Should Johnson & Johnson Join the Buyout Boom?

Mergers and acquisitions have been all the rage in health care in 2014. Big pharma's taken over the spotlight recently, but medical device giants have joined in the game recently, and now major orthopedics and spine device maker Smith & Nephew (NYSE: SNN  ) may be in the crosshairs of some of the industry's biggest names.

Orthopedics leader Stryker (NYSE: SYK  ) has been one of the hottest names thrown around in potential acquisition talks. After rival Zimmer Holdings acquired Biomet for more than $13 billion last month, rumors have swirled around Wall Street that Stryker itself could go after a buyout. Reports broke earlier this week that Stryker denied interest in acquiring Smith & Nephew, however, throwing cold water on analysts' predictions.

But is Wall Street focused on the wrong company to seek a buyout? Quietly, Johnson & Johnson's (NYSE: JNJ  ) avoided the health-care acquisitions merry-go-round in 2014, and the company's orthopedics division has emerged as the largest in medical devices following its acquisition of Synthes back in 2011 for more than $21 billion. But could adding Smith & Nephew to its portfolio benefit investors even more?

A costly buy, but would it be worth it?
One thing's for sure about a possible acquisition: Smith & Nephew won't come cheap. This device company sports a market cap of more than $14 billion right now, and while a buyout seems as if it'd end up cheaper than J&J's Synthes acquisition, it'd still be a costly move for the company. Smith & Nephew's stock surged after initial rumors of a Stryker buyout emerged, and a potential partner like J&J could push the momentum behind this stock even higher. Already, Smith & Nephew's stock has outgained many of the biggest names in orthopedics over the past year.

SNN Chart

SNN data. Source: YCharts.

However, J&J would be gaining a company that's done a good job of pushing revenue and earnings higher as of late. Smith & Nephew racked up 4% overall revenue growth in 2013, roughly in line with J&J's own medical device and diagnostics sales growth last year, although that was including Johnson & Johnson's since-sold blood diagnostics unit that had weighed down that figure. It wouldn't be J&J's first flirtation with Smith & Nephew, either; it reportedly approached the orthopedics company back in 2010 regarding a possible merger, according to Reuters. That need's lessened now with Synthes in the fold, but orthopedics have emerged as J&J's medical device bread and butter, and buying Smith & Nephew would turn this company into the undisputed king of orthopedics.

Source: Wikimedia Commons.

J&J leadership's also noted a desire to advance its extremities device unit, and Smith & Nephew could add its trauma and extremities division, which itself pulled in nearly $500 million last year at 4% revenue growth. That's slower growth than Stryker's own trauma and extremities division, which racked up double-digit revenue growth last year after posting more than 6% year-over-year sales growth in 2012, but it would help J&J keep some distance between its device division and hard-charging orthopedics rivals such as Stryker and Zimmer.

That's hardly a pressing need for a buyout on its own, but it's one piece of a good match that begins overseas, where emerging markets have stood out as Smith & Nephew's biggest offer in an acquisition.

Smith & Nephew's been a big and active player in top developing markets: Last year alone, it acquired distributors and businesses in Turkey, India, and Brazil, according to its most recent 20-F filing. Such overseas attention has helped the company's emerging and international markets group rise to 18% revenue growth last year, with 30% sales growth in just the Chinese market. This is still a small division for Smith & Nephew overall -- it made just around 13% of overall sales from its emerging and international markets division -- but it's one that J&J could make the most out of.

Johnson & Johnson's no slouch in emerging markets. Its medical device and diagnostics group racked up $1.4 billion in sales in the world's second-largest market last year, recording 18% revenue growth in that figure. The company's established its diabetes device division as the leader in China. That's a key strength, as the country's diabetic population has swelled with its rising middle and urban classes.

Rivals haven't shied away from international opportunities, however. Stryker made waves last year with its purchase of China's Trauson Holdings in order to boost its orthopedics exposure in the fast-growing Chinese market. Adding Smith & Nephew to its own emerging market strength, however, would keep Stryker and other fast-rising orthopedics players at bay -- and give Johnson & Johnson the best chance to solidify its dominance in these highly coveted growth markets.

A chance at orthopedics dominance
Johnson & Johnson could just as easily sit tight and wait for the M&A storm to blow over in health care. After all, even without Smith & Nephew, the company still reigns as the largest orthopedics player in the business. But while Stryker's out of the Smith & Nephew buyout talk for now, it could change its mind in the future -- and Zimmer's not backing down in the wake of its Biomet acquisition. If J&J wants to entrench its orthopedics and device division as the industry's superpower for years to come while firming up its growth opportunities overseas, acquiring Smith & Nephew would be a huge leg up for the company and its investors in the long run.

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