Another Tepid Year for Medical Device M&A

The medtech gurus had such high hopes for 2011. Buoyed by a slight boost in merger and acquisition (M&A) activity in 2010, the monetary mavens that track such data for the medical device industry were fairly confident that companies would be more liberal with their spending last year. Most of the largest OEMs, after all, had spent most of 2009 hoarding cash and displaying a level of thrift not seen since the 2002 downturn (the average EV/Revenue, or enterprise value-to-revenue multiple, was 2.9x in 2009, compared with 2.6x in 2002). Surely, the worst was over and corporate spending would start flowing freely again. It had to.

And it did, though not as fast or as much as the pundits had anticipated. Based on a 65.2 percent increase in the number of 2010 transactions (using a minimum deal value of $68 million) and a 27.2 percent jump in total deal value ($14 billion compared with $11 billion in 2009), analysts expected 2011 to be the year M&A activity returned to normal. Or close to normal, at least.

“Although the total deal value for the year remains below average, the average EV/Revenue multiple increased substantially to 4.5x in 2010 (the 10-year average is 3.9x). It appears that as the economy stabilized and visibly improved, management teams became more willing to pay for growth platforms that might help to drive the top-line in the next few years,” according to a BMO Capital Markets report released last January, titled “2011 Medtech Outlook— Navigating the New Normal.” “At the same time, it seems that so-called ‘transformative’ acquisitions are less attractive, as management commentary during the year clearly favored ‘tuck-in’ acquisitions. As the economy improves, however slowly, we expect larger acquisitions to take place…”

And the market did not disappoint in this area. According to BMO CapitalMarkets data, there were six deals worth more than $1 billion last year, a 50 percent increase compared with the four that took place in 2010 and tripling the number that occurred when the market was at its worst in 2009. In addition, there were 35 total M&As worth more than $68 million, and the average deal value more than tripled, reaching $1.3 billion in 2011.

Not a bad turnaround, considering the venture capital market is still bone-dry, the nation’s economy is limping along at a snail’s pace and the euro zone’s escalating debt crisis continues to threaten global growth. Still, analysts expected more from the market last year.

“M&A, we would have thought there would have been more by now,” states BMO Capital Markets’ 2012 Medtech Outlook report. “We have been writing about a consolidatedmedical technology industry for some time, and yet the deals are not coming at the pace, or at the valuations, we would have expected. On the surface, the number of transactions in 2011 is not far off from the average, yet we would have anticipated more given the low cost of debt, as the environment is more difficult for smaller companies to maneuver and as larger companies are in search of growth and scale given a more rigorous hospital purchasing environment.”

“Yet, peeling the onion back a bit shows that the price point has dropped, the average 2011 EV/trailing 12-month (TTM) sales multiple was 3.4x versus the 10-year average of 4.0x and the EV/TTM EBITDA multiple was 12.5x versus 19.0x,” the report continued. “We suspect that herein lies the rub: There is a mismatch between what the acquirer wants to pay and what the acquisition candidate believes it is worth.”

Despite such a mismatch, there were some noteworthy deals that occurred last year. Those of significance included:

Dentsply International purchases AstraZenica’s Astra Tech unit. This $1.8 billion deal gave the Swedish maker of prosthetic teeth and medical devices an impressive new title: No. 3 global manufacturer of dental implants. “It gets them into a fast-growing area where they haven’t really had the kind of presence they’ve had in some of their other lines of business,” explained Les Funtleyder, a portfolio manager with New York, N.Y.-based Miller Tabak + Co. LLC. But better market share isn’t the only benefit. The transaction also creates a leading dental implant franchise—Astra Tech Dental, one of the fastest-growing implant businesses, is recognized as a leader in clinical research and products in the global dental implant market. It also is growth and earnings accretive: The deal should boost revenue and earnings growth rates. Another benefit is the acceleration of Dentsply’s digital dentistry strategy—Astra Tech’s Atlantis business is considered a leader in the fast growing customized abutment category with a substantial opportunity to leverage the technology in global markets. The combination of Atlantis’ CAD/CAM offering with Dentsply’s global digital dentistry platform positions the company to capitalize on and accelerate the market’s shift to digital solutions. And finally, the deal provides Dentsply with new opportunities for growth in non-core areas, analysts said. Astra Tech Healthcare is regarded as a leader in the European hydrophilic intermittent catheter market. This business leverages Dentsply’s core competencies and provides a new growth opportunity within the broader consumable medical device markets.

Fresenius Medical Care acquires two competitors. For a cool $2 billion, Fresenius picked up two dialysis chains—Mercer Island, Wash.-based Liberty Dialysis LLC ($1.7 billion) and Glen Rock, Pa.-headquartered American Access Care Holdings ($385 million). The deal caps a three-year spending binge for Fresenius that included the acquisitions of International Dialysis Centers from Euromedic International and Schaumburg, Ill.-based APP Pharmaceuticals Inc. in 2008 (that deal gave Bad Homburg, Germany-based parent firm Fresenius SE & Co. KGaAaccess to the U.S. market for generic

intravenous medicine). Executives said Fresenius’ most recent purchase will create a “superior platform for innovation” in service delivery and enhance patients’ lives. The purchase also stands to advance the company’s bottom line: It is expected to add another 19,000 patients to Fresenius

Medical Care’s existing treatment population of 140,000, placing it well ahead of its largest rival, DaVita Inc., which treats about 128,000 dialysis patients annually.

“Like all dialysis companies, whatFresenius needs to do is have the biggest possible footprint and to act as a market consolidator. Getting a larger footprint in the North American market is a good move,” said Stefan Muehlbauer of Silvia Quandt Research. “By acquiring newclinics, not only are they able to make more treatments, but they are also able to get the clinics to use FMC equipment.”

Investment consortium buys Kinetic Concepts Inc. Last summer’s $68.50-per-share deal to take Kinetic Concepts private turned out to be the largest leveraged buyout since Lehman Brothers Holdings Inc. collapsed in the fall of 2008. The San Antonio, Texas-based developer of therapies and products for the wound care, tissue regeneration and therapeutic support systems markets was purchased by British private equity firm Apax Partners and two Canadian pension funds—the Canada Pension Plan Investment Board and the Public Sector Pension Investment Board. The trio settled on a $6.5 billion asking price (including assumed debt) and agreed to borrow as much as $5 billion to finance the deal. Apax and its partners likely were attracted toKinetic for its cash flow rather than its sales: Analysts project that Kinetic’s free cash flow yield of nearly 9 percent and its new portable wound care device could help generate a return of up to 40 percent in five years. “The cash flow is the attraction for private equity…” said Jason Wittes, a Caris & Co. analyst in New York, N.Y. But not the only one. Another enticement for Apax and its fellow investors likely was Kinetic’s leadership position in the global market for negative-pressure therapy products. The company maintains an impressive 81 percent market share, despite losing some ground to lower-priced competitors. Investors, however, are betting on that market share to rise as Kinetic’s products gain traction overseas. “KCI’s business is well-positioned for growth,” Andre Bourbonnais, senior vice president of private investments for the Canada Pension Plan Investment Board said when the deal was announced. Let’s hope he’s right.

Danaher Corp. acquires Beckman Coulter Inc. Danaher, the Washington, D.C.-based maker of microscopes and water-treatment systems, expected Beckman Coulter to add as much as 10 cents to adjusted earnings per share last year and up to 30 cents to net per-share earnings in 2012. Not bad for a $6.8 billion investment. Beckman was folded into Danaher’s Life Sciences division, which makes diagnostic equipment and posted 2010 revenue of $2.3 billion, or about 17 percent of the company’s total sales. Danaher President and CEO H. Lawrence Culp Jr. claims his company has “a tremendous opportunity to unlock value at Beckman Coulter. We believe this will be a high-fit, high-opportunity deal.” Analysts agree, noting that Danaher’s solid emerging market presence (sales grew from 12 percent of total revenues in 2004 to 19 percent in 2009) can reinforce Brea, Calif.-based Beckman’s

vulnerability overseas.

Johnson & Johnson acquiresSynthes Inc. This deal arguably is the most significant in recent memory, though not for its hefty $21.3 billion price tag. Rather, J&J’s blockbuster purchase potentially could affect the entire orthopedicindustry, forcing heavy hitters such as Zimmer Holdings Corp., Stryker and to a lesser extent, Smith and Nephew, to re-evaluate their long-term growth strategies. The deal immediately boosted J&J’s share of the $5.5 billion trauma products market 11-fold (to 55 percent) and doubled its slice of the $9 billion spinal-care segment to 22 percent, analysts noted. Such mind-boggling increases could pressure Zimmer and Stryker, which mostly build devices for knee and hip replacements, to bulk up their own portfolios by acquiring smaller orthopedic companies in faster-growing parts of the industry, said David Turkaly, a Susquehanna Financial Group analyst in New York, N.Y. “What clearly happens is J&J becomes No. 1 in all of ortho,” Turkaly said in a telephone interview. “The Strykers and Zimmers of the world are probably now a good distance behind the animal that J&J is in those markets.”

Once the transaction is completed, Johnson & Johnson will combine its DePuy segment with the Synthes business. Industry experts believe the products made by both DePuy and Synthes should complement each other—DePuy is considered a leader in joint replacement, the largest segment of the orthopedics business, and sports medicine, while Synthes is looked at as a leader in several important market segments where DePuy has little or no presence at all. J&J segments that should benefit from the acquisition include trauma, cranio-maxillofacial and power tools. The company expects the $5 billion trauma market to grow at about 7 percent annually going forward.