Stryker decides not to follow Zimmer’s lead – at least, not yet

With consolidation very much the flavour of the month in orthopaedics, is not so much that Stryker was considering buying Smith & Nephew that was surprising as that it ultimately pulled back. The synergies between the companies, the sense of expectation around the Zimmer-Biomet merger and the fact that S&N has the UK tax base that underlined Pfizer’s longing for AstraZeneca all pointed to a done deal.

Many will be asking why the US firm stopped in its tracks. If Zimmer sees no antitrust issues with its move there is no obvious reason for Stryker to fear competition rules. Perhaps it reached out to S&N’s shareholders on the quiet and found them to have demands it could not meet. Or the tax situation was not as clear-cut as it thought. Or maybe, more worryingly, a closer look at the UK company’s underlying performance gave Stryker cause to pause.

Bigger than ZimMet

While there are indications that the orthopaedics market is improving on the back of increased insurance coverage in the US and economic growth, which fuel elective surgeries, companies in this sector still face pressures. Hospitals are not slackening their cost-cutting efforts, and pricing pressures mean companies must seek their own efficiencies.

The lure of combining forces, even among the very biggest players in the sector, is therefore strong. This naturally raises the question of how much consolidation is feasible. So far no pushback from anti-competition authorities over the Zimmer deal has been observed, and while that is no indication that the transaction will be problem-free the FTC’s forbearance might have given Stryker confidence to seriously consider an approach.

If Stryker were to pursue an acquisition of S&N – and it will doubtless spend the next six months thinking carefully about whether to do so – it would change the orthopaedics sector even more dramatically than the $13.4bn Zimmer-Biomet deal. The company formed from Stryker and Smith & Nephew would be predicted to have 2020 orthopaedics products sales of $10.2bn, EvaluateMedTech data show, compared with $9.4bn for ZimMet (or whatever it may come to be called).

The top three ortho companies by worldwide sales in 2020 would therefore be Johnson & Johnson, StrykerSmithNeph, and ZimMet (see table).

In terms of ortho sales, Stryker is much larger than its target, with 2013 sales of $5.2bn compared with S&N’s $2bn. Zimmer and Biomet were more evenly matched, with 2013 orthopaedics sales of $4.4bn and $2.9bn respectively.

Defensive

If the rationale for the buy is clear, the reasons for abandoning it are less so. But there are some possible explanations.

Stryker simply may wish to see whether the FTC okays Zimmer’s move before risking a megadeal of its own.

And the tax situation in particular repays examination. It has been speculated that Stryker’s plan was to relocate its headquarters to the UK with its favourable tax regime, but analysts from Bernstein wrote that Smith & Nephew actually has a higher tax rate, at 29%, than Stryker’s 23%.

To gain a tax benefit, Stryker would therefore need to relocate the merged company to an entirely different place such as the ever-popular Ireland. If the Pfizer-Astra deal played badly with both the US and the UK governments, shifting both Stryker and S&N elsewhere would be even less favourably received. It would be a brave board willing to kick this PR hornet's nest again so soon.

Smith & Nephew has long been considered a tempting acquisition target, and such a buy would be an obvious defensive move for Stryker in the face of J&J and a putative ZimMet behemoth. Bernstein reckons there is a 35% chance of a bid at £11.50. The orthopaedics sector could yet finish 2014 a very different place from where it started.

To contact the writer of this story email Elizabeth Cairns in London at [email protected] or follow @LizEPVantage on Twitter