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Home » Seven questions raised by Medtronic’s $43B Covidien acquisition

Seven questions raised by Medtronic’s $43B Covidien acquisition

June 18, 2014 By Brad Perriello

Five take-aways from the Medtronic-Covidien deal

With combined annual revenues at the $27 billion mark, the Medtronic (NYSE:MDT)-Covidien (NYSE:COV) combination will rival Johnson & Johnson‘s (NYSE:JNJ) medical device operation in scale.

Along with another pending mega-deal, the $13 billion acquisition of Biomet by orthopedics rival Zimmer (NYSE:ZMH), the MDT/COV deal changes everything for the medtech industry, from small-cap players to the largest companies in the field.

Here are 7 questions prompted by Medtronic’s whopper buyout of Covidien, starting with its implications for smaller companies.

  1. What does it mean for the mid-caps? For Stryker (NYSE:SYK), Abbott (NYSE:ABT), Boston Scientific (NYSE:BSX) and St. Jude Medical (NYSE:STJ), it’s simple: Scale up or die.

    "It becomes more necessary for the medical device companies to have a broader product line in order to be able compete and have economies of scale," Len Yaffe, portfolio manager at StockDoc Partners, told Reuters, saying St. Jude "could be an acquirer of a smaller company to emulate what Medtronic is doing."

    Morningstar analyst Debbie Wang listed Stryker as another potential buyer, according to the news service.

    "That company is a serial acquirer and CEO Kevin Lobo has indicated that it is trying to move the company in the direction of becoming a larger partner with its hospital customers, the same strategy that Johnson & Johnson and Medtronic are taking to heart," Wang said.

  2. Who’s on the auction block now? Companies doing big business with hospitals are sure to pique acquirers’ interest. That means Hospira (NYSE:HSP), Becton Dickinson & Co. (NYSE:BDX), Baxter (NYSE:BAX) and Masimo (NSDQ:MASI) could find themselves being wooed on the strength of their business with hospitals, according to StockDoc Partners’ Yaffe.

  3. Whither Smith & Nephew (FTSE:SN, NYSE:SNN)? With Stryker on the M&A sidelines for 6 months and Medtronic clearly interested in another target, Smith & Nephew needs to find another suitor or risk losing the premium its share price has enjoyed since news of Stryker’s interest broke in early June.

    "SN’s premium valuation is currently supported by M&A," Morgan Stanley analyst Michael Jungling wrote in a note to investors yesterday.

    Could that acquirer 1 day be Medtronic? Eventually, perhaps, but not for a while, CFO Gary Ellis said yesterday.

    "[Orthopedics is] a big area that we’re not in, that we’ve always had some interest in getting in, but it’s always been a struggle on figuring out exactly how. And it’s also something we didn’t necessarily believe we needed to be in," Ellis said yesterday at the Wells Fargo healthcare conference in Boston. "As the consolidation in the area continues to change … and we need to have more of an orthopedic product line to be competitive in spine, it’s something obviously we will look at, but it just never has made financial sense. We could never see exactly how we could become a strong player in that marketplace. And right now, our focus obviously is going to be on integrating the acquisition we do have under way. But at some point in time, if you asked me, ‘In the next 10-12 years, is Medtronic somehow in orthopedics?’ – probably. How we get there and [at] what time, I don’t know and I am not going to predict at this point."

  4. What is Covidien likely to cut? Jobs, for 1 thing.

    Although Medtronic hastened to reassure Minn. Gov. Mark Dayton that the deal likely means another 1,000 medtech jobs for the Land of 10,000 Lakes, Mass. Gov. Deval Patrick, told MassDevice.com today that neither company felt compelled to contact him ahead of the merger.

    That’s not a good portent for the Bay State’s medtech scene, where Covidien employs about 2,000 people, mostly at its headquarters in Mansfield. There’s no official word on the number of cuts, but a Covidien spokesman told the Boston Globe that "synergies" are certainly in the cards.

    "It’s expected that there will be some synergies in headquarters jobs, and the companies will address that as part of the integration planning," Covidien vice president Peter Lucht told the newspaper.

    In terms of the combined device portfolio, the companies are so complementary that there’s little overlap to be found, Leerink Partners analyst Danielle Antalffy told MassDevice.com.

    "There are some complementary product lines, like COV’s peripheral vascular product offering and neurovascular. The real cost synergies will come primarily from the back office operations," Antalffy told us via email this week.

    "With minimal overlap across product lines, COV provides meaningful scale and incremental breadth to MDT, which now will have product offerings touching nearly all areas of the hospital. COV brings a steady, mid-single-digit sales growth heavily weighted towards hospital supplies with some complementary technologies including a $1.2B peripheral vascular business, nearly $1B patient monitoring business, and a ~$500M neurovascular business. This deal overall is a strong signal that scale and portfolio breadth are increasingly being viewed by medtech industry leaders as paramount to remaining competitive in a post-ACA environment," added Richard Newitter, Antalffy’s colleague at Leerink, writing Monday in a note to investors.

  5. Could Medtronic have better spent that $43 billion? Yes, at least according to 1 hedge fund operator that liquidated its stake in Medtronic after the deal was announced.
  6. "In one of its recent presentations, Covidien lists its primary acquisitions and divestitures since 2009, noting that it was purchasing higher-margin products than it was selling. These 10 acquisitions totaled approximately $5.5 billion. It’s difficult to imagine that Medtronic did not have an opportunity to bid on most of these deals, which begs the question, how much of the $43 billion purchase price is paying a premium on top of the premium that Covidien already paid to purchase these companies? It’s impossible to discern, but worth contemplating for Medtronic shareholders," wrote Noble Equity Fund’s Paul Nouri. "Since I started my healthcare focused hedge fund in 2008, I’ve owned Medtronic as it has been consistently undervalued given its superior operating margins, cash flow generation and the focus the company has shown on its core products. With this acquisition, Medtronic is succumbing to the pressure that many other large companies have to issue debt while it’s cheap in order buy as large of a competitor as one’s credit rating can withstand. With this increased level of uncertainty, we sold out of our position this morning, but will continue to monitor the company for updates. We would revisit shares under $60."

  7. A curb to the digital health M&A trend? Analysts yesterday predicted that small-cap players will hold less luster than before, especially in once-hot areas like cardio, spine, and extremities.

    "It makes sense that Stryker is contemplating a deal with Smith & Nephew, and we would not be surprised to see Johnson & Johnson and Abbott Laboratories at some point look to get bigger in medtech. In our opinion, this means small-cap medtech companies in may no longer be targets over the near to intermediate term," RBC Capital Markets analyst Glenn Novarro wrote in a research note.

  8. According to Mobihealthnews, that could extend to include small companies in digital health, where both Medtronic and Covidien have made plays.

  9. Will Medtronic lose its spot on the Fortune 500? The shift to an Irish HQ will mean Medtronic loses its long-held spot on the Fortune 500 list of the largest public U.S. corporations. Medtronic was 173rd on this year’s list.

Filed Under: Mergers & Acquisitions, News Well, Wall Street Beat Tagged With: Covidien, Medtronic buys Covidien

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