Summary
- Stryker was expected to be a buyer in the extremities market, but its choice of Small Bone Innovations was a little surprising.
- Stryker now has a credible presence in the upper and lower extremity markets, and can use its considerable R&D and marketing prowess to leverage that further.
- Losing Stryker as a potential buyer arguably hurts Tornier more, but suggests that Wright Medical could get $35 or more per share from Johnson & Johnson or Zimmer.
It may be a little extreme to diagnose the med-tech market with buyout fever, but it’s definitely a frequent talking point – particularly in the case of orthopedic extremity companies Wright Medical Group (WMGI) and Tornier(TRNX). While it may be wise advise not to own stocks just for their takeout potential, the reality is that there is a widespread expectation that major orthopedics players will look to these companies as a way of adding some extra growth (extremities markets are growing at double-digits, and likely to continue to do so for several years) and rounding out their product offerings.
Stryker Paying Up For A Limited Player
At the risk of talking my book (I own Wright Medical shares), I believe Stryker is paying a lot for not all that much. The company is buying Small Bone Innovations for $375 million in cash, or about 6x trailing revenue, for a company that expects revenue to decline this year. Stryker is structuring the deal as an asset purchase so as to benefit from the net operating losses at SBi.
About 50% of SBi’s sales come from its STAR total ankle system, which has about 30% share of the total ankle market. The design of STAR is starting to look dated though, and the platform is losing share to Wright Medical and Tornier’s Salto Talaris. Wright Medical has a new total ankle system called INFINITY and this should further erode SBi’s share in the total ankle market.
Outside of total ankle systems, SBi generates about 30% of its sales from other lower extremity products and another 20% from upper extremity products for the wrist, elbow, and fingers. Prior to this deal, Stryker’s presence in extremities was pretty limited and focused mostly on trauma products.
What Does This Mean For Tornier And Wright Medical?
Having a large player move into your neighborhood is rarely a positive for med-tech companies. This isn’t an “awareness-building” market or anything of the sort; doctors are plenty aware of the lower extremity market and a revitalized SBi backed by Stryker’s R&D dollars and marketing prowess is not a company that I would regard lightly. What’s more, hospitals are increasingly looking to reduce the number of vendors they deal with in various therapeutic areas – with Stryker now able to offer lower extremity products in addition to its existing major joint products, either Tornier or Wright Medical may find themselves squeezed out of accounts that currently favor Stryker for large joints.
With this deal, the list of buyers goes down by at least one. I say “at least one” because Smith & Nephew (SNN) also lacks a credible presence in extremities and could be seen as a buyer… that is, unless it and Stryker agree to a merger after all. After these two, Johnson & Johnson (JNJ) andZimmer (ZMH) could also factor into the mix, but not necessarily equally. Johnson & Johnson has significant share in shoulders and upper extremities (in the neighborhood of 25%) and that may preclude a deal for Tornier (with 20% share). Likewise with Zimmer, which has around 15% to 17% share, though regulators have shown a willingness in the past to let buyers get 35% or so share. I also wouldn’t completely exclude Medtronic (MDT) from the discussion, though it seems much less likely.
The Bottom Line
All things considered, maybe this isn’t such terrible news for Wright Medical. The premium offered by Stryker supports the general idea that Wright Medical could sell for around $35 to $40 in an M&A transaction on the basis of expected 2014 sales. What’s more, it may be a wake-up call to Johnson & Johnson and Zimmer that if they wait too much longer, they might not have a good option for positioning themselves in the fast-growing extremities market.
For Tornier, I see this as a less positive development. Johnson & Johnson and Zimmer could be more problematic buyers from a regulatory perspective and Stryker is now off the table as a buyer. While med-tech has a way of producing unexpected deals, it now looks like the M&A landscape has shifted a bit more in Wright Medical’s favor versus Tornier’s.
