The Health Care M&A Monthly: The Orthopedics M&A Market -

Will Smith & Nephew Ultimately Join Forces With Biomet?

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Rumors swirled in early December that medical device maker Smith & Nephew (NYSE: SNN) was preparing an $11.0 billion bid for rival Biomet, Inc. (NASDAQ: BMET). We now know that BMET was in play, but that it was ultimately snapped up for $10.9 billion by a consortium of private equity firms. This is the second time in three years that SNN was out-maneuvered: it courted Centerpulse in 2003 only to lose the Swiss orthopedics firm to Zimmer Holdings (NYSE: ZMH) for $3.2 billion. The loss of two big deals makes us wonder whether SNN’s role in the M&A market will now change from a (potential) buyer to a target.
Let’s first take a look at the players and winning combination. Based in Warsaw, Indiana, Biomet is a medical device company whose focus is orthopedics: it designs, manufactures and markets products for musculoskeletal medical specialists in surgical and nonsurgical therapy. On a trailing 12-month basis, BMET generated revenue of $2.05 billion, EBITDA of $700 million and net income of $409 million.
Under competitive pressure from giants in the orthopedics industry (names are named below), the company engaged Morgan Stanley earlier in 2006 to help it explore strategic alternatives. Bidders included both strategic and financial buyers. Among the former, SNN was a natural choice. Based in London, England, SNN develops, manufactures and markets tissue repair products, primarily in the areas of bone, joints, skin and other soft tissue. On a trailing 12-month basis, SNN generated revenue of $2.54 billion, EBITDA of $633 million and net income of $320 million. As its recent $72.3 million acquisition of Texas-based Osteobiologics shows, SNN is eager to expand operations in the United States. The acquisition of BMET would have given SNN a secure footing in the U.S. market, and the size to compete more effectively in the orthopedic devices industry.
But, alas for SNN, in the end BMET went to a set of financial buyers that includes such notables as The Blackstone Group, Goldman Sachs Capital Partners, Kohlberg Kravis Roberts & Co. and TPG. The consortium offered to pay $44.00 in cash for BMET, to be financed through a combination of debt and equity. This deal, valued at 5.3x revenue and 15.6x EBITDA, offered BMET shareholders a 27% premium over the stock’s prior-day price. Even though slightly lower than the $11.0 billion SNN was rumored to have offered, we assume the private equity bid won because of the ready cash it offered, as against the cash and stock combination that SNN would most likely have put together.
Interestingly, when news broke that the private equity consortium won the deal, SNN’s stock rose by as much as 7%. Maybe shareholders were just relieved that SNN wasn’t going to become so highly leveraged, but the jump also appears to have been driven in part by the speculation that SNN might itself become an acquisition target of the very same private equity group that acquired BMET. We know that venture capital firms often acquire two or more similar companies with the express purpose of combining their businesses; although doing so on this scale is somewhat less common for private equity firms, the market is teeming with cash chasing after investments. Operationally, privatizing and combining SNN and BMET would allow for a more rapid integration, without the pressure of being held accountable to two historically different sets of shareholders. The possible combination of SNN and BMET would create a firm better able to compete with the three giants in the field, Johnson & Johnson (NYSE: JNJ), Stryker Corp. (NYSE: SYK) and Zimmer Holdings.
Analysts as Nomura Code Securities were sanguine about such a deal, downgrading their recommendations on SNN shares from "buy" to "neutral," indicating the shares were almost fully valued. The crux of the matter, they believe, is that the upside from a rumored acquisition is not enough to balance the risk that a deal does not occur. Still, the pressures driving both BMET and SNN to seek a larger market share remain in play, so in the end it may matter less whether the two join forces under their own steam or through the auspices of a financial buyer. Speculation? Yes, but one worth considering.