ev3 and Somanetics The management at Covidien plc certainly is true to its word. In discussing r

ev3 and Somanetics

The management at Covidien plc certainly is true to its word. In discussing reasons for the company’s recent $2.6 billion acquisition of ev3 Inc., Chairman and CEO Richard Meelia said, “when the right strategic deal comes along we don’t preclude them.”

There have been few, if any, deals Meelia and his colleagues haven’t precluded lately as they reshape and expand the company’s medical device business. During the last 14 months, Dublin, Ireland-based Covidien (U.S. headquarters are in Mansfield, Mass.) has acquired five companies and divested four others as it continues to craft a long-term growth plan and restructure the business that spun off from Tyco International in mid-2007. Within the last three years, Covidien has acquired nearly a dozen companies.

Covidien’s most recent find was Somanetics Corporation, a Troy, Mich.-based firm that sells the INVOS System, a device that measures blood oxygen levels in the brain of patients undergoing surgery to help detect and correct various life-threatening complications. The price tag was $250 million for the publicly traded firm in a deal that represents a 32 percent premium to the closing price prior to the acquisition and a valuation of nearly six times on a trailing price-to-sales basis.

“The acquisition of Somanetics will allow Covidien to broaden our product offerings and add another monitoring technology to our portfolio,” Pete Wehrly, president of Respiratory & Monitoring Solutions at Covidien, said in a news release. “The Somanetics product line, which we currently distribute in Europe, will expand our presence in the operating room.”

Analysts said the purchase is a “logical fit” for Covidien as it attempts to diversify its selection of oximetry and monitoring products. Stephen Simpson, a financial investor and consultant and former equity analyst, believes Somanetics’ core products and technologies are a logical fit for Covidien’s
Nellcor patient monitoring business.

“This deal should enable Covidien to package together more appealing total solutions (and harness technology into new applications) to compete with Masimo and Philips in the patient monitoring market,” he wrote in a story posted on investopedia.com. Plus, Simpson added, Covidien distributes Somanetics’ products in Europe and has been a “significant” part of its rising sales.

In fiscal 2009, Somanetics reported $50 million in sales, a 5 percent increase compared with the $47.5 million the company reported in fiscal 2008. The firm’s latest earnings report shows the increases continuing in fiscal 2010—Somanetics reported $13.9 million in net revenue during the second quarter (ended May 31), a 17 percent increase compared with the $11.8 million it generated during the same period last year. U.S. net revenue jumped 15 percent to $10.7 million, while international revenue rose 28 percent to $3.2 million.

Besides broadening Covidien’s patient monitoring product offering, the INVOS technology from Somanetics pairs nicely with the Bispectral Index, the only system capable of measuring the effects of anesthesia and sedatives on the brain, analysts noted. Covidien added the Bispectral system to its oximetry and monitoring group last year with the $210 million acquisition of Aspect Medical Systems Inc. of Norwood, Mass. Analysts expect the combined revenues from Aspect and Somanetics to add $150 million in annual revenue to Covidien’s Oximetry and Monitoring group, which reported $636 million in revenue in each of the last two fiscal years.

Covidien’s billion-dollar deal with ev3 will further expand its presence in the high-margin, fast-growing vascular device market—a sector the company has been aggressively pursuing. Though they touted the “growth benefits” of the merger during a conference call with analysts, executives admitted that significant growth is not expected to occur before 2012.

Charles J. Dockendorff, Covidien’s executive vice president and chief financial officer, said the acquisition most likely will reduce non-GAAP earnings in fiscal 2010 by 5 cents to 8 cents per share and in fiscal 2011 by about 10 cents to 15 cents.

Such short-term losses, however, pale by comparison to the anticipated growth in the vascular device market. During the conference call, Covidien executives forecast growth of 6 percent to 8 percent within the next five years for the $3.1 billion peripheral vascular market, and 10 percent to 12 percent growth during that time for the $1.3 billion neurovascular market.

“We believe ev3 brings sustainable long-term opportunities in developed regions as well as advanced treatment opportunities in emerging markets such as Brazil, Russia, India and China,” said Joe Woody, president of Covidien’s vascular therapies unit. “Ev3 has the broadest product portfolio in the industry. The opportunity to acquire a strong endovascular lineup in one step was a key reason why we believe ev3 was such a unique opportunity for us.”

And an unexpected one at that. While Covidien steadily has beefed up its vascular business in the past year, the ev3 deal resulted from a competitive bidding process. Meelia called the deal “opportunistic.”

“Some of you may be asking, ‘why now?’“ Meelia said during the conference call. “As we’ve mentioned in the past, acquisitions are opportunistic. When an asset like ev3 becomes available, a company that fits our growth profile and our strategy of vascular expansion, we owe it to our shareholders to investigate the opportunity. When the right strategic deal comes along, we don’t preclude them.”
Covidien executives haven’t precluded the “right” strategic deals for three years now.

Last year, the company created a vascular therapies business unit under the umbrella of its medical devices business in an effort to become a market leader in the endovascular device sector. The creation of that unit coincided with the $440 million acquisition of San Jose, Calif.-based VNUS Medical Technologies Inc. in May 2009. VNUS Medical develops devices for the minimally invasive treatment of venous reflux disease. That acquisition followed the purchase (in March 2009) of Bacchus Vascular Inc., a privately held and venture-backed company selling a system to treat deep vein thrombosis.

Leerink Swann analyst Rick Wise said Covidien’s latest purchase would“dramatically broaden and deepen” its vascular franchise because ev3 develops products in two sectors in which the Ireland-based firm does not participate—peripheral vascular and neurovascular. While vascular devices that combat heart disease receive more attention, peripheral artery disease (PAD) is much more prevalent, William Blair &Co. analyst Ben Andrew said. “Coronary is ultra-saturated,” he told Reuters. “You have the big boys dominating. PAD is less crowded with players.”

To help the company focus on building its vascular business, Covidien executives sold the company’s sleep therapy product line for an undisclosed amount to PHInvest, a privately held company in Luxembourg. The sale is not expected to impact operating income or earnings per share in fiscal 2010 or 2011.