Investors In Stryker are hardly reacting to the acquisition of Patient Safety Technologies. With the deal, Stryker gets a hold of the Safety-Sponge System and SurgiCount's software, yet the addition is too small to move the needle in terms of Stryker's overall operations.
Given the significant momentum in 2013 and the significant earnings multiple, I remain cautious and do not initiate a position in the stock.
Stryker Acquires Patient Safety Technologies
Stryker (SYK) announced that it has reached an agreement to acquire Patient Safety Technologies (OTCQB:PSTX) for $2.22 per share, or $120 million. Shares of Patient Safety rose by nearly 49% on the back of the news flow.
Patient Safety's proprietary Safety-Sponge System and the SurgiCount 360 compliance software prevents Retain Foreign Objects (RFOs) in the operating room, improving patient safety while reducing healthcare costs.
RFOs are the most common operation room "Never Event" in the US. Spongers are the most common of these events with some 2,300 incidents occurring every year at an average cost of $400,000 per incident, implying almost a billion in annual costs for society at large.
Patient Safety's launch of SurgiCount in 2006 has resulted in a customer base of 300 hospitals, and the business will become part of Stryker's Instruments division.
Timothy Scannel who is Stryker's president for MedSurg and Neurotechnology commented on the reason behind the deal, "We are committed to providing solutions that result in a higher quality of care and level of safety for both patients and healthcare professionals. This acquisition aligns with Stryker's focus on offering products and services that have demonstrated cost effectiveness and clinical outcomes."
Patient Safety Technologies generated revenues of $14.9 million for the first nine months of the year, up nearly 20% on the year before. Losses narrowed from $2.4 million to $1.9 million in the meantime. With revenues seen around $20 million per annum, the deal is valued at some 6 times annual revenues.
The deal is as usual subject to normal closing conditions, including approval by shareholders and the Hart-Scott-Rodina Antitrust Improvements waiting period. The transaction is expected to close in the first quarter of 2014.
Solid Revenues, Earnings Fall On Recalls
Stryker has reported solid results so far this year. Revenues for the first three quarters of this year rose by 3.7% to $6.55 billion. Reported earnings fell by nearly 40% to $620 million as the company took massive charges of $245 million on the voluntary recall of Rejuvenate and ABG II modular-net hip stems in the third quarter alone.
With shares trading around $75 per share, the market values Stryker at some $28.4 billion. The company operates with a rock-solid balance sheet including $5.1 billion in cash, equivalents and short-term investments. The debt position is limited at $2.7 billion, implying that operating assets of the firm are valued around $26 billion.
This values operating assets of the firm at around 2.9 times expected annual revenues of $9 billion for 2013. As GAAP earnings could come in around $800 million, this values the business at around 32 times earnings. Excluding these product recall expenses, earnings could total $1.5 billion, implying a valuation at 18 times earnings.
Stryker Has Been A Mediocre Investment Over The Past Decade
Investors in Stryker have seen modest returns over the past decade. Shares peaked at $75 in 2007 to fall to lows of $30 during the financial crisis of 2009. Ever since, shares have steadily risen to current levels at $75 again after shares have risen nearly 40% in 2013.
In recent years, Stryker has managed to increase its revenues substantially. Between 2009 and 2013, the company is expected to increase revenues by about a third. GAAP earnings came in between $1.1 and $1.3 billion over this period, seen to fall in 2013.
On the back of the solid financial position, Stryker has increased its payouts to investors. The company repurchased nearly 5% of its shares outstanding in recent years, and recently hiked its quarterly dividend by 15% to $0.305 per share, thereby providing investors with a 1.6% dividend yield. Note that investors have seen an incredible increase in their dividends. Annualized dividends of $1.22 per share compare to 2006's dividends of just $0.11 per share.
Implications For Investors
The news about the deal to acquire Patient Safety is small news. For starters, the price tag represents less than half a percent of Stryker's market capitalization. Growth has to come from access and learning of technologies, as well as marketing the Patient Safety's proprietary Safety-Sponge System and the SurgiCount 360 through Stryker's sales force. Even when this strategy will work successfully, the deal won't move the needle in a significant way.
Yet the deal shows that Stryker continues to look around for nice deals. Back in September of 2013, the company already announced the $1.65 billion deal to buy Mako Surgical. The deal gives Stryker access to Mako's technology in robotic assisted surgery, yet it comes at a price. Revenues of Mako are seen at roughly $100 million for 2013, while losses could come in around $75 million.
Stryker's diversity is a major strength with the company deriving revenues from Neurotech & Spine, Recon and MedSurg. Even within these three segments, the diversity in revenues is strong with no individual business making up more than 15% in revenues. A drawback is the geographical coverage, with Stryker deriving two-thirds of its annual revenues from the US. Disappointing is the mere 6% exposure to emerging markets.
Back in September, I looked at the implications for shareholders following the acquisition of Mako Surgical for which the company paid an 86% premium. The deal adds to Stryker's promising technologies in a growing market, yet the real impact of the deal will take years to materialize.
The valuation at 20 times normalized earnings at the time was a bit rich in my opinion. The diversification is a plus, but also limits growth to some degree. Another drawback as seen this year is the exposure to many technologies and medications, resulting in expensive product recalls at times.
In September, I concluded to remain on the sidelines. Despite the solid revenue growth and spectacular dividend growth, the current valuation does not represent a great opportunity for investors. The latest small addition does not change my opinion.