Kinetic Concepts Grafts On a New Division

Sometimes, it's easier for companies to grow and diversify by buying other companies, rather than developing products internally. That's true for Kinetic Concepts' (NYSE: KCI) $1.7 billion cash purchase of LifeCell (Nasdaq: LIFC), a maker of tissue-repair products. The deal's $51-per-share price tag is an 18% premium over Friday's close.

On the surface, the acquisition looks like a good fit. Both companies sell wound-management products to hospitals, but their product lines don't really overlap. There's potential for cross-selling amongst the companies' customers, although the new company is planning to keep two separate sales forces, because the products -- beds and regenerative tissue -- are so different. Since Kinetic Concepts is just grafting on a new division, there won't be a lot of places to cut costs after the merger.

In the long run, Kinetic Concepts may be able to grow revenue from LifeCell products faster than LifeCell could do on its own, since Kinetic Concepts has an international sales force -- something LifeCell had been lacking. Kinetic Concepts isn't expecting the acquisition to be accretive on a GAAP basis until 2010.

Even with that added potential, LifeCell looks a tad expensive to me. The acquisition price is about 50 times its projected 2008 earnings per share, when revenue was expected to grow 22% to 28% year over year. Therefore, I think it's unlikely that another company that sells wound-management products, such as Johnson & Johnson (NYSE: JNJ) or Covidien (NYSE: COV), would make a competing bid.

Kinetic Concepts' investors, on the other hand, think LifeCell is just what the doctor ordered, sending the stock up more than 5% yesterday. While I can see the advantages of diversifying Kinetic Concepts' revenue stream, and the synergies between the companies are certainly there, I'm just not so sure about the lofty valuation that it's paying. I guess we'll know in a couple of years how accretive the purchase really was.

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