The health care sector is littered with acquisitions -- some good, some bad, some downright horrendous. British medical device maker Smith & Nephew (NYSE:SNN) engaged in an acquisition of its own recently, picking up wound care company Healthpoint Biotherapeutics to add to its own wound care division. While Smith & Nephew has made strong strides in this industry, the acquisition comes with a hefty price tag -- one tough to justify to investors.
Focusing on what works
Smith & Nephew's acquisition of Healthpoint for $782 million gives the company a nice place in bioactive wound treatment. The company's done well in wound management recently; this division posted Smith & Nephew's highest revenue growth in 2011 at 7%, with a solid trading profit margin of 24.3% to lead all company branches.
It's only natural that Smith & Nephew would want to add to this area. According to the company's most recent annual report, Smith & Nephew is the second-largest competitor in this industry after privately-held Kinetic Concepts, and holds an 18% global market share. The competition isn't a who's who like it is in the company's largest division, orthopedics, which only posted a 2% revenue gain last year and offers the lowest trading profit margin of any division.
In orthopedics, Smith & Nephew has to compete with established rivals like Stryker (NYSE:SYK) and Johnson & Johnson's (NYSE:JNJ) DePuy and Synthes, not to mention up-and-comers in the orthopedic sphere like MAKO Surgical (UNKNOWN:MAKO.DL). That's tough sledding with MAKO's rise and minimally invasive technology, not to mention the big names already well-entrenched with larger market shares.
A high price to pay
But despite Smith & Nephew's advantages in the wound care market, the company paid a hefty price for Healthpoint. The $782 million price tag is more than four times Healthpoint's projected 2012 revenue of $190 million -- and even with R&D expenses taken out, that's 23 times a 2011 trading profit of $34 million. Ouch.
It's not all bad. Smith & Nephew expects Healthpoint's business to post growth percentages in the mid-teens in coming years. Excluding R&D, Healthpoint's trading profit margin was already more than 17% before the acquisition, which is good enough to stand alongside Smith & Nephew's already-successful division. It should only benefit from the company's infrastructure in place and resulting synergies, and I give credit to Smith & Nephew for taking steps to boost its top-growing segment. Healthpoint's footprint in the bioactive market, which includes cutting-edge technologies such as regenerating skin, should certainly give Smith & Nephew solid footing for the future.
Nonetheless, I question whether this deal could have been made cheaper. It's tough to justify a price that high to investors, even with the growth potential. As investment firm Panmure Gordon said, "Although this deal seems to be strategically important, the market will look at the valuation, which at 4.1 times revenues and 71 times EBIT will be seen as rich."
In the end, a worthy deal
All in all, Healthpoint's purchase will help Smith & Nephew in the long run. With the company expecting the acquisition to provide a serious boost to U.S. wound care sales, it should cement its status in its top-growing segment and vie for market leadership. Smith & Nephew can only hope that investors will quickly forget that hefty price tag; if the deal pans out as expected, however, that might be sooner rather than later.
Fool contributor Dan Carroll has no positions in the stocks mentioned above. The Motley Fool owns shares of Johnson & Johnson and MAKO Surgical. Motley Fool newsletter services recommend Johnson & Johnson and MAKO Surgical. 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.