Jenks Healthcare Business Report August 2003

Jenks Healthcare Business Report

August 2003 issue

Health Care M&A Market: Getting Back To Normal
It’s not just the number of mergers and acquisitions
that are starting to look like the “good old days,” it’s the feistiness of some of the deals too. See page 1

Public Market News
It may be a snowball in August, but the IPO market
picked up speed with three IPOs filed in the life
science sectors; and five secondaries priced. See page
4

Private Placement
For the first time in at least two years, we registered
more than 20 private placement deals in one month. This
time 22 public companies raised over $215 million from
private investment, with biotech and pharma leading the
way. Chart page 5

Venture Capital Market
Thirty-one deals and $466 million made this the biggest
month of the year in VC. Records fell that have been
standing since early 2002 as more and more companies
get some serious investment money. See page 7

Feature Profile
Archus Orthopedics Next in our series of closer looks
at firms successfully attracting VC, a medical device
company and its relationship with Scout Medical, its
incubator. See page 11

Departments

Mergers & Acquisitions Chart - 6

Notes & Briefs - 12

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Health Care M&A Market: Getting Back To Normal

In each of the past seven quarters there have been more than 200 announced mergers and acquisitions in the health care market. Except for the high of 287 transactions in the fourth quarter of 2002, the range in the past five quarters has been between 213 and 238 deals—a fairly consistent level of activity. But to see this as a sign that we are returning to the more robust M&A market of the 1990s—something bankers would like to see—we need to take a look at the most important measurements: the makeup of the market, and its competitiveness. While the makeup shows some troubling weakness in certain segments, the feistiness of the competition certainly harkens back to the "good old days."

Let’s take a look at the second quarter’s results. There were just over 220 announced transactions, 2% lower than the activity of the previous quarter and 7% below the year-ago quarter. Once again the technology segment (medical devices, biotechnology, pharmaceuticals and e-health) led the way with about 60% of the deals, while health services hit their lowest level of activity in a decade with just 87 transactions.

Even though the volume of transactions dipped slightly in the second quarter, based on revealed prices the dollar value of the deals jumped to $18.1 billion, up 37% from the first quarter and 9% from the year-ago second quarter. A little more than 50% of the total came from the biotechnology sector, most of which was the result of Idec Pharmaceuticals’ (NASDAQ: IDPH) acquisition of Biogen (NASDAQ: BGEN) for $6.8 billion. For the first half of the year, 41% of the total dollars committed in the overall health care M&A market were in the biotechnology sector, though that drops to 25% if the Biogen deal is removed. However, for two months in a row now, the medical devices sector dominated the big deals. The chart on page 3 displays the distribution of the M&A dollars by segment in the second quarter.

The hospital sector, which historically has had between 10 and 25 M&A transactions announced each quarter, has had just four deals in each of the last two quarters. Although we expect volume to pick up in the second half of the year, the mood in that segment has definitely changed for the worse. The extremely low level of activity in the hospital sector is of concern, primarily because the hospital market often drives the rest of the health services sectors.

At the other end of the services spectrum, the senior care market announced 25 acquisitions in the second quarter—almost 30% of all health services deals—and for the year is expected to post its highest level of activity since 1998. Consolidation among the large providers continues, with Emeritus Assisted Living (AMEX: ESC) emerging as the winning bidder for Alterra Healthcare (PK: ATHCQ) in late July. The acquisition will increase the number of facilities operated by ESC from 185 to almost 500, making it the largest assisted living operator in the country based on number of facilities.

The presence of hostile bids, raised offers and venture capital financing of mergers has resulted in a new atmosphere in the M&A market. A prime example is what happened to Smith & Nephew’s (NYSE: SNN) expected $2.6 billion purchase of Centerpulse AG (NYSE: CEP), a Zurich-based manufacturer of artificial orthopedic products, implants, valves and vascular grafts with annual revenues of just over $1 billion. Announced in March, the combination of the two companies (currently numbers 7 and 8, respectively) would have created the third largest orthopedics company in the world, behind Johnson & Johnson (NYSE: JNJ) and Stryker Corp. (NYSE: SYK). SNN’s offer was just 4% above CEP’s prior-day stock price and represented a 16.2x multiple of EBITDA.

But along came Zimmer Holdings’s (NYSE: ZMH) unsolicited $3.2 billion offer for Centerpulse to create the largest player in the $14 billion global orthopedics market, unseating JNJ from its number 1 spot. Management at SNN and CEP were not too happy with the hostile offer, but an extra $600 million—23% higher than SNN’s offer—could not be ignored. We may never know how high SNN would have gone, since it definitely did not want to take part in a bidding war and walked away from the competition on August 6. An unintended result, however, is that SNN may now be vulnerable to a takeover itself, with JNJ and Medtronic (NYSE: MDT) possible candidates to make an offer. This was not what SNN management had in mind last March. Antitrust issues could make such an acquisition difficult, however, and some analysts expect SNN to move quickly to bulk itself up with acquisitions of smaller companies. The company is known to have expressed some interest in acquiring Wright Medical Group (NASDAQ: WMGI).

In a very different situation, but nonetheless contentious, Ribapharm (NYSE: RNA) continues its defiant stand against ICN Pharmaceuticals’ (NYSE: ICN) attempt to buy back the 20% interest it sold to the public in an IPO that priced in April 2002 at $10 per share. It was always questionable why ICN spun out the 20% interest in the first place, other than raising $250 million of cash, since the majority of ICN’s earnings come from RNA’s primary product, Ribavirin, which treats hepatitis C. Now, ICN wants it back, and in early June offered $5.60 per share.

RNA management, which had already squabbled with ICN since going public, immediately rejected the offer as inadequate (how many times did this happen in the 1990s?) and recommended that shareholders reject the offer as well. In July ICN extended its offer but refused to sweeten the terms. Meanwhile, a federal court ruled in July that com-petitors of Ribapharm are not infringing on the Ribavirin patents and can develop generic versions of the hepatitis C drug. At that point, shareholders of both companies were probably wondering what the real value of either entity was.

But on August 4, ICN increased its offer by 11.5% to $6.25 per share (less than a week after stating that it had no intention of doing so) and extended the offer until August 19. The increase, which ICN insists will not be increased further, came in conjunction with an agreement by RNA’s board to exclude the ICN offer from its poison-pill provision and to allow a shareholder vote, with a two-thirds majority required to approve the deal. At the $5.60 per share price 53% of RNA’s shares had already been tendered, and the stock price has remained below the $6.25 level, so the percentage should rise, particularly given the court ruling (which RNA plans to appeal). Nevertheless, RNA’s board has still not recommended the offer to shareholders and in fact has incurred more ICN wrath by hinting that the offer might go higher.

While all this can be viewed simply as a family feud, it does heighten the tension in the market, and shows that holding out for a higher bid often works.

In the case of a large venture investment enabling a company to complete an acquisition, Medex, Inc., a provider of critical care products with $100 million of revenue, was able to purchase the Vascular Access business of JNJ’s Ethicon Endo-Surgery Inc. subsidiary for an estimated price of between $400 and $450 million. The deal could not have been completed without an approximately $100 million investment by One Equity Partners, a subsidiary of Bank One Corporation (NYSE: ONE), which enabled Medex to borrow about $125 millon of senior debt and $200 million of high-yield debt to complete the acquisition. Now, Medex will be triple its former size with revenues of $300 million and projected EBITDA of $75 million in 2003. One Equity Partners will control about 80% of the combined companies, with the original Medex shareholders owning the rest.

In a much larger transaction, One Equity Partners is providing the equity financing to allow the founder of Quintiles Transnational Corp. (NASDAQ: QTRN) to take the company private in a $1.7 billion deal. This acquisi-tion has not closed yet, but came several months after a $1.32 billion bid by the same buyer was rejected by the board. As readers are aware, venture firms have been pumping about $400 million a month into private health care companies.

Resolution of hostilities was also involved in the month’s second largest transaction, Roche Holding AG’s (SWX: ROCZ) $1.4 billion acquisition of Igen International (NASDAQ: IGEN). The unusual deal is an extreme measure to acquire a license for technology Roche clearly sees as vital. Roche and Igen had been in court since 1997 over what Igen claimed was Roche’s abuse of its license for Igen’s Origen blood-testing technology. In early July, a federal appeals court upheld Igen’s right to withdraw the license from Roche, which was bad news for Roche, but it reversed the $486.8 million in compensatory and punitive damages that had previously been awarded, which was bad news for Igen.

Roche then agreed to buy Igen, at $47.25 per share plus shares in a new company that is to be spun off and run by Igen management. Roche will also provide the new company with $155 million in working capital. Roche in return gets unlimited access to the Origen technology, and won’t have to pay royalties, but the rights are nonexclusive and the new company will theoretically be able to compete with Roche if it chooses, as well as retaining free rein over its life science, biodefense and industrial business. Igen shares jumped 60% on the news.

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