Stryker (NYSE:SYK) announced yet another acquisition, this time acquiring assets of Small Bone Innovations, in its latest nimble deal to boost organic growth in the future.
Stryker has a solid balance sheet and growth track record. Still the valuation based on GAAP earnings is a bit steep, preventing me from jumping on the bandwagon at the moment. I remain on the sidelines, awaiting better entry levels in this long-term grower.
Acquisition Of Small Bone Innovations
Stryker announced that it has reached an agreement to acquire some assets from Small Bone Innovations in an all-cash deal valuing the business at $375 million.
SBi is a privately-held business located in Pennsylvania, which designs upper and lower extremity small bone indications, focusing on small joint replacements. SBi has manufacturing locations in France and Germany.
The acquisition of certain, but not all, of SBi's activities is anticipated to close in the third quarter of this year.
Strategic And Financial Reasons For The Deal
SBi has been founded as recently as 2004. Included in the purchase of "certain assets" from SBi is the Scandinavian Total Ankle Replacement System, also known as the STAR ankle. This is the only PMA-approved three-piece ankle replacement system, sold in over 40 countries across the globe.
The STAR ankle is the most used ankle replacement product around the globe, adding to Stryker's Foot & Ankle product portfolio.
While the official price tag is $375 million, Stryker anticipates to benefit from tax benefits as a result of the deal structure, which lowers the effective purchase price to $285 million. The acquired activities posted revenues of $48 million in 2013, valuing it at nearly 6 times sales, based on the effective purchase price.
The deal is anticipated to dilute 2014's earnings by two pennies before considering acquisition-related charges, as well as potential impairment costs.
Back in April of this year, Stryker reported its first-quarter results. Total cash, equivalents and marketable securities stood at $4.05 billion, giving the company plenty of liquidity to make such deals. Total debt of $3.06 billion leaves a solid net cash position of a billion before the deal closes.
For the full year of 2014, Stryker anticipates organic sales growth of 4.5% to 6.0%. Adjusted earnings excluding amortization charges on intangible assets are seen between $4.75 and $4.90 per share.
At $84 per share, equity in Stryker is valued at roughly $32 billion, which values operating assets at about $31 billion after adjusting for the $1 billion net cash position. This values equity at roughly 3.3 times anticipated sales of $9.5 billion. Shares trade at 16-17 times adjusted earnings, which appears appealing.
Note, however, that the gap between GAAP and non-GAAP earnings is substantial. First-quarter GAAP earnings of $0.18 per share were just a fraction of reported adjusted earnings of $1.06 per share.
Stryker currently pays a $0.305 per share quarterly dividend, providing investors with a 1.4% dividend yield.
Stryker has been a solid growth story, more than doubling its revenues from $4.3 billion in 2004 to $9.0 billion in 2013. Earnings doubled to little over a billion, but have stagnated in recent years. Over this time period, the company has reduced its outstanding share base by about 5%, while it has incurred a bit of leverage lately.
Investors have seen some volatility along the way, but no great returns. Shares traded at highs of $75 in 2007 ahead of the recession, to fall to just $30 in 2009's recession. Ever since, shares have seen solid returns, after steadily increasing to current levels at $85 per share.
To boost its organic growth profile, Stryker has resorted to making multiple smaller deals in recent times. Earlier this year, it bought Berchtold in a $172 million deal to boost its healthcare equipment business. A day later, it acquired Pivot Medical for an undisclosed sum.
Back in January of this year, I last checked out the prospects for Stryker, following the $120 million acquisition of Patient Safety Technologies.
By now, the company has already made numerous, small and targeted deals to boost its organic growth profile going forward. These deals have followed the larger $1.65 billion deal to buy Mako Surgical in September last year, getting access to robotic surgery technologies.
I concluded that I liked the product diversification, although Stryker still very much relies on the US in terms of geographical diversification. For now and back then, the valuation was my main concern. Paying a 16-17 times multiple for a growing business with a rock-solid balance sheet is perfectly justifiable in this environment, yet the gap between GAAP and non-GAAP earnings is holding me back.
On average, Stryker earned 15% of its revenues on a GAAP after-tax basis, which would translate into earnings of $1.4-$1.5 billion, on average, given its current revenue base. Given the large charges already in the first quarter, such high GAAP earnings are not likely for this year.
Even when using this input to value Stryker, shares would be trading at 21-22 times GAAP earnings, which does not make the company a bargain.
Yet, the continued focus on future growth, small and nimble acquisitions and strong track record would make shares attractive, if a potential 15-20% sell-off might occur over time. For now, I remain on the sidelines.
Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.