More on those Smith & Nephew bid rumours, this time from Merrill Lynch, whose investment bankers have reportedly been trying to put the medical devices group together with a heavily indebted US rival.
Analyst Ed Ridley-Day has told clients on Wednesday morning that he is moving to a “No Rating” on S&N because of all this takeover speculation.
It is our view that the stock is no longer trading on fundamentals and we thus move to No Rating on the stock. Investors should no longer rely on our previous fundamental equity opinion or price objective on the stock.
However, he still thinks the idea of merger with Biomet — the highly indebted rival referred to in the opening paragraph — is a rather good one and goes on to detail at length presicely why.
How strange.
A Biomet/Smith & Nephew merger would create a global leader in orthopaedics between the current 4th and 5th largest companies in the market. There would be no regulatory concerns with a Biomet/Smith & Nephew deal, on our analysis, whereas we believe a JNJ bid for Smith & Nephew would face significant regulatory hurdles on market share concerns.
Combined entity worth more than the sum of its parts As Biomet’s own weak results for 2QFY11 (6th January) highlighted, the fundamental outlook for the US and European orthopaedic markets remains challenging. As reimbursement pressure increases in both the US and Europe, greater negotiating power and a strong and differentiated product offer are vital. The companies would also be able to extract synergies from SG&A costs and central functions, as well as leveraging JNJ’s larger sales force to increase sales of Smith & Nephew’s strong hip and knee product offering.
Viable due to Smith & Nephew’s relatively debt-free balance sheet We estimate that a combined Biomet/Smith & Nephew entity could sustain Biomet’s debt with pro forma net debt/ EBITDA of 2.7x. At the end of 3Q10, SNN had net debt of US$599mn and Biomet had net debt of US$5,717mn, respectively for a combined net debt amount of US$6,317mn.
Potential structure of the deal In light of Biomet’s $5.7bn net debt, we believe that a deal with Smith & Nephew would most likely be arranged as a reverse takeover (as speculated in the press), using Smith & Nephew stock and benefitting from Smith & Nephew’s relatively un-geared balance sheet (3Q10 net debt $599mn). We believe that a deal would be likely to appeal to Biomet’s debt holders, if not its private-equity backers. On our analysis the deal would require either the creation of a special purpose acquisition company – a TopCo – but this has less appeal than before the FSA updated its regulations governing their use. This would probably need to be set up through a scheme of arrangement which requires a 75% shareholder vote. Alternatively Smith & Nephew could issue shares, a Class 1 transaction requiring 50% vote at a shareholder meeting.
Wednesday’s price action in S&N:
Related links:
One for the M&A watch list – FT Alphaville