The Health Care M&A Monthly: Guidant Buys Cook For $3 Billion To Prop Open Revenue Flow
Guidant Corporation (NYSE: GDT), based in Indianapolis, Indiana, recently announced that it would pay a total of $3 billion to acquire The Cook Group, a privately held medical device manufacturer. What GDT seeks most in this deal is to obtain Cook’s technology and clinical data for drug-coated stents and, ultimately, a dominant position in the drug-coated stent market.
Guidant develops, manufactures and markets a variety of therapeutic medical devices for the treatment of cardiovascular and vascular diseases. On a trailing 12-month basis, GDT generates net income of about $600 million, EBITDA of $877 million and revenue of $2.9 billion. The company’s market cap is just over $11 billion. Guidant’s interest in stents did not just appear out of the blue, of course. Its own product line already includes stents, for example, that prop open non-coronary vessels such as bile ducts. Further, last August, GDT and Cook entered into a series of development and distribution agreements that involve Cook’s drug-eluting stent and balloon dilatation technology.
The Cook Group, based in Bloomington, Indiana, manufactures and markets products for interventional cardiology, radiology, urology and vascular medicine. Of signal interest to GDT is Cook’s ACHIEVE™ Drug Eluting Coronary Stent System. Cook has, in turn, licensed some of its technology from a Vancouver, British Columbia-based company, Angiotech Pharmaceuticals (TSE: ANP), which produces drug coatings for surgical stents. In 2001 The Cook Group’s revenue exceeded the $500 million mark.
Guidant’s interest in The Cook Group’s technology inexorably led to the current deal. Under terms of the merger agreement, GDT will issue $3 billion in stock in two phases. In the first phase, GDT will issue a maximum of 41.25 million GDT shares at $40 per share. In the second, it will issue a maximum of 24.52 million shares at $55 per share. After the deal, Cook shareholders would own about 18% of GDT’s equity.
This price to revenue multiple of 6.0x might strike some as a bit pricey at first blush, but investors seem to have welcomed this deal. While shares of companies that announce a big stock deal typically drop, GDT shares rose $0.47 to $35.45 on announcement of the deal. What lies behind this optimism?
The current market for stents is about $2.5 billion per year; the addition of drug-coated stents could, it is estimated, double that to $5 billion by next year. At least part of that upside was delivered by the Centers for Medicare & Medicaid Services (CMS), which recently announced the creation of two new diagnosis-related groups, or DRGs, for drug-coated stents. These two DRGs, one for patients with myocardial infarction and one for those without, will provide 17% more in payments than current levels for uncoated stents, effective April 2003. They will result in additional reimbursement of $1,700 to $ 1,800 for Medicare patients receiving coated stents over the current reimbursement levels for plain stents. Procedures typically cost around $12,000, and the average procedure uses about 1.4 stents. The government also raised its payment for the base procedure by between $300 and $500, which brings the total reimbursement increase to over $2,000.
Establishing a DRG before product approval is virtually unheard of, but CMS was apparently persuaded by the urgency of drug-coated stents for heart patients. The typical uncoated stent costs about $1,000; now, with the CMS’s new DRGs, companies may be able to charge about $3,000 per drug-coated stent. Importantly, under the new DRGs, CMS will picking up about 65% of the tab and hospitals the remaining 35%. Such figures will obviously translate into enhanced revenue and profits.
Guidant is not alone in the race to capture a share of the stent market. Johnson & Johnson (NYSE: JNJ), which already sells its drug-coated stent in Europe through its Cordis subsidiary, currently has the inside track. JNJ can be expected to bring its own product to the U.S. market by 2003, some six to nine months ahead of its competitors. JNJ will thus be the immediate beneficiary of CMS’ largesse; on news of the CMS decision, its stock jumped 4%. And one analyst at Piper Jaffray has, in fact, raised his estimate for JNJ’s sales of drug-coated stents in 2003 from $600 million to $1 billion. The stakes are high: The Guidant-Cook deal, if completed, would make GDT the second largest manufacturer of stents behind JNJ.
Also in the fray are rivals Boston Scientific (NYSE: BSX) and Medtronic (NYSE: MDT). BSX, which also had a license agreement with Angiotech, has been contesting the distribution agreement between Guidant and Cook which gives GDT access to the drug coating Paclitaxel that Cook had co-licensed from Angiotech. While a judge ruled in BSX’s favor in June, the legal wrangling persists as GDT strives to expand into this market.
The legal issues are only one of the two deal-breakers in this transaction. The other is that Cook must also obtain regulatory approval for a key product. If Guidant walks away, it will have to pay a hefty $50 million breakup fee. With such high amounts at stake, we can expect that GDT will commit much of its resources to getting the deal done. And other companies will want to tap into the lucrative coated stent market, some even through acquisition. Although it is in first place, JNJ might conceivably wish to cement that position through an acquisition.