Smith & Nephew Still Entices as Regulators Loom: Real M&A
A deal between Stryker Corp. (SYK) and Smith & Nephew Plc (SN/) makes as much sense now as it did six months ago. It just might be tougher to pull off.
Stryker is considering structuring the takeover as a tax inversion, allowing the Kalamazoo, Michigan-based company to move its legal address to the U.K., where Smith & Nephew is based. The $16 billion-plus transaction would give Stryker future access to the cash it’s been accumulating overseas without being hit by repatriation taxes. Even without an inversion structure, the deal would offer benefits and may help the businesses gain back pricing power after hospital consolidation squeezed margins at orthopedic-implant makers.
The challenge is that Stryker’s competitors had a similar idea and moved more quickly. Zimmer Holdings Inc. agreed in April to buy Biomet Inc. for $13.4 billion, which will reduce the orthopedic-reconstruction market to four major manufacturers from five. It will be harder for Stryker, which has been barred from making an offer since May under U.K. takeover rules, to make the case to antitrust regulators for further consolidation, according to Wells Fargo & Co.
“You have a different hurdle rate now given that the industry will likely be more consolidated than it was six or 12 months ago,” Jason McGorman, an analyst for Bloomberg Intelligence, said in a phone interview. “Whether or not that means it’s a larger antitrust risk, that’s something we’re going to look at.”
The rationale for a deal hasn’t changed though, he said. “Longer term, Stryker would have greater access to that cash and be able to use it more efficiently.”
Foreign Earnings
Stryker has avoided U.S. tax on about $7 billion in accumulated foreign earnings, the sixth-highest among medical-device makers in the Standard & Poor’s 500 Index, according to data compiled by Bloomberg. It paid a 17 percent effective tax rate in 2013, according to its annual filing.
A Financial Times report May 28 said Stryker was preparing a takeover offer for the maker of artificial hips and knees, sending Smith & Nephew’s stock to a then-record price of 993.50 pence. Stryker Chief Executive Officer Kevin Lobo confirmed that his company was in the early stages of evaluating a deal.
Rules governing acquisitions in the U.K. required Stryker to either make an offer in the following 28 days or wait six months. It opted to wait.
As the standstill period expires this week, Stryker is examining a bid for $16 billion Smith & Nephew once again, people with knowledge of the matter told Bloomberg News. The shares jumped 4.4 percent to 1,138 pence. Stryker also climbed to a record.
Today, Smith & Nephew fell 1.3 percent to 1,123 pence. Stryker climbed 0.6 percent to $91.90.
Deal Structure
Stryker is considering structuring the transaction as a tax inversion, though it sees strong strategic reasons to pursue a combination and an inversion wouldn’t be essential to make the deal work, three of the people said.
Inversions have been heavily scrutinized by U.S. lawmakers this year, and in September the Treasury Department detailed rules designed to make inversions less attractive.
A merger of Stryker and Smith & Nephew would be accretive in the first year whether or not it’s an inversion, Larry Biegelsen, a New York-based analyst at Wells Fargo, wrote in a report yesterday. In fact, given that an inversion would require more equity be distributed, a non-inversion may be more accretive, he said.
The potential merger would need regulatory approval. Their competitor Zimmer is awaiting clearance from both American and European authorities for the takeover of Biomet announced in April. Zimmer may have even had an advantage in striking its deal first.
“While we believe that a Smith & Nephew acquisition makes strategic sense for Stryker, we think the regulatory risk will be greater than the Zimmer-Biomet deal,” Biegelsen said. “It will be harder to move from four to three major recon players than five to four.”
