Last month, Smith & Nephew (NYSE: SNN ) said it had preliminary talks with Biomet (Nasdaq: BMET ) to combine the two companies, which would create a dominant player in the global orthopedic industry. It turns out that Biomet had also hired Morgan Stanley to help "pursue strategic alternatives," a euphemism for trying to sell itself.
Fast-forward to today, which is reportedly the deadline Morgan Stanley set for offers for Biomet. I've discussed the financial pitfalls of an acquisition, so let's take a second look at a possible transaction.
It's a no-brainer that Smith & Nephew and Biomet would benefit from a merger. Both companies have smaller market shares in the orthopedic industry, and a combination would rival industry leaders Johnson & Johnson (NYSE: JNJ ) , with its orthopedic division DePuy; Stryker (NYSE: SYK ) ; and Zimmer Holdings (NYSE: ZMH ) . Furthermore, the two companies complement each other both in products offered and geographic areas served.
The increased scale of research and development costs and better pricing power would also be benefits. (I wouldn't go too far with pricing power because of the U.S. Department of Justice's ongoing antitrust investigation into several orthopedic companies, including Biomet.) The combination of increased market share, economies of scale, and product offerings would transform the merged company into a more competitive player.
Regardless of the operational gains, my biggest concern is that Smith & Nephew will overpay, especially if Morgan Stanley can get a bidding war going. Smith & Nephew's management must stay financially disciplined and not overestimate the potential synergies or operational gains. Winner's curse is not a good thing: Just ask Boston Scientific (NYSE: BSX ) shareholders.
Consider an estimated purchase price of $44 per share for Biomet. With roughly 245 million shares outstanding, that translates to a $10.8 billion deal. With only $304 million in cash on the books, Smith & Nephew doesn't have much of a war chest, and it's going to have to raise more than $10 billion through issuing debt as well as equity to finance the deal. (This is barring selling assets to raise cash so that it won't have to issue stock or take on debt.)
The best scenario is that Smith & Nephew can issue as much stock for Biomet as possible. Neither company generates significant cash relative to their market multiples, and Smith & Nephew would be hamstrung servicing a significant amount of debt. Furthermore, if Smith & Nephew can issue stock, at least any amount overpaid would be shared with Biomet's shareholders.
The bottom line is that the merger makes a lot of sense operationally but only at the right price. So Smith & Nephew -- what's the deal?
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