The orthopedics industry's become a huge force in health care as populations in some of the world's biggest markets age and experience wear and tear on joints. Companies like Zimmer Holdings (NYSE:ZMH) and Stryker (NYSE:SYK) have reaped billions of dollars in revenue from orthopedics devices, and new, innovative technologies such as MAKO Surgical's RIO robotic surgical system, which Stryker snapped up in its acquisition of the company last year, are bringing new frontiers into this massive market.
Among the top companies, however, competition's fierce -- and Zimmer only added fuel to the fire of this war for dominance on Thursday when it announced an industry-shaking acquisition of rival Biomet. The big-time buy vaults Zimmer into the discussion of the top company in orthopedics, but will Biomet help Zimmer's stock outrun its rivals in the long term?
Zimmer's big play for the future
Zimmer forked over more than $13 billion in cash and stock in Thursday's deal for Biomet that shook up the market. It's an industry-shaking move: Combined, the two companies reported revenue of around $7.8 billion, placing the new Zimmer in the same class as Stryker and Johnson & Johnson's (NYSE:JNJ) DePuy as the clear-cut leaders by sales in the orthopedics industry. Previously, Zimmer had been the fourth-largest orthopedics producer; analysts expect that the merger will propel the company to the second spot behind only J&J. Investors certainly rallied behind the stock, sending shares shooting up more than 11% and turning Zimmer into one of the best buys among the top orthopedics device leaders over the past year.
It's also promising for Zimmer's future outlook. While it will naturally see a boost to earnings in the year following the deal's close, Zimmer also projects that it will gain $270 million in savings in the third year and beyond following the acquisition. That'll help the company as it works toward improving profitability, something it failed to do last year as its operating margin declined by a full percentage point even as it lowered R&D and SG&A costs.
For investors and this stock, however, it's crucial that Zimmer capture the synergies of the Biomet acquisition particularly in its reconstructive orthopedics division. The business makes up around three-fourths of Zimmer's overall sales, split between knee, hip, and extremities products -- each of which has managed to ride the demographic trends buoying the market's optimism to respectable annual growth in sales last year.
Will the top orthopedics players fire back?
Still, Zimmer has its work cut out for it. Competition will only grow hotter as the company's acquisition puts pressure on competitors to generate growth of their own, whether organically or through buyouts. Acquisitions, after all, spurred the growth of Johnson & Johnson's own medical device business when it purchased orthopedics and trauma products producer Synthes in 2011 for more than $21 billion. The synergies from that deal have powered orthopedics to the top of J&J's device business and managed 2.5% year-over-year growth in the most recent quarter.
While J&J likely will be content to remain in its top position in the orthopedics industry, Stryker and Smith & Nephew (NYSE:SNN) could be more active following Zimmer's deal. Stryker's already made big moves on the buyout front lately, from the MAKO buy to ride the cutting edge of the industry to last year's purchase of China's Trauson Holdings, giving Stryker an easy route into the world's second-largest economy. Smith & Nephew's also been active on the international front, with its emerging markets division now making up a full 13% of total revenue after 18% sales growth in 2013. Biomet's buyout has raised consideration now among analyst groups that Smith & Nephew could be the acquisitions target of Stryker or J&J in the near future, and Zimmer will need to keep growth churning along in order to keep up.
It's overseas that Zimmer investors need to keep a close eye on. China's orthopedics market has averaged around 20% compound annual growth in past years, and growth's likely to remain high with the rise of urbanization and the middle class in the country. Meanwhile, Zimmer's Asia-Pacific revenue in knee and hip reconstructive products fell in 2013, a trend it will need to turn around to keep geographic growth on course and investors happy about its future in emerging markets.
A fight for market share intensifies
While Zimmer still has work to do to show it can keep up with the likes of J&J's DePuy unit, the acquisition of Biomet plants this medical device leader squarely among the giants of the orthopedics industry. Demographic trends in the U.S., Europe, Japan, and China -- if Zimmer can capture that last market -- will only keep the market growing for the company and its rivals. As the market concentrates on the biggest players -- a trend that could be exacerbated should Stryker or J&J move on a Smith & Nephew acquisition in the coming years -- Zimmer will have to fight tooth and nail for market share. The buyout of Biomet's a good first step, but it's only the beginning for this device leader.
Dan Carroll has no position in any stocks mentioned. The Motley Fool recommends and owns shares of Johnson & Johnson. It also owns shares of Zimmer Holdings. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.