Stryker (NYSE:SYK) CEO Kevin Lobo yesterday admitted that his company was evaluating an acquisition of British orthopedics rival Smith & Nephew (FTSE:SN, NYSE:SNN)
Rumors of the deal prompted investors to boost Smith & Nephew’s share price to £10.12 apiece yesterday, for a record high and a gain of some 17.5%. The surge forced Stryker to shelve the plan for at least 6 months under U.K. merger & acquisition rules, sending SN shares back down to earth.
After the hullaballoo subsided, Lobo confirmed Stryker’s interest during a television interview last night.
"We were actually in preliminary evaluations about considering a transaction," Lobo told Fox Business. "It was early, but based on the price spike of Smith & Nephew we were called by the panel and we had to make this public statement."
The acquisition would be worth an estimated $19 billion, according to analysts at Morgan Stanley, and would confer an important benefit: The ability to return future overseas cash earnings back to the U.S., known as inversion.
"We believe the most important benefit of an inversion for Stryker could be to expand capital deployment options by reducing limitations on use of its significant [outside-the-U.S.] earnings," the Morgan Stanley analysts wrote "While Stryker generates only 35% of its sales overseas, our estimates suggest that as much as 50-60% of its pretax income might be OUS. Such lopsided profitability has driven significant OUS cash generation, and an inversion would significantly ease constraints on use of future OUS earnings."
And, although it would be a departure from Lobo’s acquisition rationale, a tie-up between Stryker and Smith & Nephew would give Stryker the scale to compete with Zimmer (NYSE:ZMH) once its acquisition of Biomet goes through, according to the analysts.
"Lobo’s strategy in orthopedics has been to drive more aggressively into emerging markets (Trauson) and to focus on differentiation through robotics (Mako). The acquisition of Mako was in many ways a statement that Stryker did not need another hip and knee company, as implants have become increasingly commoditized. This transaction would stand in contrast with that strategy to some extent, but there is clearly enough strategic rationale to rationalize the potential deal. When combining gaining scale in orthopedics with the benefits of an inversion, this potential deal could make sense. In fact, Zimmer/Biomet disruption could provide some cover for other orthopedics companies to consider consolidation, which would accelerate efforts to decrease reliance on distributors. Basically, there is safety from disruption in numbers," according to Morgan Stanley. "If Stryker were to acquire Smith & Nephew, the combined company would have ~35% of the ortho recon market, compared to ~40% for Zimmer/Biomet. By gaining additional scale, companies can combat pricing pressure by removing costs through distribution, inventories, and G&A. Additionally, having multiple companies going after distribution at the same time would lower the risk to any individual company and would be better for the industry overall if this process was accelerated."
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