It can be tricky to make the right choice when under pressure. Stryker’s decision last week to back off from its planned takeover of Smith & Nephew after the UK’s Takeover Panel insisted it make its intentions clear means that the company could find its place usurped by Medtronic.
A Medtronic-S&N tie-up makes more sense than the Stryker buy, as buyer and target are active in different areas – spine and hips/knees, respectively. This ought to produce a company with a wide product range and the transaction would almost certainly entail fewer divestments to sidestep antitrust issues compared with a Stryker purchase. And, if Medtronic holds its nerve in the face of UK takeover rules, the merged company would displace Siemens to become the second-largest medtech company in the world (See table below).
The companies’ shareholders are enthused by the prospect, sending Medtronic’s shares up 4% and S&N’s up 12%, valuing the latter at $17.4bn. The UK group’s stock has risen 23% since the Stryker bid became public knowledge on May 28 (Stryker decides not to follow Zimmer’s lead – at least, not yet, May 29, 2014).
If the deal were to go ahead, it would be by far Medtronic’s largest acquisition, dwarfing its previous record, 2007’s purchase of bone cement maker Kyphon for $3.9bn.
Medtronic is holding its investor day today, but a company spokesperson was quick to point out on a conference call that the company would not comment on the rumours. Smith & Nephew also declined to discuss the situation.
For all companies’ talk of "product synergies", the more similar two companies’ franchises are, the more likely it is that divestments will be necessary to placate the competition authorities. The overlap between Zimmer and Biomet, both of which are heavily invested in hip and knee replacement, is huge; Zimmer will surely end up having to spin off some of its devices or entire units (Zimmer and Biomet hook up for second orthopaedics megamerger, April 24, 2014).
Thus the model for a theoretical Medtronic-S&N transaction would be less Zimmer-Biomet than the previous orthopaedics megamerger, Johnson & Johnson’s $20bn purchase of Synthes in 2011. J&J’s orthopaedics operations were almost entirely focused on hip and knee replacement, whereas Synthes was known for its trauma products. In order to get the deal done, J&J did have to sell off its own tiny trauma business, but at $280m this was peanuts compared with the total value.
Medtronic is a relatively varied medtech company with cardiology, neurology and diabetic care businesses, but within orthopaedics its operations are specialised: it is the number one player in spinal technologies and lacks any activity in joint replacement, trauma, or sports medicine – all areas in which S&N excels.
And this putative new company would have interesting implications for the medtech sector overall. Buying S&N does not alter Medtronic’s rank within the ortho sector, EvaluateMedTech data show – ranked solely on sales of orthopaedics products the new company would remain number four worldwide (see table).
|Top orthopaedics companies if Medtronic buys Smith & Nephew|
|Total sales ($bn)||Market rank|
|Johnson & Johnson||8.9||11.2||1||1|
|Smith & Nephew||2.1||2.7||6||-|
However, Medtronic would become a much bigger player overall. The data show that, in terms of overall worldwide medtech sales, the post-acquisition Medtronic would be second only to Johnson & Johnson, leapfrogging Siemens.
It is possible to look at the deal from the other end: Medtronic’s need for S&N is greater than Stryker’s. Medtronic’s orthopaedics unit is performing sluggishly, with a predicted compounded growth rate of just 1% between 2013 and 2020. The company’s spinal bone growth product Infuse has been little short of a nightmare, with negative trial data piling up and a lawsuit being filed this week under RICO statutes alleging that the company promoted it illegally.
The final factor is the tax advantages that Medtronic – like Stryker – might enjoy by redomiciling itself in the UK after the merger. Bernstein analysts wrote that Medtronic had a significant ex-US cash generation problem; the ability to use this non-US generated cash freely could make the takeover worthwhile.
Medtronic may be reluctant to confirm its interest in S&N, but there are very good reasons for that interest to exist.