Stryker (NYSE:SYK) certainly found a way to liven up the ortho space, with Wednesday’s announcement that it is buying Mako Surgical (NSDQ:MAKO) for a whopping 13 times 2013 estimated revenue. Stryker had been pretty clear about its intentions to put cash towards M&A, and Stryker’s relative challenges in knees were already known, but few industry-watchers saw this deal coming, and certainly not at this price.
Over time, I think Stryker could do a lot with Mako. Obviously Stryker’s management thinks so too, or they wouldn’t have paid so much for it. What I’m interested to see now, though, is whether this move leads to any sort of consolidation push in the ortho industry and/or whether Stryker+Mako will fundamentally alter the balance of power in major joint recon and push the likes of Johnson & Johnson (NYSE:JNJ) and Zimmer (NYSE:ZMH) to up their games.
A new dawn in knees and hips?
It was known prior to this deal that Stryker was 1 of, if not the, most bullish of the major ortho companies as to the potential of robotic systems to improve outcomes and alter market dynamics. To that end, there have been rumors for some time now that Stryker was or would be building its own robotic system.
We may never know whether Stryker actually did work on its own system, but we will see what Stryker can do with Mako’s Rio system. Right off the bat, Stryker’s experience and credibility in selling capital equipment to hospitals ought to improve the prospects for selling Mako’s nearly $1 million robotic system. Longer-term, I would also imagine that there’s a lot Stryker can bring to the table in terms of implant design and tools/technologies integrated into the Rio system and its successors.
In particular, I’m curious to see what this deal can do for Stryker in its battle for market share in hips and knees versus Johnson & Johnson and Zimmer. Stryker’s knee platform has looked a little stale relative to J&J and Zimmer, and though the Rio is primarily used to facilitate uni knee procedures (a small, albeit fast-growing segment of knee recon), I don’t think J&J and Zimmer can afford to assume that Stryker won’t be looking to move this into total knees down the line.
I think it’s worth remembering that one of the bigger attractions of the Rio system is that it can allow less experienced (and, if we’re honest, perhaps less talented) surgeons to generate results on par with what better surgeons can achieve with more conventional tools. Teamed with Stryker’s large sales force, that could make uni knee procedures a more viable alternative and give Stryker a new edge in competing in the knee recon space. Longer term, if Stryker-Mako can generate the requisite outcomes data, the hip opportunity is likewise considerable and a threat to the existing businesses of the other major joints companies.
Time for more consolidation?
Stryker had previously been tapped as a likely consolidator in the ortho space, just not in the direction of Mako. Although the deal for Mako does sweep up the company’s net cash, I suppose it doesn’t automatically follow that the company is done with deals – given the low cost of debt financing today, I think Stryker could easily put together the financing if the opportunity for another accretive deal came along.
While Stryker is number 3 or 4 in spine, they’re well behind Medtronic (NYSE:MDT) and JNJ and it would have made some sense for the company to have acquired Globus Medical (NYSE:GMED) to gain scale, share, and product leverage. Now it’s less clear what happens in spine; Zimmer is likewise sub-scale in this market, but a Zimmer-Globus tie-up doesn’t necessarily solve that issue definitively, though a NuVasive Inc. (NSDQ:NUVA)-Globus tie up could be interesting in some respects.
Stryker had likewise been thought to be interested in expanding its extremities business, with either Tornier (NSDQ:TRNX) or Wright Medical (NSDQ:WMGI) serving as a logical target. I still believe consolidation in the faster-growing extremities makes sense, and a company like Zimmer could look at Tornier as not only an avenue towards taking the #1 position in upper and lower extremities, but also leveraging Tornier’s highly focused hip and knee business (basically a Europe-only business, with considerable share in France).
But what about something even bigger? When JNJ bought Synthes, it created a very large player in both trauma and spine, with more than 30% share in the former and roughly 25% share in the later. Would Zimmer consider a similar move for Smith & Nephew (FTSE:SN, NYSE:SNN) or Biomet ? Doing so would give the company over ⅓ global share in hips and knees, not to mention better scale and share in trauma and extremities. Spine would still be an area of relative weakness, but the operating synergies in such a combination could be meaningful and Smith & Nephew has potentially attractive assets in areas like sports medicine (arthroscopy) and wound management.
What’s true for Zimmer could also be true for others. I don’t think Medtronic necessarily wants to get into major joint reconstruction (nor do I think shareholders would be pleased, given the sluggish growth in that industry), but trauma, sports medicine, and extremities could make sense given their better growth rates and potential leverage with Medtronic’s spine business. Likewise, JNJ could see some advantages in adding additional scale in hips and knees, sports medicine, and extremities, though any large deal would almost certainly require divestitures to get antitrust approval.
The bottom line
Often as not, the right guess in M&A speculation is "none of the above" as deal speculation always runs far ahead of actual deals getting done. Even so, the realities of the ortho market would seem to argue for more consolidation. Procedure growth and reimbursement have both gotten more challenging in recent years, and I’m not sure there’s a great leap forward on the drawing boards that will really change things (apart, perhaps, from the wider use of robotic systems in ortho procedures).
With that, 5 major hip and knee companies in North America and Europe may be at least 1 or 2 too many. It will take some time for Stryker to really alter Mako’s trajectory, but if Johnson & Johnson or Zimmer feel a threat to their major joint recon business, consolidation could be an alternative they might consider. Likewise, given the growth in extremities and sports medicine, the temptation for larger, slower-growing companies to buy growth via M&A may be too much to resist.
As of this writing, the author owns shares of Wright Medical Group.
Stephen Simpson CFA is a former sell-side and buy-side analyst who focuses most of his professional attention on financial and investment writing. In addition to a decade of work as an analyst, Mr. Simpson has worked as a wet-bench biomedical researcher and a consultant in the med-tech industry, as well as writing on a freelance basis for over 10 years. He can be reached via email at tuonela.fool@gmail.com.
