Takeover Flurry Attests to Battle in Medical-Products Industry: Spotlight
Bloomberg News
August 16, 1998, 12:26 p.m. ET
Takeover Flurry Attests Battle in Medical Products: Spotlight
Zurich, Aug. 16 (Bloomberg) -- The second multibillion-
dollar medical-technology acquisition in three weeks, Stryker
Corp.'s $1.9 billion purchase of Howmedica from Pfizer Inc.
proved Friday that the battle for market share is escalating in
the $9 billion orthopedic-products market.
The normally sedate industry, dominated by Johnson &
Johnson and rivals Smith & Nephew Plc, Bristol-Myers Squibb
Co.'s Zimmer, Howmedica and others, was jolted July 21 when
Roche Holding AG said it would sell DePuy to Johnson & Johnson
for $3.5 billion. Analysts said at the time the move would
prompt others to shed medical-products units. Pfizer, the maker
of blockbuster antidepressant Zoloft, soon proved them right.
When Johnson & Johnson bought DePuy, the world's fifth-
biggest maker of artificial joints, the price was the biggest
surprise: a rich four times sales in an industry that typically
produces no more than single-digit rates of growth. While
Stryker is buying Howmedica for a less dramatic 2.3 times 1997
sales, that's still more than medical products makers were
fetching until recently.
''DePuy will trigger a revaluation of other medical-
supplies companies,'' said Beat Buob, who manages 650 million
Swiss francs ($429 million) in shares at Julius Baer Asset
Management in Zurich.
Companies valued on such high sales multiples are usually
to be found in the faster-growing drug sector. Like real estate
brokers rushing to raise house prices when adjacent homes are
sold for unexpectedly high prices, analysts quickly raised their
valuations of similar companies.
Customers Want Discounts
Orthopedic-products companies, analysts say, are caught in
the same squeeze that forced dozens of drug companies into a
merger and acquisition craze beginning late last decade.
Investors are demanding higher growth rates to justify high
valuations, while ever-larger customers like hospitals are
demanding heavy price cuts in return for sales contracts.
Many predict the result will be a spate of corporate
marriages in the industry that makes products ranging from
artificial hips and knees, wound treatment devices and equipment
for minimally invasive, or ''keyhole,'' surgery.
For companies big enough to prosper, the attraction of the
market is that aging populations in developed countries are
expected to ensure increasing demand.
''The consolidation is only at the beginning,'' said
Michael King, an analyst at SG Securities in London. ''You'll
see more pressure from hospitals and surgeons for one-stop-
shopping, and you have drugmakers that want to get out of the
business.''
Even before last week's sale, Pfizer, the U.S.'s second-
largest drugmaker behind Merck & Co., already agreed to sell two
medical-products units. In July, it said it would sell its
American Medical Systems unit, which makes devices to treat
incontinence, for $130 million to E.M. Warburg, Pincus & Co. A
month earlier it agreed to sell its Swiss-based Schneider
Worldwide division to Boston Scientific Corp. for $2.1 billion.
Spinoffs
Drugmakers including Eli Lilly & Co. began spinning off
their medical-devices businesses in 1994, but the Johnson &
Johnson purchase price changed the landscape because it offered
much more than anyone paid for an orthopedics maker.
When American Home Products Corp. sold its medical-supplies
unit Sherwood-Davis & Geck last March, for instance, Tyco
International Ltd. paid $1.77 billion cash for the unit that
generates sales of about $1 billion a year. It sells catheters
and other products.
With Stryker's purchase of Howmedica nearly doubling its
size, the Kalamazoo, Michigan-based company will become one of
the world's biggest makers of devices to repair injured joints
and bones. The company, already the world's fifth-biggest maker
of orthopedic implants, said it will have a 15 percent share of
the global orthopedic market with Howmedica.
''They will be an 800-pound gorilla,'' said Robert
Faulkner, an analyst at Hambrecht & Quist. ''They will have
secured their future in the orthopedics industry.'' Faulkner has
a ''buy'' rating on Stryker's shares, though he said there is a
degree of risk in the acquisition because it will be expensive
to integrate Howmedica.
U.K. medical-products maker Smith & Nephew Plc may be the
next to make the news.
Merger Candidate
Analysts have tipped the London-based company as a
potential merger candidate after it faced serious setbacks with
a promising artificial skin that it is developing with San Diego-
based Advanced Tissue Sciences Inc., analysts said. Dermagraft,
which some analysts said could generate $500 million in annual
sales by 2004, was rejected in June by. U.S. regulators, who
said more testing was needed. Now London-based Smith & Nephew
probably won't have the product on the market until 2000.
The DePuy sale price prompted SG Securities analyst Alyson
Coates to raise her rating on Smith & Nephew to ''hold'' from
''weak hold'' while analyst Steven Abbott at Credit Lyonnais
Securities raised his rating to ''hold'' from ''sell.''
''What we are really seeing is the start of a major
consolidation in this industry,'' said Coates.
Chris O'Donnell, Smith & Nephew chief executive, said while
the Johnson & Johnson move ''sent shockwaves through the
industry,'' he said the company isn't worried about being a
takeover candidate. ''Any company is at risk of being taken
over, but we think it's unlikely we will be.''
Acquisition Opportunities
O'Donnell said the shakeout is likely to lead to
acquisition opportunities. ''We have been saying for a while we
think consolidation is likely to occur,'' said O'Donnell. ''I
think that is going to shake some fruit off the trees.''
Bill Blair, an analyst at Robert Fleming Securities, said
Smith & Nephew should try to expand to build market share to
offset sluggish growth.
''To get some impetus behind this stock, they need to make
a fairly significant acquisition in a growth area,'' said Blair.
''The basic problem is that the markets they operate in are
highly competitive with little scope for technological
breakthroughs.''
If Smith & Nephew is on the lookout for acquisitions, it
may find itself competing with Switzerland's Sulzer Medica AG,
which engineering company Sulzer AG listed as a separate entity
last year to allow it to focus more on the medical-devices
business. Pfizer, questioned before it announced its agreement
with Stryker last week, said Sulzer Medica was also considered
to be a contender to buy the Howmedica unit.
Units Up for Sale
Sulzer Medica continues to refine its own product range. As
it concentrates on orthopedics and cardiovascular prosthetic
products, it is trying to sell Intermedics, its struggling
pacemaker unit, and Osypka, a unit making catheters. Together
the two units account for one-third of Sulzer Medica's sales.
Drug companies, which in the 1980s bought into the medical-
supplies market to broaden their reach and benefit from high
growth, are mostly moving out of the area to focus on their most
profitable business of selling drugs. Margins in orthopedic
products are shrinking amid government-imposed health cost cuts.
The ones who keep their businesses such as Johnson & Johnson
have to invest billions of dollars to buy market share and
extend their product ranges.
''Roche realized that it would have to make further
acquisitions to make DePuy a core business,'' said Plinio
Zanetti, a fund manager and analyst at Bank Leu AG.
While DePuy has a leading market share in spinal implants -
- it lags only Sofamor Danek Group Inc. of the U.S. in sales --
Roche would have had to make further purchases to increase
Warsaw, Indiana-based DePuy's sales of trauma devices, for
example, in which it has a market share of only 5 percent.
Trauma devices include plates and screws to reassemble bones.
--Reto Gregori in the Zurich newsroom (411) 224 4111 and Dane
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