European Equities

Company Overview

Over the last decade, Philips has transformed from a sprawling conglomerate across a range of electronics to a business focused on healthcare. Today, over 70% of revenue is from healthcare, including the sale of medical imaging equipment such as MRI, CT, ultrasound, and X-ray machines, as well as ventilators, respirators, CPAP machines, hospital monitors, and software. The rest of the business is consumer health products, such as Sonicare toothbrushes and men’s electric razors.

> 70%
of revenue is from healthcare

ESG Consideration

At the onset of the COVID-19 pandemic, hospitals came under strain and demand for ventilators skyrocketed. As the leading producer of hospital-grade ventilators, Philips entered into many contracts with governments to supply ventilators and other pieces of hospital equipment. To service the demand, Philips reoriented its production facilities to step-up the manufacturing of these products.

In April 2020, Philips entered into a contract with the U.S. Department of Health and Human Services (HHS) to sell 43,000 Trilogy EV300 ventilators at a price of $15,000 per unit, for a total of $645 million (in U.S. dollars). This enormous contract required Philips to further reorient its production facilities and took the company all of 2020 to fulfill.

On July 31, 2020, the Subcommittee on Economic and Consumer Policy (part of the Committee on Oversight and Reform) released a report accusing Philips of profiteering at the U.S. government’s expense and calling the current U.S. administration’s handling of the matter incompetent. Philips was accused of selling the ventilators at above market prices and not honouring a separate older contract, which called for Philips to sell 10,000 ventilators at a much lower price of $3,280 each (in U.S. dollars). One month later, HHS cancelled the remaining portion of the large contract, along with its other outstanding ventilator contracts with other manufacturers. As the largest supplier, Philips was affected the most, with only 12,300 of the 43,000 ventilators delivered (all per the agreed schedule).

We take any suggestion of profiteering at one of our portfolio companies extremely seriously and had three meetings with the company about the matter, one prior to the allegations. The company’s position is that Philips was fully transparent with the government about the production ramp-up plans and pricing, that the report lacked important information in determining market pricing, and that the other contract noted in the report was for a lower-quality and older model of ventilator. The newer, higher-priced ventilator was what HHS decided to order. Philips was not given a formal reason from HHS for the contract cancellation, but reports had been made in the weeks preceding about the U.S. government’s stockpile of ventilators, stating that they were at a sufficient size. The cancellation of contracts with all manufacturers and not just Philips means it was likely related to high stockpiles as well as the declining rates of COVID-19-related hospitalization in the U.S.

We continue to monitor this situation. Entering large contracts with governments is a delicate matter, particularly at times of severe stress. Philips needed to balance the needs of all stakeholders by doing what was right for humanity. To do so, the company began stepping up the production of its ventilators while ensuring the additional costs would not overburden the company.

Final thoughts

Overall, there appears to be low legal risk for Philips, which has never been part of the allegations. We think it is most likely that Philips acted properly and that the report was politically influenced as it was written by a Democratic-led subcommittee and placed as much emphasis on its view of incompetent dealing by the Republican administration as on Philips. But it remains a serious matter. In future meetings with management, we will continue to emphasize the importance of handling government contracts with extreme care.

Sources: Burgundy research, Philips filings

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