492) (300) (329) (219) (186) (166)Free Cash Flow (FCF) to Discount 1,317 1,602 1,631 1,589 1,618

Continuing Value (t=5) 26,693

PV of FCF Discounted by WACC 1,223 1,382 1,306 1,182 1,118 18,440

Value of Operating Assets 24,652+ Excess Cash 533- Current Debt Obligations 1,163- Long Term Debt 5,229- PV Operating Leases 167- Unearned Compensation -- Minority Interest -- ESOP 239Value of Equity 18,387÷ Shares Outstanding 283.67Intrinsic Value (Per Share) 64.82Fraction of Year Elapsed 0.3005Stock Price as of Today (4/19/2016) $66.35

EP ModelBeginning Invested Capital 4,759Economic Profit (EP) 459 974 997 1,091 1,170 1,231Continuing Value (t=5) 23,460

EP to Discount 459 974 997 1,091 1,170 23,460PV of EP Discounted by WACC 427 840 799 811 808 16,207

PV of Economic Profit 19,893+ Beginning Invested Capital 4,759Value of Operating Assets 24,652+ Excess Cash 533- Current Debt Obligations 1,163- Long Term Debt 5,229- PV Operating Leases 167- Unearned Compensation -- Minority Interest -- ESOP 239Value of Equity 18,387÷ Shares Outstanding 283.67Intrinsic Value (Per Share) 64.82Fraction of Year Elapsed 0.3005Stock Price as of Today (4/19/2016) $66.35

St. Jude Medical, Inc.Dividend Discount Model (DDM) or Fundamental P/E Valuation Model

Fiscal Years Ending Dec. 31 2016E 2017E 2018E 2019E 2020E 2021E (CV)

EPS 1.62$ 2.14$ 2.31$ 2.76$ 3.15$ 3.48$ Periods to Discount 1 2 3 4 5 5Key Assumptions CV Growth 2.43% CV ROE 27.42% Cost of Equity (Re) 9.29%

Future Cash Flows P/E Multiple (CV Year) 13.29 EPS (CV Year) 3.48$ Future Stock Price 46.28$ Dividends Per Share 1.62$ 2.14$ 2.31$ 2.76$ 3.15$ Future Cash Flows 1.62$ 2.14$ 2.31$ 2.76$ 3.15$ 46.28$

Discounted Cash Flows 1.48$ 1.79$ 1.77$ 1.93$ 2.02$ 29.68$

Intrinsic Value (Per Share) 38.69$ Fraction of Year Elapsed 0.3005Stock Price as of Today (4/19/2016) 39.60$

St. Jude Medical, Inc.Relative Valuation Models

EPS EPSTicker Company Price 2016E 2017E P/E 16 P/E 17 Price/Sales Price/BookBSX Boston Scientific Corporation $19.23 $1.05 $1.19 18.3 16.2 3.43 4.01 MDT Medtronic Plc $76.40 $4.37 $4.71 17.5 16.2 4.11 2.03 SYK Stryker Corporation $109.48 $5.60 $6.13 19.6 17.9 4.01 4.69 ABT Abbott Laboratories $42.54 $2.16 $2.41 19.7 17.7 3.01 2.89 BDX Becton, Dickinson & Co. $154.86 $8.42 $9.38 18.4 16.5 2.88 4.47

Average 18.7 16.9 3.49 3.62

STJ St. Jude Medical, Inc. $56.42 $1.62 $2.14 34.8 26.3 2.82 3.86

Implied Value:Relative P/E (EPS16) $ 30.26 Relative P/E (EPS17) 36.16$

Rev/Share (2016E) 21.25$ Rev/Share (2017E) 23.14$ Relative P/S Price (2016E) 74.12$ Relative P/S Price (2017E) 80.70$

Equity Share (2016E) 14.56$ Equity Share (2017E) 13.90$ Relative P/B Price (2016E) 52.68$ Relative P/B Price (2017E) 50.30$

St. Jude MedicalKey Management Ratios

Fiscal Years Ending Dec. 31 2013 2014 2015 2016E 2017E 2018E 2019E 2020E 2021E (CV)

Liquidity RatiosCurrent Ratio (CA/CL) 2.83 1.47 1.32 1.29 1.28 1.24 1.26 1.28 1.32Quick Ratio (CA - Inventories)/CL 2.32 1.17 0.95 0.97 0.96 0.91 0.91 0.93 0.96Cash Ratio (Cash and Cash Equivalents/CL) 0.99 0.54 0.27 0.19 0.16 0.09 0.05 0.06 0.08

Activity or Asset-Management RatiosAsset Turnover Ratio (Sales/Total Assets) 53.68% 55.08% 42.41% 46.64% 50.18% 51.67% 54.75% 57.08% 58.70%Inventory Turnover Ratio (Sales/Total Inventory) 7.77 7.17 6.10 7.65 7.65 7.65 7.65 7.65 7.65Receivables Turnover Ratio (Sales/Average AR) 3.97 4.26 4.52 4.24 4.01 4.03 4.03 4.03 4.03

Financial Leverage RatiosDebt-to-Equity Ratio (Total Debt/Total Equity) 0.85 0.92 1.58 1.56 1.67 1.73 1.80 1.85 1.88Equity Ratio (Shareholders' Equity/Total Assets) 0.43 0.42 0.31 0.32 0.30 0.29 0.28 0.27 0.27Interest Coverage (Operating Income/Interest Expense) 12.98 13.54 10.00 2.89 3.48 3.62 4.16 4.60 4.91

Profitability RatiosReturn on Assets (NI/Total Assets) 7.06% 9.82% 6.74% 3.55% 4.65% 5.11% 6.03% 6.78% 7.34%Return on Equity (NI/SE) 16.42% 23.61% 21.77% 11.12% 15.41% 17.47% 21.46% 24.87% 27.42%Gross Margin (Revenue-COGS)/Revenue 76.17% 75.52% 73.15% 73.15% 73.15% 73.15% 73.15% 73.15% 73.15%EBIT Margin (EBIT/Sales) 19.11% 20.47% 18.59% 13.59% 15.09% 15.83% 16.79% 17.55% 18.14%Profit Margin (NI/Sales) 13.14% 17.82% 15.88% 7.62% 9.26% 9.88% 11.02% 11.88% 12.50%

Payout Policy RatiosPayout Ratio (Dividends per share/Earnings per share) 39.68% 30.68% 37.30% 76.57% 61.62% 60.53% 53.71% 49.48% 47.11%Total Payout Ratio (Dividends + Repurchases)/NI 154.22% 77.74% 93.41% 192.01% 151.51% 146.15% 127.50% 115.57% 108.38%

Beta PV/PP&E Ratio66.35$ 1.012 1.062 1.112 1.162 1.212 1.262 1.312 1.362 1.412 66.35$ 65.65% 67.65% 69.65% 71.65% 73.65% 75.65% 77.65% 79.65% 81.65%5.30% 84.40 80.13 76.21 72.58 69.22 66.10 63.19 60.47 57.93 3.28% 70.76 70.76 70.75 70.75 70.74 70.74 70.73 70.73 70.735.35% 83.55 79.32 75.42 71.82 68.49 65.39 62.50 59.80 57.27 3.53% 69.62 69.62 69.61 69.61 69.61 69.60 69.60 69.59 69.595.40% 82.73 78.52 74.65 71.08 67.76 64.69 61.82 59.14 56.63 3.78% 68.51 68.51 68.50 68.50 68.49 68.49 68.49 68.48 68.485.45% 81.91 77.73 73.89 70.34 67.05 64.00 61.15 58.49 56.01 4.03% 67.43 67.43 67.42 67.42 67.41 67.41 67.40 67.40 67.39

ERP 5.50% 81.11 76.96 73.14 69.62 66.35 63.32 60.50 57.86 55.39 4.28% 66.37 66.37 66.36 66.36 66.35 66.35 66.35 66.34 66.345.55% 80.32 76.20 72.41 68.91 65.67 62.66 59.85 57.23 54.78 4.53% 65.34 65.34 65.33 65.33 65.32 65.32 65.31 65.31 65.305.60% 79.54 75.45 71.69 68.21 64.99 62.00 59.21 56.61 54.18 4.78% 64.33 64.33 64.33 64.32 64.32 64.31 64.31 64.30 64.305.65% 78.78 74.71 70.97 67.52 64.33 61.36 58.59 56.01 53.59 5.03% 63.35 63.35 63.34 63.34 63.33 63.33 63.32 63.32 63.315.70% 78.02 73.99 70.27 66.84 63.67 60.72 57.97 55.41 53.01 5.28% 62.39 62.38 62.38 62.38 62.37 62.37 62.36 62.36 62.35

WACC66.35$ 7.2778% 7.3778% 7.4778% 7.5778% 7.6778% 7.7778% 7.8778% 7.9778% 8.0778%

2.0306% 68.48 66.82 65.23 63.69 62.21 60.78 59.40 58.06 56.772.1306% 69.65 67.94 66.30 64.72 63.19 61.72 60.30 58.93 57.602.2306% 70.86 69.10 67.41 65.78 64.21 62.69 61.23 59.82 58.462.3306% 72.13 70.31 68.56 66.88 65.26 63.70 62.20 60.75 59.342.4306% 73.45 71.57 69.76 68.02 66.35 64.75 63.20 61.70 60.262.5306% 74.82 72.87 71.01 69.21 67.49 65.83 64.24 62.70 61.212.6306% 76.25 74.24 72.31 70.45 68.67 66.96 65.31 63.73 62.202.7306% 77.75 75.66 73.66 71.74 69.90 68.13 66.43 64.80 63.222.8306% 79.31 77.14 75.07 73.08 71.18 69.35 67.60 65.91 64.29

COGS66.35$ 22.8544% 23.8544% 24.8544% 25.8544% 26.8544% 27.8544% 28.8544% 29.8544% 30.8544%

30.9207% 94.91 91.34 87.77 84.20 80.63 77.06 73.49 69.92 66.3531.9207% 91.34 87.77 84.20 80.63 77.06 73.49 69.92 66.35 62.7932.9207% 87.77 84.20 80.63 77.06 73.49 69.92 66.35 62.79 59.2233.9207% 84.20 80.63 77.06 73.49 69.92 66.35 62.79 59.22 55.65

SG&A 34.9207% 80.63 77.06 73.49 69.92 66.35 62.79 59.22 55.65 52.0835.9207% 77.06 73.49 69.92 66.35 62.79 59.22 55.65 52.08 48.5136.9207% 73.49 69.92 66.35 62.79 59.22 55.65 52.08 48.51 44.9437.9207% 69.92 66.35 62.79 59.22 55.65 52.08 48.51 44.94 41.3738.9207% 66.35 62.79 59.22 55.65 52.08 48.51 44.94 41.37 37.80

Pre-Tax Cost of Debt

Sensitivity Analysis

CV Revenue Growth

St. Jude Medical, Inc.

Present Value of Operating Lease Obligations (2015) Present Value of Operating Lease Obligations (2014) Present Value of Operating Lease Obligations (2013) Present Value of Operating Lease Obligations (2012)

Operating Operating Operating OperatingFiscal Years Ending Dec. 31 Leases Fiscal Years Ending Dec. 31 Leases Fiscal Years Ending Dec. 31 Leases Fiscal Years Ending Dec. 31 Leases2016 53 2015 35 2014 30 2013 372017 36 2016 28 2015 22 2014 282018 26 2017 23 2016 15 2015 212019 22 2018 18 2017 15 2016 162020 21 2019 11 2018 10 2017 14Thereafter 32 Thereafter 7 Thereafter 4 Thereafter 9Total Minimum Payments 190 Total Minimum Payments 122 Total Minimum Payments 96 Total Minimum Payments 125

Less: Interest 23 Less: Interest 13 Less: Interest 10 Less: Interest 13PV of Minimum Payments 167 PV of Minimum Payments 109 PV of Minimum Payments 86 PV of Minimum Payments 112

Capitalization of Operating Leases Capitalization of Operating Leases Capitalization of Operating Leases Capitalization of Operating Leases

Pre-Tax Cost of Debt 4.28% Pre-Tax Cost of Debt 4.28% Pre-Tax Cost of Debt 4.28% Pre-Tax Cost of Debt 4.28%Number Years Implied by Year 6 Payment 1.5 Number Years Implied by Year 6 Payment 1.0 Number Years Implied by Year 6 Payment 1.0 Number Years Implied by Year 6 Payment 1.0

Lease PV Lease Lease PV Lease Lease PV Lease Lease PV LeaseYear Commitment Payment Year Commitment Payment Year Commitment Payment Year Commitment Payment1 53 50.8 1 35 33.6 1 30 28.8 1 37 35.52 36 33.1 2 28 25.7 2 22 20.2 2 28 25.73 26 22.9 3 23 20.3 3 15 13.2 3 21 18.54 22 18.6 4 18 15.2 4 15 12.7 4 16 13.55 21 17.0 5 11 8.9 5 10 8.1 5 14 11.46 & beyond 21 24.6 6 & beyond 7 5.4 6 & beyond 4 3.1 6 & beyond 9 7.0PV of Minimum Payments 167.1 PV of Minimum Payments 109.2 PV of Minimum Payments 86.1 PV of Minimum Payments 111.6

Effects of ESOP Exercise and Share Repurchases on Common Stock Balance Sheet Account and Number of Shares Outstanding

Number of Options Outstanding (shares): 10Average Time to Maturity (years): 3.60Expected Annual Number of Options Exercised: 3

Current Average Strike Price: 40.76$ Cost of Equity: 9.00%Current Stock Price: 56.42$

2016E 2017E 2018E 2019E 2020E 2021E (CV)Increase in Shares Outstanding: 3 3 3 3 3 3Average Strike Price: 40.76$ 40.76$ 40.76$ 40.76$ 40.76$ 40.76$ Increase in Common Stock Account: 117 117 117 117 117 117

Change in Treasury Stock 500,000,000 500,000,000 500,000,000 500,000,000 500,000,000 500,000,000Expected Price of Repurchased Shares: 56.42$ 61.50$ 67.03$ 73.07$ 79.64$ 86.81$ Number of Shares Repurchased: 8,862,106 8,130,372 7,459,057 6,843,172 6,278,139 5,759,761

Shares Outstanding (beginning of the year) 282,200,000 273,337,897 265,207,528 257,748,474 250,905,305 244,627,169Plus: Shares Issued Through ESOP 3 3 3 3 3 3Less: Shares Repurchased in Treasury 8,862,106 8,130,372 7,459,057 6,843,172 6,278,139 5,759,761 Shares Outstanding (End of the year) 273,337,897 265,207,528 257,748,474 250,905,305 244,627,169 238,867,411

VALUATION OF OPTIONS GRANTED IN ESOP

Ticker Symbol STJCurrent Stock Price 56.42$ Risk Free Rate 2.62%Current Dividend Yield 1.18%Annualized St. Dev. of Stock Returns 38.80%

Average Average B-S ValueRange of Number Exercise Remaining Option of OptionsOutstanding Options of Shares Price Life (yrs) Price GrantedRange 1 10 40.76$ 3.60 23.16$ 239$ Total 10 40.76$ 3.60 25.07$ 239$