Last week saw a slew of huge M&A activity. Comcast (CMCSA) bought the remaining 49% of NBC still owned by GE (GE), US Airways (LCC) merged with a chapter 11 American Airlines (OTCQB:AAMRQ), and finally Berkshire Hathaway (BRK.A) teamed up with 3G capital to buy Heinz (HNZ). This comes on the heels of Dell's (DELL) LBO, and Liberty Media's (LMCA) buyout of Virgin Media (VMED). Major players predicted these events, pointing out that cheap credit and inability to grow revenues will force more and more companies to look at M&A for growth. In this article, I would like to examine the M&A prospects for the medical device industry, and more specifically, for Stryker Corp (SYK). Before diving into the specifics relating to SYK, I would like to make two additional points relating to specific medical device industry dynamics.
First, beginning this year as part of Obamacare, medical device companies will have to pay a 2.2% excise tax on the gross sales of their devices. Meaning if a company makes $100mm in revenue, and $2.2mm in profit, it will now make no profit. This development will have particularly devastating effects on development stage companies struggling to turn a profit. Second, over the next 10 years, the amount of people over the age of 65 will increase from 13% to more than 16% of the population. By 2030, the ratio will more or less top out at around 20% of the population. This staggering development has many effects on the economy, most notably the need for increased healthcare spending. Taken together -- the macro M&A environment, medical device excise tax, and demographic shifts -- the medical device sector generally, and as we will see, SYK specifically, should see increased M&A activity.
In this article, I will address why I think SYK has the greatest potential for M&A activity, specific sub sectors/companies in the medical device space it could target, and finally, some larger M&A possibilities open to SYK.
Stryker: Fertile Ground For M&A
In order to understand why Stryker will conduct the most M&A activity, we need a brief word of introduction. When we say the term "medical devices," what does this term include? Obviously, it includes heart implants and orthopedic implants, but that only begins to scratch the surface. Surgical equipment, radiological equipment, stretchers, wheelchairs, and hospital beds all fall under the medical device category. Basically, if you go into a hospital, anything that "do[es] not achieve its intended use through chemical reaction and [is] not metabolized in the body" is considered devices.
With that word of introduction, we can turn our attention to SYK and its important history. SYK -- one of the largest medical device companies -- started by Dr. Homer Stryker in 1940, began as a manufacturer of hospital beds. In fact, for the first 39 years, the company focused solely on hospital equipment. Only in 1979 did the company take its first steps away from the hospital equipment space and into implantable orthopedic devices. In that year, SYK acquired Osteonics Corporation of New Jersey, and entered the orthopedic implant market. Its desire to establish itself in the orthopedic market culminated with its purchase of Howmedica, the orthopedic division of Pfizer (PFE), for $1.8bn in 1998. Since then, it has continued to strengthen its implantable orthopedic franchise through internal R&D and external M&A. In 2011, SYK derived less than 10% of total revenue from its hospital equipment operation. In short, I have recounted this history to show SYK's history of growing its business through acquisitions, and the significant impacts it has had on its business.
One final word on SYK's history. When we compare SYK's history with Medtronic (MDT), Boston Scientific (BSX), or St. Jude (STJ), we see a stark distinction. Each of the above companies began focusing on one type of product -- MDT in pacemakers, BSX in catheters, and STJ in heart valves -- and maintained this main part of its business, even while conducting significant M&A activity. This draws sharp distinction to SYK, which has significantly expanded its business through M&A, allowing it to draw on this experience when pursuing new ventures.
In addition to its history of M&A activity, SYK also has a strong balance sheet that can support acquisitions. SYK currently has $5bn in cash, and $1.75bn in long-term debt, giving it a lot of flexibility to make acquisitions, especially when considering the liquidity of its competitors. The following table gives the frankly inflexible liquidity of the major device manufacturers (excluding JNJ).
Short Term Debt (mm's)
Long Term Debt (mm's)
Cash Less Debt (mm's)
Clearly, we see that BSX, STJ, and Zimmer Holdings (ZMH) have their hands tied in terms of M&A activity, and MDT and SYK remain the only legitimate players in the market.
We will now move to specific areas where SYK could get active in acquiring other companies, and some other larger M&A possibilities open to SYK.
Specific Acquisition Targets
As we mentioned above, back in 1998, SYK acquired the orthopedic implant division of PFE. This established a beachhead for SYK in the implantable orthopedic market. In January 2011, SYK spent $1.5bn acquiring BSX's neurovascular unit, giving it access to the market for stroke intervention. Immediately preceding this acquisition, and afterwards, SYK made a string of acquisitions in the neurovascular space, and in the orthopedic extremity (hands, feet, wrist, shoulder) space. These two areas -- neurovascular and trauma and extremities -- have clearly formed the core of the company's focus for future growth.
Another company focused on these two areas is Integra Lifesciences Holdings Corp. (IART). IART currently organizes itself into three divisions -- Orthopedic, Neurosurgery, and Instruments. Its orthopedic division focuses almost exclusively on extremity devices, and its neurosurgery unit has a presence in both neurovascular devices and general neurosurgical procedures. SYK might like IART's portfolio and customer base, further allowing it to grow its business in these areas.
Aside from IART, I have not found an area, either in the interventional stroke market, or in the extremity market, which would qualify as a solid acquisition target for SYK. After looking at the SYK neurovascular website, I didn't see that it offered any catheters and guidewires -- seemingly giving the company an M&A possibility in that space. However, I called up SYK, and the company said it does offer these products, but they have not made up to its website in that area yet. Therefore, I am back to square one, and if you know of one, then please leave a comment below.
Finally, I will direct my attention to a large acquisition SYK could undertake. I know it's ambitious, but I think it makes sense for both companies.
SYK's Large M&A Opportunity
SYK has two distinctive features. First, it has a strong liquidity position, and second, it has no presence in the cardio device market. It has a primary focus on the implantable orthopedic market, which accounts for over 50% of its revenue. Additionally, it has a secondary focus on instruments and medical equipment, and lastly, it has a small neurovascular unit.
Revenue (in mm's)
% of Revenue
Instruments, Endoscopy, Medical
This leaves SYK completely out of the market dominated by MDT, STJ, and BSX. As we saw above, MDT has an extremely solid liquidity position, and relatively speaking, STJ remains on strong footing. However, BSX continues to struggle under the weight of a crushing debt load. BSX made its name in the catheter market, but has since expanded its catheter offerings, and has had a strong focus on the cardiac market. Llast year, BSX got 60% of its revenue from interventional cardiology and cardiac rhythm management.
In short, SYK's strong balance sheet and lack of exposure to the cardiac space, and BSX's strength in the cardiac market and weak balance sheet make them perfect partners. Additionally, SYK already has a relationship with BSX after its purchase of BSX's neurovascular business two years ago. While this section is pure speculation, I think it stands up to the facts, and could prove a smart move for both companies.
I looked very hard into different acquisition targets for SYK, especially smaller companies that would be more severely affected by the medical device excise tax. However, I did not find anything, and IART is the best I could come up with. Therefore, I ask again, please submit any ideas in the comments section below. Additionally, despite its large size, as we see BSX, because of its large debt load, will also experience effects from the excise tax, further pushing it into a possible merger with another company, like SYK.
Two final points: First, SYK, because of its strong balance sheet, can easily absorb BSX, and possibly refinance its debt at more favorable rates. Second, SYK has started to slow in growth in its traditional orthopedic implant market, and has made an effort historically to growth through acquisitions. It could continue that in a major way with a BSX acquisition.
This year should prove an exciting one for M&A, and the medical device market should not disappoint. Stay tuned!