Should Medtronic Buy Smith & Nephew?

Medtronic's avoided rumors of takeover interest, but should the market's largest pure medical device player make a big push into orthopedics?

Jun 6, 2014 at 9:30AM

Orthopedics device maker Smith & Nephew's (NYSE:SNN) been no stranger to the spotlight over the past month. Mergers and acquisitions have defined the health care sector in the early goings of 2014, and Smith & Nephew's emerged as the latest target for a buyout. Rival orthopedics giant Stryker (NYSE:SYK) was linked to the firm earlier, and while Stryker still might make a play for Smith & Nephew down the line, the newest company rumored to be interested in a merger, Medtronic (NYSE:MDT), isn't an orthopedics star.

Medtronic's made its name in the cardiac device market, but reports that the firm's eying moving into orthopedics make Smith & Nephew a top target. But with company leadership avoiding questions about the topic and eying returning value to shareholders, an imminent deal for Smith & Nephew looks unlikely. Still, would Medtronic make a good fit for this medical device company?

Smith & Nephew: Worth Medtronic's buy?
Stryker and Medtronic are two different beasts linked to Smith & Nephew. While Stryker makes the bulk of its money from orthopedics products such as knee replacements and hip replacements, Medtronic made more than 50% of its revenue in its most recent quarter from its Cardiac and Vascular Group. On paper, a Smith & Nephew acquisition doesn't bring close to the synergies to Medtronic that it does to Stryker.

Additionally, Medtronic late on Thursday said it's focused on revenue and earnings growth – and that potential acquisitions would be undertaken with returning shareholder value in mind. Medtronic's done a good job keeping quarterly revenue churning higher over the past three years, a trend that's boded well for investors.

MDT Chart

MDT data by YCharts

In the near term, that goal rules out Smith & Nephew, whose takeover would likely require a significant matter of time to maximize the addition of its spine and hip and knee replacements to Medtronic's portfolio. While Medtronic operates a small spine product business already, it accounted for less than 18% of the company's overall sales in its most recent quarter.

Also, Smith & Nephew – while a sizable business – isn't one of the top leaders in the orthopedics space for spine products and hip and knee replacements. According to Bloomberg, the firm's only ranked fifth in those areas – enough to make Medtronic a player, but hardly enough to put it on the same level of competition as the giants of orthopedics such as Stryker and Johnson & Johnson.

However, Medtronic has one big reason to look overseas for an acquisition like Smith & Nephew. Over the past nine months, Medtronic's made nearly 50% of its revenue outside of the U.S. over the past nine months. According to a new report from the U.S. Public Interest Research Group, the company holds more than $20 billion offshore. Following in Pfizer's planned footsteps for the now-failed attempt to buy AstraZeneca, Medtronic could use an acquisition of Smith & Nephew to incorporate overseas and return cash to shareholders while avoiding hefty taxes.

Medtronic, though, believes that's not necessary to bring some of that money home. The company feels it can return around 50% of that cash pile to shareholders over the next five years even without a tax inversion. While Smith & Nephew's emerged as a strong player overseas – particularly in emerging markets lately – that strength is more of a luxury to Medtronic than a necessity.

Not the best deal Medtronic could make
While Medtronic could capitalize on a Smith & Nephew acquisition to expand into orthopedics while bringing back more cash to shareholders, there are simply not enough advantages to a takeover. Medtronic's commitment to maximizing revenue and earnings growth is at odds with the lack of synergies that a merger with Smith & Nephew would bring. With Medtronic confident in its ability to return overseas cash to shareholders even without a tax inversion, the benefits don't add up to a multi-billion dollar acquisition – particularly the way Smith & Nephew's stock has rocketed up the charts lately. For investors, this is one health care acquisition that's better off avoided.

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Dan Carroll has no position in any stocks mentioned. The Motley Fool recommends Johnson & Johnson. The Motley Fool owns shares of Johnson & Johnson and Medtronic. 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.

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