It seems that you wait years for a big deal to come along in the medtech sector, and then three come all at once. This weekend it was the turn of Medtronic to join in the merger fever gripping the usually staid medtech sector with its history-making $42.9bn bid for Covidien, creating what would be the largest medical devices company (see table below).
The move by Medtronic, giving it worldwide sales of $35.7bn in 2020 and positioning it above Johnson & Johnson, will alter the sector dramatically and could trigger further consolidation in the highly fragmented market. Speaking today, Omar Ishrak, chief executive of Medtronic, said the deal would drive some level of action in the market, warning: “Consolidation of some sort will follow.”
Follow my leader
Who will follow is anyone’s guess given that few in the market would have ever put Medtronic and Covidien together, but the reasons for companies to scale up are compelling and growing.
Margins have come under pressure from price declines, as device makers have struggled with innovation and increasingly relied on incremental changes to existing products.
Combine this with a change in the customer base from physicians to more cost-conscious hospital administrators and further healthcare reform and it is no wonder chief executives might want to add bankers to their speed-dial numbers.
Medtronic’s move follows Zimmer’s $13.4bn purchase of Biomet in April, the fourth-biggest M&A deal in history, and has eclipsed Boston Scientifics $27bn buyout of Guidant (Zimmer and Biomet hook up for second orthopaedics megamerger, April 24, 2014). Speculation is now growing that Smith & Nephew, once linked with Medtronic, could be the next takeout target.
|Top 5 M&A deals in the history of medtech|
|Announcement date||Acquirer||Target||Deal type||Value ($bn)|
|June 15, 2014||Medtronic||Covidien||Company acquisition||42.9|
|December 5, 2005||Boston Scientific||Guidant||Company acquisition||27.0|
|April 27, 2011||Johnson & Johnson||Synthes||Company acquisition||19.7|
|April 15, 2013||Thermo Fisher Scientific||Life Technologies||Company acquisition||13.6|
|April 24, 2014||Zimmer||Biomet||Company acquisition||13.4|
By merging, Medtronic and Covidien will have the scale to offset margin pressure and offer more products, in more combinations, to both physicians and hospital buyers, which could make them more attractive than their smaller rivals and bring long-term benefits. In morning trading Covidien shares were up 22% to $87.54, below the $93.22-a-share offer price, indicating that few are expecting a counterbid.
|Top medtech companies with Medtronic/Covidien acquisition|
|Total sales ($bn)||Share of medtech market||Rank|
|Johnson & Johnson||28.5||34.7||7.9%||6.7%||1||2|
The tax elephant in the room
However, it would be disingenuous to think that this deal had been struck solely on the merits of scale. Although there was much talk of innovation and growth today, the lack of crossover between the two companies means the surprise move from Medtronic can only be viewed in light of Covidien’s attractive Irish tax domicile (Vantage point – Pfizer bid ignites tax debate but fixes are distant, May 8, 2014).
The share and cash structure of the deal will give Covidien shareholders a 30% stake in the new combined company, allowing Medtronic to move its tax affairs to Ireland. Normally this would result in tax savings, but as Medtronic’s tax rate is already 19%, the 17% paid by Covidien is not the lure; instead the attraction is access to the billions of dollars Medtronic generates outside the US.
Using Covidien’s Irish tax domicile means Medtronic no longer has to pay US taxes on the estimated $11bn or so of cash it has ex-US. Derrick Sung, analyst at Bernstein Research, said that dealing with the outside US cash problem had been a key priority for Medtronic, which had been borrowing against the cash to meet its commitment of 50% return of free cash flow to shareholders.
In terms of selling the deal Medtronic has also obviously learned lessons from Pfizer’s botched overseas venture and loudly stated that it will be investing $10bn over 10 years in the US either through venture funding or research. But this gesture is likely to do little to appease those in the US government looking to crack down on tax minimisation employed by large companies.
However, until legislation is passed there is little that politicians can do, and thanks to the lack of overlap the deal is unlikely to be held up by competition issues; it should complete by the 2014 year end/early 2015 deadline given by the group.
The shockwaves caused by Medtronic’s move, however, are bound to ripple out way beyond early 2015.