Medtronic's Expensive Acquisition Of China Kanghui Has Long-Term Strategic Benefits

| About: Medtronic plc (MDT)
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Medtronic (MDT) announced on Thursday that it will acquire China Kanghui Holdings (KH) in a deal valuing the company at $30.75 per share, for a total transaction value of $816 million.

Shares of Medtronic traded 0.8% lower on Friday, as investors had the chance to react on the news. Shares of Kanghui Holdings rose more than 20% to $30.35 per share on the back of the deal. Since the start of 2012, shares of Kanghui have more than doubled.

The Deal

Medtronic announced that it will acquire China Kanghui Holdings, a developer, manufacturer and marketer of orthopedic implants in China. Kanghui's orthopedic brands include Kanghui and Libeier, and it offers trauma and spine orthopedic implants.

Medtronic will pay $30.75 per share for China Kanghui, or $816 million in cash for the total firm. Net of Kanghui's cash holdings, the deal value is approximately $755 million.

CEO and Chairman Omar Ishrak commented on the deal, "This agreement is directly aligned with our corporate strategies of globalization and economic value. Kanghui represents a significant investment in China, accelerating Medtronic's overall globalization strategy with an established value segment distribution network and strong R&D and operational capabilities."

China Kanghui generated annual revenues of CNY327 million in 2011. The company net earned CNY121 million. In U.S. dollars, revenues came in at $52.1 million, and net income at $19.3 million.

For the first six months of 2012, China Kanghui reported revenues of CNY184 million, or $29.3 million in U.S. dollar. Net income came in at CNY64 million, or $10.3 million in US dollar.

The deal values China Kanghui at 14 times annual earnings, and 40 times annual profits. The acquisition is expected to be neutral to 2013s and 2014s earnings per share as Medtronic aims to offset any dilutive effects of the acquisition.

Medtronic expects to close the deal in a few months time. The deal is subject to regulatory and shareholder approval, and the usual closing conditions.


Medtronic ended its first quarter of its fiscal 2013 with $2.5 billion in cash and equivalents, giving the company enough firepower to finance this latest deal. The company operates with a sizable amount of short and long term debt, some $10.8 billion, resulting in a net debt position of $8.3 billion. The acquisition of Kanghui would most likely push the net debt position towards the $9 billion mark.

For the full year of 2012, Medtronic generated revenues of $16.2 billion. The company net earned $3.6 billion, or $3.22 per diluted share. The acquisition of Kanghui would have a very limited effect on both group-wide earnings and revenues.

Medtronic is currently valued at $44 billion, or 2.7 times annual revenues and 12 times debt.

Currently, Medtronic pays a quarterly dividend of $0.26 per share, for an annual dividend yield of 2.4%.

Investment Thesis

Year to date, shares of Medtronic have risen some 13%. Shares traded between the $36 and $40 mark until August, when the company reiterated its full year fiscal 2013 outlook. Currently shares are exchanging hands at $43. For its fiscal 2013, Medtronic expects to earn $3.62-$3.70 per share.

A little over a month ago when shares were about to break out of the $40 resistance level, I already argued that shares offered long term investors with a decent investment opportunity. The company's shares have fallen roughly a quarter over the past five years, while the company almost doubled its earnings, and has doubled its annual dividend payout.

The acquisition of Kanghui is no game changer for the company. The direct addition to revenues and earnings is negligible, but it highlights the acquisition-driven growth strategy and boosts the company's position in China. While $755 million is a lot of money for Kanghui, Medtronic aims to let the deal have a neutral effect on earnings per share.

While there are few short term benefits to the deal, given the high valuation, it does offer Medtronic some long term benefits in growth markets like China. Shares of Medtronic saw a very modest correction on Friday, on the back of the deal.

Still, the investment thesis in Medtronic is intact. I would not be surprised to see shares hit the $50 mark in the next year.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.