February 12, 2019

Breakingviews: Smith & Nephew $3 bln spinal deal is a backbreaker

by Breakingviews.

Less than a year after becoming Chief Executive, Namal Nawana laments that sales of most of Smith & Nephew’s products are growing more slowly than their respective markets. A multibillion-dollar acquisition in a totally new area, like the potential takeover of spinal surgery group NuVasive, looks like a risky solution.

It’s easy to see why Nawana is looking for new ideas. Sales at London-listed Smith & Nephew, which makes knee-replacement and other medical devices, grew by 2 percent last year. Yet the group’s current suite of products targets a market with about $40 billion of annual sales, just a tenth of the global sector, Nawana reckons.

However, shareholders appear to be wary of straying too far. Smith & Nephew’s stock fell around 4 percent on Monday after the Financial Times reported that Nawana is eyeing an acquisition of NuVasive, worth $3 billion including debt. NuVasive’s top line is expected to grow by 6 percent this year, according to Refinitiv, but the spine market overall is sluggish: JPMorgan reckons annual sales growth of just 2.6 percent over the next four years. And cost savings would be limited given the lack of overlap, and the need for specialist salespeople.

Assume a 25 percent premium, and the total outlay, including debt, would be about $3.7 billion. Analysts expect NuVasive to make $263 million of operating profit in 2022, according to Refinitiv. Throw in cost savings of $70 million, the average of Jefferies and Credit Suisse forecasts, and Smith & Nephew shareholders would acquire operating profit of perhaps $333 million, and earn a post-tax return on invested capital of just over 7 percent. The sector’s cost of capital is probably around 8 percent.

Nawana is no stranger to the spine sector or bold deals. As worldwide president of Johnson & Johnson’s DePuy Synthes unit, he oversaw the integration of Synthes following its $22 billion acquisition in 2012. Still, a more modest approach may be more effective. Since taking over in 2018, Nawana has been conducting a review of each business, and looking at small bolt-on acquisitions, like a recent deal for Ceterix. Smith & Nephew shares had risen by 16 percent since he took over, before Monday’s fall. Just like in medicine, where surgery is a last resort, Nawana should complete his less-invasive treatments before trying anything too drastic.


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