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VOL. 126 | NO. 14 | Friday, January 21, 2011

Smith & Nephew Rumors Continue to Swirl

By Aisling Maki

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Despite Smith & Nephew’s attempts to quash rampant rumors that it’s being targeted for takeover, Wall Street seems to be sticking with the maxim that where there’s smoke, there’s fire.

Analysts and industry observers seem certain that the medical device company is in play as its stock has soared recently, reaching near 52-week highs.

Smith & Nephew did not return calls for this report.

Although company officials decline to comment on widespread reports that it is in acquisition talks, the company did take the unusual step of releasing a statement on Jan. 14 in which it reiterated its “long standing policy of not commenting on press speculation.”

But Robin Young, CEO of PearlDiver Technologies Inc., a Fort Wayne, Ind.-based analytics company tracking the global orthopedics industry, told The Daily News a possible Smith & Nephew takeover may be nothing more than a rumor.

“It really began with trade rumors from stock market traders,” he said. “And traders are notorious for passing along speculation and rumor, and it’s usually wrong. It was picked up by bloggers in the U.K. and it matriculated to the ‘anonymous sources’ – The Daily Telegraph – and worked up the media food chain to The Financial Times and The Wall Street Journal.”

Still, the speculation continued this week as Johnson & Johnson, Medtronic, Zimmer Holdings and Biomet are all reportedly interested in making a bid.

The British Daily Telegraph has been aggressively covering the story, most recently reporting that an $11 billion bid from Johnson & Johnson was rejected last month.

The British newspaper also reported that Smith & Nephew CEO David Illingworth and Biomet CEO Jeffrey Binder had planned to meet informally in New York this week but the meeting was canceled after the media learned of it.

Rumors aside, the orthopedic industry has seen pressure to consolidate mount in recent years as the market has come under strong pricing pressure.

The Great Recession has compelled potential patients to turn to older, lower-cost artificial hips or defer elective surgery altogether. Exacerbating market pressures is the cost-hiking prospect of tougher regulatory standards both in the U.S. and Europe.

All of these dynamics are forcing companies to cut costs to become more competitive, and one way to do that is through mergers and acquisitions, which can help achieve economies of scale.

Illingworth has publicly stated that he expects to see increased merger and acquisition activity in the market.

“We want to be as broad as we can while being synergistic,” he told a global health care conference in San Francisco last week.

So despite Smith & Nephew officials insisting that the company “is not engaged in any discussions, which could lead to a merger or a takeover involving the company,” analysts and industry observers aren’t convinced.

Christoph Gretler, an analyst at Credit Suisse, wrote in a note last week: “We believe M&A considerations are unlikely to cool down in light of the substantial benefits of further industry consolidation.”

Matrix Corporate Capital analyst Navid Malik told Reuters this week that “there is huge pricing pressure in the U.S. and until we see recovery in the jobs market, elective procedures are going to continue to get delayed, so orthopaedics companies are under pressure.”

And Young, who also is publisher of “Orthopedics This Week,” said the orthopedic industry is one of the most consolidated industries in the world.

“Seven companies ship 90 percent of all orthopedic products. In hip and knee reconstruction, five companies – just five – sell nine out of every 10 implants,” he said. “This is a highly consolidated industry already. So it’s hard to see where two of these large companies merging makes a strong business case. It’s a tough case to make, really.”

He said there are other medium-sized companies, including one in the Memphis metropolitan area, that are more attractive acquisition targets.

“There are other arguments that make more sense,” he said. “There are some medium-sized companies that have really nice market shares. For example, Wright Medical has the leading market share in hand, foot and ankle surgery, which, with the aging baby boomers is itself really accelerating its footprint.”

Smith & Nephew is the fourth-largest company in the orthopedic device market, trailing Stryker, Zimmer and J&J subsidiary DePuy Orthopedics, so it is not surprising that the company is in the crosshairs.

Analysts say industry leaders like Stryker and Zimmer would enjoy immediate benefits from an acquisition. Even the smaller Biomet would make sense; in fact, Smith & Nephew targeted Biomet for takeover in 2007 only to be out-bid by a consortium of private equity firms led by Blackstone Group LP.

Since buying Biomet for $11 billion, Blackstone, Goldman Sachs, KKR and TPG have been interested in Smith & Nephew.

A Biomet and Smith & Nephew merger would create the world’s second-largest orthopedics company behind Stryker, according to the Royal Bank of Scotland.

But the most likely suitor remains J&J, which has been very active in mergers and acquisitions recently. Additionally, J&J and Smith & Nephew compete head-to-head in many markets, meaning there’s ample opportunity to cut costs.

But The Financial Times notes that such a merger would attract regulatory attention. The two companies would have a combined market share of 34 percent in reconstructive hip and knees, globally, and about 20 percent in orthopedic trauma.

If a deal does get done, it could have a significant local impact. The company employs more than 2,000 people locally and is in the process of moving into its new 285,000-square-foot headquarters at Goodlett Farms in East Memphis, formerly the headquarters of Las Vegas-based Harrah’s Entertainment.

The $42 million expansion, which includes hiring 160 people, will house the research, marketing and development functions of its global orthopedics division. It also will be a training facility for the orthopedics sales team and the company’s sales team. The site includes 40 acres for future growth and expansion.

Concerning to local officials is that if Smith & Nephew gets taken over, it might trigger a breakup or sell-off of some Smith & Nephew divisions – notably its wound care and endoscopy divisions.

That’s probably most likely if Biomet emerges with the winning bid because the privately owned company is carrying more than $5 billion in debt.

The Daily News staff contributed to this report.

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