City analysts covering Smith & Nephew have never been so popular. Over the past week, they have been bombarded by calls from clients demanding information on the UK medical devices maker, which has been the subject of takeover speculation.
The chatter continued over the weekend, with Smith & Nephew shares rising 3.5 per cent on Monday to 709p in response. Since the start of December 2010, the shares have risen almost 20 per cent.
There are sound reasons why the stock is being targeted. Venkat Rajan, medical devices manager at research firm Frost & Sullivan, says: “Smith & Nephew is very strong, with a good brand reputation and a high presence outside the US in sales and marketing.”
The economic background has also played its part. Medical devices, including orthopaedics, which is one of Smith & Nephew’s core markets, have come under pricing pressure since the downturn. Patients have traded down to older, lower-cost artificial hips or deferred elective surgery. And debates around tougher regulatory standards in the US and Europe alike are threatening higher costs both for approval and post-approval scrutiny. In this environment, companies are looking for opportunities to cut costs. A deal would present just such an opportunity.
The UK-based company also has a strong geographical spread of revenues, offering scope for diversification into new markets for many of its US peers.
“We believe M&A considerations are unlikely to cool down in light of the substantial benefits of further industry consolidation,” Christoph Gretler, an analyst at Credit Suisse, wrote in a note last week.
David Illingworth, chief executive of S&N, is expecting to see deal activity in the industry. “We want to be as broad as we can while being synergistic,” he told a global healthcare conference in San Francisco last week, while declining to comment on the speculation around the company.
After criticism of its earlier silence, the company put out a statement last Friday that did not rule out expressions of interest from rivals. “Smith & Nephew wishes to clarify that it is not engaged in any discussions which could lead to a merger or a takeover involving the company,” it said.
The list of realistic bidders for S&N is limited to a handful of US groups: Biomet, Johnson & Johnson, Zimmer and Stryker.
For Zimmer and Stryker a deal would help to alleviate the impact of falling prices and would also enable them to diversify outside the US. But analysts caution that their management teams had less experience than others in consolidating large transactions.
Biomet and Smith & Nephew have tried to get together before. In 2006, the latter tried to buy the former, but was outbid when a private equity consortium comprising Blackstone, Goldman Sachs, KKR and TPG Capital stumped up almost $11bn to seal the deal.
But with Biomet reporting net debt equivalent to 5.7 times operating earnings, a deal with S&N now would have to be structured as a reverse takeover. To help pay down its debt, S&N could look at selling its wound care business – which analysts at Deutsche Bank estimate is valued at between $2.6bn and $3.4bn.
Analysts at Sanford Bernstein argue that for S&N investors, Biomet’s debt would make it an unfavourable merger partner.
“We think that a merger between Smith & Nephew and Biomet looks unappealing for Smith & Nephew shareholders who would face significant dilution. Since J&J seems much better placed than anyone else, a bidding war for Smith & Nephew seems unlikely”.
And some Smith & Nephew investors have argued that a combination with Biomet may not produce synergies high enough to justify the rise in the company’s share price.
Tactics will be key. If Biomet makes the first move for S&N, it may quickly be outbid by cash-rich J&J, which has completed a steady stream of recent deals. One investor said that a move to combine S&N and Biomet would in effect serve as a “put-up or shut-up” for J&J.
Unlike Biomet, J&J and S&N are competitors in all of S&N’s markets, creating the potential to squeeze out significant savings.
But that also means there are likely to be regulatory hurdles. In orthopaedics, for example, the two companies would have a combined market share of 34 per cent in reconstructive hip and knees, globally, and about 20 per cent in orthopaedic trauma, according to analysts at Credit Suisse.
S&N’s wound care business would be less problematic for antitrust regulators, but J&J is unlikely to be very interested in it given that it sold its own professional wound care business to buy-out group One Equity Partners three years ago.
Finally, J&J, with much revenue generated outside the US, could enjoy a tax advantage by acquiring a target abroad, instead of repatriating its spare cash.
For now, few investors are expecting any imminent news. One trader who specialises in short-term investments in takeover situations said: “Is the market being stupid? Yes. Will the shares go up on every further bit of speculation? Yes. Will I be buying any shares? No.”