August belongs to the Medical Devices sector. Not only did it rack up the highest deal volume with 13 transactions out of 59, but it outscored all other sectors in terms of dollars committed to fund those deals. Based on prices revealed to date, a total of $6.2 billon was earmarked to bankroll the month’s 13 deals, representing 84% of the total $7.4 billion committed to finance this activity.
The Swiss Connection
Among the factors contributing to the sector’s activity this month were three billion-dollar transactions. Each of these three deals involved at least one Swiss company.
The largest deal this month was not entirely unexpected, and emerged from the shadows as another transaction collapsed under the weight of a bidding war. At the center of the battle is Centerpulse AG (NYSE: CEP), the Swiss orthopedics company formerly known as Sulzer Medica. Back in March Smith & Nephew (NYSE: SNN) offered to pay $2.7 billion in an attempt to become the second-largest orthopedics firm after market leader Johnson & Johnson (NYSE: JNJ) and ahead of (currently) number two Stryker Corp. (NYSE: SYK).
However, third-place Zimmer Holdings (NYSE: ZMH) saw an opportunity to become the largest pure-play orthopedics company, and made a competing offer for Centerpulse, which ultimately topped out at nearly $3.2 billion.
After some months of wrangling and fine-tuning proposals and counterproposals, SNN decided within the past four weeks that it would not attempt to trump ZMH’s offer, and withdrew. When that happened, ZMH’s offer came front and center, with a price to revenue (P/R) multiple of 3.1x and a price to EBITDA multiple of 9.4x.
What now will become of Smith & Nephew? Word on the street seems to think the British-based company could itself become an acquisition target within a year, as other large orthopedic companies such as Stryker or Medtronic (NYSE: MDT) attempt to reassert themselves in the pecking order and regain market share lost to Zimmer, as enlarged by Centerpulse.
The Zimmer-Centerpulse deal already appears to have spurred other orthopedics companies to take the plunge. In Switzerland, two competing orthopedics companies, Synthes-Stratec (SWX: SYSZn) and family-run Mathys Medical (MM), have long been regarded as potential merger partners. As the Zimmer-Centerpulse deal looked more and more inevitable, SYSZ proposed buying MM for $1.1 billion. The world’s largest manufacturer of trauma products, SYSZ provides a variety of instruments, implants and power tools for the orthopedic and spine surgery markets while MM specializes in joint replacement products. The deal would create a company with complementary strengths: SYSZ is strong in the U.S. and one half of Europe while MM is strong in Asia and the other half of Europe. As a matter of fact, MM already sells the SYSZ brand in Asia and in some European countries where SYSZ isn’t present.
Under terms of the proposal, Synthes would pay two-thirds in cash and one-third in SYSZ stock. The cash portion is to be paid out of money on hand as well as bank borrowings arranged by Credit Suisse First Boston. In the past SYSZ management has declined to use cash for stock buybacks, viewing them as an admission that a company doesn’t know what to do with its cash. It seems SYSZ management has now found a good way to spend it. The transaction is valued at 3.9x revenue, which is at the high end of what analysts had expected. Still, the synergies seem good, and with consolidation in the sector, the two must grow to staunch the loss of market share.
In the month’s third billion-dollar deal, Roche Holding (SWX: ROCZs) is paying $1.4 billion for Igen International (NASDAQ: IGEN). IGEN owns the patents for an electrochemiluminescence technology called ORIGEN, which is used in blood testing. Most of IGEN’s revenue comes from royalty payments on the technology. In 2002 ROCZ subsidiary Roche Diagnostics GmbH generated $404 million from the sale of its Elecsys products, which incorporate the ORIGEN technology.
Roche’s immediate goal is to resolve a dispute between the two companies since 1997 over licensing rights to ORIGEN. ROCZ had been using it until a U.S. court ruled the company had violated its license agreement and assessed damages of $487 million. A subsequent ruling reduced the amount to $18.6 million, but affirmed IGEN’s right to terminate the license and sell the tecnology to the highest bidder. Rather than face the loss of a profitable business, ROCZ decided to buy its way out.
Under terms of the deal, Roche will pay $47.25 in cash for each share of IGEN and issue one share in a new company to be created from IGEN. ROCZ will buy IGEN, get a nonexclusive license for the ORIGEN technology and spin off the remainder of the business to former IGEN shareholders. In essence, the $1.4 billion represents a prepayment of licensing fees. And while IGEN retains ownership of ORIGEN, as well as the ability to license it elsewhere, it also loses its biggest source of revenue, ROCZ’s royalties, which accounted for 90% of IGEN’s royalty revenue. ROCZ also gets to sell its products to smaller labs and physician offices, which were outside its previous license agreement and which could bring the company an additional $40 million in annual revenue.
These three deals rank among the top 12 transactions announced in the Medical Devices sector during the past three years (see table on page 12). Nine of August’s remaining 10 deals were relatively modest in size. However, Eastman Kodak’s (NYSE: EK) proposed $500 million purchase of PracticeWorks (NASDAQ: PRWK) would be notable in any month. Although the target historically offered information management systems to the dental industry, it diversified its holdings in late 2002 with its $51 million acquisition of Trophy Radiologie S.A. from Thermo Electron (NYSE: TMO). Trophy, which currently operates as a PRWK subsidiary, develops, manufactures and sells X-ray imaging systems and related software for dental radiology.
Under terms of the deal EK will pay $21.50 for each share of PRWK common stock, and $7.33 for each share of preferred stock. In addition, the company will incur $34 million in assumed debt and transaction fees. This deal will give the buyer greater depth in the dental imaging market.
What They Paid
A total of 450 deals were announced in the three-year period running from July 1, 2000 through June 30, 2003. In the first year, July 1, 2000 to June 30, 2001, a total of 141 deals were announced. The second year, from July 1, 2001 to June 30, 2002, posted a slight decrease with 137. However, the most recent period, from July 1, 2002 to June 30, 2003, saw a marked increase with the announcement of 172 transactions.
Over this period, pricing has softened somewhat, as noted in the chart above, which gives the average and median P/R multiples for the past three years. The chart compares all deals in a given period with those in which the target has annual revenues of $20 million or more. The chart reveals that the gap between the average and median multiples is narrower for deals in which the target has revenue of $20 million or more. Companies with revenue below this level are often new and untested, without a history of significant revenues. This tends to skew their valuation and, hence, their acquisition multiples.
One optimistic note that may be gleaned from this chart, however, is in the pricing of the larger, more seasoned targets with revenue of $20 million and above. Both the median and average figures for the year 2002-2003 have risen against the comparable figures in 2001-2002.
A further, nonnumerical indicator may buttress the claim that the M&A market is becoming more resilient and robust. In moves reminiscent of the 1990s, more deals now being pursued involve hostile bidding, as in the Zimmer-Centerpulse case, or hard-ball tactics, as in the Roche-Igen deal, to get what a company wants. This suggests the players now have greater confidence in the economy and believe it is strong enough to provide them with the background and resources to get the deals done.
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