Robotic surgery is upending the healthcare industry as we know it and Medtronic (MDT -0.98%) wants in on the action.

The medical-device titan announced that it is shelling out $1.6 billion to acquire Mazor Robotics (MZOR). That represents a double-digit premium to the stock's closing price on the day before the transaction and values the business at 22 times sales.

Is Medtronic making a smart move, or did Mazor's shareholders just make out like bandits? 

Men in suits shaking hands and exchanging money.

Image source: Getty Images.

What is Medtronic buying?

Mazor Robotics has been following in the footsteps of robotic-surgery granddaddy Intuitive Surgical (ISRG 2.33%) for years. However, Mazor knew that competing against the entrenched giant was going to be a losing battle, so it chose to focus on parts of the body that were left untouched by Intuitive's machines: the spine and brain.

Mazor's two main products -- called the Renaissance and Mazor X -- assist surgeons with the placement of implants into a patient's body. The systems provide surgeons with 3D analytics and virtual-planning tools that guide robotic arms to enable screws to be placed with far more precision than freehand alone.

Precision is a big deal in spine and brain procedures. Improperly placed implants can sometimes lead to permanent nerve damage and expose medical practitioners to legal headaches. What's more, increased precision also lowers complication rates, lessens the need for exposure to radiation, and leads to lower levels of post-surgery pain.

These advantages have already caught on with practitioners who like to adopt bleeding-edge technology. More than 36,000 procedures have already been performed on the hundreds of Mazor's systems. That's impressive, but it's still small potatoes when compared to the company's addressable market opportunity of 500,000 procedures that are performed in the U.S. alone each year. 

Just as with Intuitive Surgical, Mazor's systems require the use of consumable parts and accessories each time a surgery is performed. Hospitals are also required to sign an annual service contract to ensure the systems are always performing at their best. This acts as a one-two punch that provides the company with a dependable stream of revenue.

Forging a partnership

Mazor had a lot of success with commercializing its devices on its own early on. However, the company was small and lacked resources, so it was limited in the promotion that it could do.

Despite those limitations, the company's early track record and technology impressed Medtronic so much that it decided to take a substantial equity position in the business and forged a multi-stage commercial agreement in an effort to turbo-charge adoption. Mazor leapt at the partnership opportunity because Medtronic employs a vast commercial team that has the know-how and relationships in place to rapidly increase adoption.

The deal also provided Mazor with another massive benefit: It enabled the company to offload the majority of its sales force. This move drastically lowered the company's operating expenses and even led to the company reporting a small profit for the first time in its history.

Wall Street gets excited

The massive opportunity ahead of Mazor and vote of confidence from Medtronic caused Wall Street to take notice. Mazor's stock went on a tear soon after the deal was announced and provided early investors with multibagger returns.

The downside to the stock's huge appreciation is that Mazor became richly valued. Shares have regularly traded hands for more than 20 times sales. This suggests that Wall Street was pricing in a lot of prosperity.

The excitement makes sense given the opportunity ahead, but growth might prove to be harder to come by in the years ahead. Globus Medical (GMED 0.47%) recently won FDA approval for its Excelsius GPS system, which also assists surgeons with screw placements in the spine and orthopedic surgery procedures.

In other words, this isn't a market that Mazor has all to itself anymore. 

Medtronic makes its move

In spite of the increased competitive pressure, Medtronic decided that it wanted to go all-in on the robotic-surgery company anyway and decided to buy out the remainder of Mazor that it didn't own.

Medtronic offered to acquire Mazor for $58.50 per share in cash, which represented a 10% premium to where shares were trading on the day before the announcement. The offer valued the company at $1.64 billion. However, since Medtronic was already a substantial equity owner, the net purchase price of the deal will be about $1.34 billion, which is an easier number to swallow.

That price still values the company at about 22 times trailing sales, so it certainly represents a premium valuation. However, Medtronic's management team stressed that the acquisition still meets its strict criteria to generate double-digit returns on invested capital within just four years. The transaction is also only expected to be "modestly dilutive" to Medtronic's earnings in fiscal 2019.

While there's no doubt that Medtronic is paying a hefty premium, it's worthwhile to put this deal size in perspective. The $1.3 billion cash outlay to close the deal is a tiny fraction of Medtronic's market cap of $131 billion. Since the company will immediately become a leader in the fast-growing robotic-surgical space and gain access to the company's patents and know-how, I think paying the premium makes a lot of sense.

In other words, no, Medtronic isn't paying too much for Mazor. In fact, this longtime Mazor shareholder thinks the company is getting a bargain.