Deals

Brooke Sutherland is a Bloomberg Gadfly columnist covering deals. She previously wrote an M&A column for Bloomberg News.

Zimmer Biomet is paying up to expand in the spinal-surgery market, but give the medical-device maker credit for showing some backbone: It's a smart deal.

The company announced Tuesday that it's buying LDR Holding at a 64 percent premium to its close Monday and for roughly double the standard revenue multiple for the medical-device industry. Zimmer doesn’t expect the $1 billion acquisition to be accretive to its earnings per share until after 2017. Shares of the artificial knee and hip maker tumbled as much as 4.4 percent on the news, and that's understandable. But the fact is, Zimmer is stepping in at an ideal time.

Pained by the News
Zimmer's stock plunged by the most in months after it announced the purchase of LDR Holding.
Source: Bloomberg
Intraday times are displayed in ET.

LDR would have cost a pretty penny more this time last year, before a few earnings misses and concerns about increased competition knocked the spinal-device maker's stock down to its lowest price in years. It also would have been more expensive if Zimmer had waited. The $37-a-share on offer is actually a discount to where some analysts saw LDR's stock recovering to on its own over the next year.

Underappreciated Asset
Even as LDR's stock dropped, analysts remained mostly positive on the company. Some saw the stock going as high as $40 on its own over the next year.
Source: Bloomberg

LDR's missteps were more growing pains than fundamental problems. It's one of the fastest-growing medical-device companies in North America: Revenue is set to climb at an average annual rate of 16 percent over the next few years -- nearly double that of a standalone Zimmer. Based on LDR's projected 2017 revenue, the deal multiple drops to closer to 4.5 times.

Upward Bound
Analysts project sales will climb steadily at LDR.
Source: Bloomberg

Most of that growth is coming from its Mobi-C device, a metal-and-plastic disc that can provide more freedom of movement when inserted in the spine than traditional fusion surgeries. It's the only FDA-approved technology to also treat two adjacent discs that have become damaged. But a regulatory sign-off doesn't guarantee insurers will cover the treatment, nor that surgeons will rush to adopt it.

A positive recommendation from the North American Spine Society as well as a major data dump showing the benefits and cost-effectiveness of Mobi-C may help change the insurers' minds. As of May, only about 50 million people were covered for two-level cervical disc replacement surgery. Meanwhile, LDR is ramping up spending on sales representatives and surgeon training to try to increase distribution of Mobi-C. It needs to hurry up because competition is looming from Medtronic, which is seeking regulatory approval for its own two-level artificial cervical disc.

Those are the kinds of things a company with Zimmer's heft and resources can help with. And in exchange, Zimmer gets to reap all that future growth for itself. A bigger slice of the spine market (about 9 percent by BMO's estimate) and a wider offering of products will also help it negotiate with hospital vendors and sell more of its own spinal technologies. The competition from device giant Medtronic is nothing to shrug off, but Cowen analyst Joshua Jennings envisions more of a duopoly with LDR (now Zimmer) in a position to claim at least 50 percent of the U.S. market. 

It's not cheap to keep up in a medical-device market that's seen an unprecedented $187 billion of deals since the start of 2014.

Consolidation Play
Takeover activity has exploded in the medical-device industry as companies seek to increase their bargaining power with hospitals seeking ever-lower prices.
Source: Bloomberg

But Zimmer's grab for LDR isn't a bad way to play the game, and it's not a back-breaking price. Now it just has to hope none of its rivals realize the bargain here and swoop in with competing bids.   

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

To contact the author of this story:
Brooke Sutherland in New York at bsutherland7@bloomberg.net

To contact the editor responsible for this story:
Beth Williams at bewilliams@bloomberg.net