No matter how many times Smith & Nephew (NYSE:SNN) says it’s not talking merger, somebody else says it is.
The U.K.-based device manufacturer sought to tamp down several days of speculation late last week that it was close to a deal with industry leviathan Johnson & Johnson (NYSE:JNJ), or possibly Biomet Inc., the privately held orthopedics firm that Smith & Nephew pursued in 2006 (only to lose out to a consortium of private equity firms). The statement had its intended effect, with S&N shares sliding lower Jan. 14 on both the London and New York exchanges as the buyout talk cooled.
By the following Sunday, however, Fleet Street was once again awash in merger tales. This time, it was The Sunday Times reporting that J&J was preparing an improved offer for Smith & Nephews’ cache of artificial joints, surgical tools and wound care products. The newspaper, without citing sources, said the "American predator" would offer at least 800 pence a share, or about $11.3 billion. That’s a 6.7 percent increase from a 750-pence offer the company reportedly made for S&N in mid-December.
"It’s getting to be like a zombie movie. Every time you knock down one rumor, up pops another," said Robin Young, co-founder and CEO of PearlDiver Technologies Inc., a Fort Wayne, Ind.-based analytics company tracking the global orthopedics industry. "For whatever reason, this story just won’t die."
Smith & Nephew shares climbed 3.5 percent on the London market Jan. 17 and gained about $2, to $56.84, when traded resumed Jan. 18 in New York — but not before establishing a new 52-week high at $57.24. SNN shares are up about 11 percent since mid-December, when the latest batch of takeover rumors started making the rounds.
The speculation is starting to influence analyst opinion, with Sanford Bernstein upgrading S&N to Market Perform yesterday, with a $55.50-per-share target, specifically citing the "sustained" buyout talk.
As the No. 4 player in the small universe of diversified device makers, there is an obvious logic to S&N joining forces with a rivals. Its $880 million-a-year wound care business, S&N’s fastest growing business unit, also makes it relatively unique among its peers.
"There’s a lot of change happening right now in the healthcare business. It’s a sense that they’re dealing with forces that are bigger than any one company," Young said. "In that kind of environment, scale provides some security."
But he’s also skeptical a deal is in the cards for S&N — or at least a deal involving any of the players or on the terms as currently portrayed.
Others observers would seem to agree, with some suggesting that a firm such as Medtronic (NYSE:MDT), which now generates nearly as much revenue from its restorative therapies group as its traditional cardiac and vascular businesses, may eventually take a run at Smith & Nephew.
Orthopedic revenues at S&N were $510 million during the three months ended Oct. 2, 2010, with the endoscopic surgery unit logging $201 million in sales. The U.S. continues to dominate sales, accounting for 44 percent of the $941 million in global sales company-wide during the latest quarter.
Based on management estimates, S&N believes its orthopedics unit held an 11 percent share of the $16.8 billion global market during 2009, trailing Zimmer Holdings (NYSE:ZMH), Stryker Corp. (NYSE:SYK) and the DePuy subsidiary at J&J. Synthes (SWX:SYST) and privately held Biomet also are sizable competitors.
A spurt in 2007 boosted S&N’s market share in orthopedics into the low double digits and another may soon be on the way, with analysts at Goldman Sachs recently predicting 6.5 percent organic growth at Smith & Nephew, outpacing several of its peers by roughly 150 basis points a year through 2014.
The Goldman analysts contend investors are undervaluing S&N by about 5 percent based on enterprise value and earnings before interest, taxes and other items. They also acknowledge the persistent merger speculation, stating they view the company as "potential strategic asset,” believing additional consolidation in the hip and knee market is likely, according to the research note obtained by Seeking Alpha.
The Telegraph newspaper;reported last week; that Smith & Nephew CEO David Illingworth and Jeffrey Binder, the chief executive at Biomet, were set to meet in New York Jan. 17 at the invitation of Bank of America Merrill Lynch. S&N promptly issued its rebutal; although a S&N spokesman reportedly later confirmed the meeting had been scheduled but said it was merely intended for the two executives to "shoot the breeze over industry issues."
The Telegraph, which has probably advanced the buyout story more than any other U.K. news outlet, also said the Merrill Lynch investment bankers previously had organized a meeting for S&N executives last fall stitching together an outline of potential deal with Biomet. Merrill put together the 2006 purchase of Biomet by the Blackstone Group (NYSE:BX), KKR, TPG and Goldman Sachs (NYSE:GS) — a deal saddling the surviving firm with $5.3 billion in debt, likely the chief impediment to an S&N/Biomet merger getting done.
Johnson & Johnson, on the other hand, certainly has more than enough cash on hand to swing a deal, sitting on a $14.3 billion hoard at the end of its September quarter. Whether they would want to spend down that stash is another matter, especially when they also could use its Aaa-rated debt or stock to acquire the right target.
“Everybody does M&A but most companies tend to do deals out of desperation,” observes William Trombetta, a professor in the < Haub School of Business; at St. Joseph’s University in Philadelphia. “They’re looking at revenue growth slowing or see a key product start to get long in the tooth, so they tell themselves they need to get bigger and go out and buy somebody.
“J&J is different,” Trombetta continued, “It typically starts out looking at whether a particular deal makes strategic sense and then moves on to working out the financial details.”
But Trombetta, who previously worked as anti-trust attorney, also is doubtful a deal between S&N and J&J would ever come to fruition. Regulators in both the U.S. and abroad, he said, would likely keep the transaction in limbo for an extended period while they sort through the competitive issues and could hit the companies with enough conditions before granting approvals the two companies would instead it’s simply easier to move ahead alone.
J&J’s desire to retain its gold-plated credit rating may also play a role in whether a deal gets done. Last summer, Moody’s Investors Service cited its global reach, reputation for product quality and "strong profitability metrics" in reaffirming J&J’s triple-A rating. But Moody’s said there are limits to that ratings prowess, noting long-term debt already totals $9.18 billion, up 11.5 percent from the start of the year.
"J&J’s Aaa rating may be more sensitive to any unforeseen operating challenges," the Moody’s analysts wrote, adding that "maintaining the Aaa rating remains largely within J&J’s control, based on how aggressive the company chooses to be in its financial policy decisions."