Smith & Nephew in Play as Device Makers Combine: Real M&A

Smith & Nephew Plc, long speculated to be a takeover candidate, has finally been put in play thanks to a merger between two of its competitors.

Stryker Corp. Chief Executive Officer Kevin Lobo said yesterday that his $31 billion company has been evaluating a purchase of London-based Smith & Nephew, which would expand its share of the market for artificial hips and knees. The news followed an April announcement that their rivals Zimmer Holdings Inc. and Biomet Inc. are merging to create an entity that will overtake Stryker as the No. 2 maker of orthopedic devices. That may have put pressure on Stryker to weigh a bid for Smith & Nephew, according to Summer Street Research Partners.

After Stryker’s potential plans were reported by the Financial Times yesterday, the company had to decide whether to make a bid in the next 28 days or wait six months because of the rules governing takeovers in the U.K. While it opted to wait, analysts from firms including Royal Bank of Canada and Wells Fargo & Co. say they don’t rule out a deal between Stryker and $15 billion Smith & Nephew at a later date because a tie-up would make sense.

“Zimmer pulled the trigger on one of the two likely takeover candidates, and that somewhat forces Stryker’s hand,” Mark Landy, an analyst at Summer Street Research in Boston, said in a phone interview. Stryker is “analyzing the competition from a larger Zimmer, the potential impact of that on its business and what is the right step for them going forward. Stryker is a logical acquirer for Smith & Nephew, which is a good asset that would bring a lot of diversification.”

Deal Possibility

Stryker had hired banks and was working on assembling financing for a bid for Smith & Nephew, the Financial Times reported, citing unidentified people familiar with the matter.

Stryker then released a statement saying that, at the request of the U.K. Takeover Panel, the Kalamazoo, Michigan-based company “confirms that it does not intend to make an offer for Smith & Nephew,” but that it has the right to announce or participate in one at a later time.

“We were evaluating this as a potential transaction,” Lobo, the CEO, said in a television interview on Fox Business yesterday. “But based on the price spike in Smith & Nephew, the Takeover Panel called us and we have to make this public statement.”

Backing Off

Jo Hawk, a spokeswoman for Stryker, didn’t return a phone call or e-mail seeking additional comment. Representatives for Smith & Nephew also didn’t respond to requests for comment outside the company’s normal business hours.

Smith & Nephew’s London-listed shares rose as much as 18 percent yesterday before ending the day with a 4.3 percent gain and a record closing price of 993.5 pence. The stock advanced again today, rising 3.3 percent to 1,026 pence at 3:40 p.m. London time. That gives it a market value of 9.2 billion pounds ($15 billion). Stryker’s stock also rose for a second day, climbing 0.7 percent to $83.22 in New York.

“It’s one of those things where, unless you’re prepared to make a definitive announcement today, then I guess you have to back off,” Jeremy Feffer, a New York-based analyst at Cantor Fitzgerald LP, said in a phone interview. “It’s either, ‘Yes, we’re initiating a takeover process,’ or, ‘No, we’re not interested.’”

Six Months

The U.K. rules prohibit Stryker from making a bid for six months, unless a deal is recommended by Smith & Nephew’s board, in which case the waiting period is shortened to three months, according to Glenn Novarro, a New York-based analyst at RBC.

A potential acquisition would have cost synergies, expand Stryker’s presence in trauma and sports medicine and give it more scale in joint reconstruction, which would put the company on par with a combined Zimmer-Biomet, he wrote in a report yesterday.

“We would not rule out a deal announcement at a later date,” according to the report.

Zimmer agreed in April to acquire Biomet for $13.4 billion to become the second-largest device maker in the market for treating muscle and orthopedic injuries. Johnson & Johnson is the No. 1 manufacturer.

While Smith & Nephew has been considered a takeover candidate by analysts and investors for years, prior to the Zimmer-Biomet announcement a deal was seen as unlikely because of antitrust hurdles, said Lisa Bedell Clive, a London-based analyst at Sanford C. Bernstein & Co.

“The Zimmer-Biomet announcement really changed the game,” she said in a phone interview. “Zimmer has consulted enough antitrust lawyers that they think they can complete the Biomet transaction. That potentially paves the way for Stryker to do the same with Smith & Nephew.”

Bidding War?

A bid for 11 pounds to 11.50 pounds a share would be reasonable, Clive said. That’s as much as a 24 percent premium to Smith & Nephew’s average price in the 20 trading days through May 27.

Landy of Summer Street estimates a similar premium based on Zimmer’s valuation for Biomet. He said a bidding war is possible, though, which could drive the takeover price even higher.

“Stryker right now is the logical acquirer,” Landy said. “But it would not shock me if somebody like Medtronic might be thinking of a bid.”

Medtronic Inc. is a $60 billion medical-device maker based in Minneapolis. More than half of its revenue is tied to cardiovascular conditions, while much of Stryker’s and Smith & Nephew’s sales come from hip and knee replacements, according to data compiled by Bloomberg.

Best Bet

While New Brunswick, New Jersey-based J&J has been pegged as a potential buyer for Smith & Nephew in the past, Canaccord Genuity Group Inc.’s William Plovanic said a deal would be challenging because it would require divesting assets to appease regulators.

“From an antitrust standpoint, it might become rather difficult for anybody else in orthopedics to buy them” other than Stryker, the analyst said in a phone interview.

Ernie Knewitz, a spokesman for J&J, said the company doesn’t comment on speculation, when asked whether it’s interested in buying Smith & Nephew. Cindy Resman, a spokeswoman for Medtronic, didn’t respond to a phone call or e-mail seeking comment.

Orthopedic-implant makers have had to grapple with the pricing power hospitals have gained in recent years, though further consolidation may help mitigate that as the companies gain scale, said Feffer of Cantor.

Stryker has the financial wherewithal to pursue a bid for Smith & Nephew, he said. As of March, the company had $4 billion of cash and equivalents, which outstrips its debt by about $1 billion.

“It doesn’t surprise me that they’ve at least kicked the tires on this,” Feffer said. “I certainly get why Stryker would be interested.”

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