The Federal Trade Commission’s move to investigate Zimmer’s purchase of Biomet, signalled in July, was widely expected as the companies’ operations were so similar. Perhaps Medtronic hoped that its $43bn acquisition of Covidien might have escaped scrutiny as the two companies have less overlap – but as the largest medtech deal ever there was always a decent chance that the FTC would want to take a closer look, and so it has proved.
Meanwhile the US government is attempting to limit tax inversions (Anti-inversion noise grows but power to act is limited, August 11, 2014). As things stand, any new laws are unlikely to be in place in time to affect the Medtronic-Covidien deal. However, if the FTC finds grounds to delay the merger significantly there is a risk that it could be ensnared in anti-inversion legislation. Medtronic must move fast.
Medtronic contends that despite the FTC’s request for more data the acquisition will close on time – late this year or early next. More than that, though: management says it will go ahead with the buy even if anti-inversion laws are passed, insisting that its primary motivation for the deal is strategic.
Even so, it is more than likely that the deal will not go through cleanly. The FTC has issued a second request for information, obliging the companies to turn over documents and their respective management to testify at hearings. It can take months to comply with the requirements (FTC starts Zimmer/Biomet inquisition, July 3, 2014). Second requests are made in less than 5% of mergers, but when they are the FTC requires divestments in around three quarters of cases.
EvaluateMedTech shows that there are three areas in which both companies are involved, and hence where divestments might be required: cardiology, surgery and neurology. In each case one company outsells the other significantly, with Medtronic making up the lion’s share of the combined company’s cardiology and neurology sales and Covidien accounting for almost all of the surgery revenue.
Cardiology is the biggest-selling of these areas, so if the FTC does demand spin-offs or sell-offs it could well be Covidien’s vascular technologies – with sales over $1.2bn in 2013 and a 3% annualised growth rate – that go first.
|Not too similar: how Medtronic and Covidien compare|
|WW sales ($m)||Market share||Market rank|
|Anaesthesia & respiratory (Covidien only)||770||937||3%||12%||10%||4||5|
|Diabetes care (Medtronic only)||1,657||2,539||6%||14%||16%||3||2|
|Ear, nose & throat (Medtronic only)||592||877||6%||8%||8%||6||6|
|General hospital & healthcare supply (Covidien only)||2,069||2,252||1%||25%||22%||1||1|
|General & plastic surgery (combined)||4,937||7,387||6%||27%||29%||1||1|
|Orthopaedics (Medtronic only)||3,041||3,247||1%||9%||7%||4||5|
|Patient monitoring (Covidien only)||969||1,398||5%||47%||46%||1||1|
|Other medtech (Medtronic only)||450||612||5%||2%||2%||20||18|
But Medtronic says it took the FTC’s data request – and therefore, presumably, the likelihood of divestments – into account when it gave the expected date for the merger’s close. Analysts from Morgan Stanley and Bernstein are bullish, disregarding the possibility that anti-inversion rules could come about before mid-2015, by which time, assuming Medtronic is right, the deal will be done.
They also consider the suggestion that the new laws could be applied retroactively and therefore interfere with the merger to be improbable.
Morgan Stanley said that even if an inversion is somehow legally prohibited, the deal’s financials will be favourable anyway. “If the acquisition were to be structured entirely as a debt and cash deal, we estimate it would be about $1.00 more accretive than an inversion, bringing FY18 cash accretion,” David Lewis and James Francescone wrote.
In this scenario, though, net debt would be elevated to 4.2x pro forma EBITDA, compared with 1.5x in an inversion, they wrote, making it “questionable whether the company would proceed with such a transaction in light of the significant constraints it would bring to future capital deployment both from a leverage and tax perspective.”
Tax inversion is still important to Medtronic, no matter how much the company chooses to play up the strategic foundation for the acquisition. It must hope that the transaction closes before the US government can limit its tax benefits, and unless Congress displays hitherto unsuspected levels of cooperation, it is set to succeed – though it might have to sell off some units to get there.