A New Year – Must Be Time For an S&N Takeover Rumour

This week’s widely reported rumors that Johnson & Johnson had made a takeover approach for UK-based Smith & Nephew shows that whilst we may have a new year upon us some things never change. The question is will this finally be the year that things happen?

Ever since the orthopedic market decreed that size does matter and that S&N just doesn’t have the scale to survive on its own globally, speculation has ebbed and flowed in time with the seasons about the company’s future. The latest rumors appear to be no different and all represent very plausible plots. Guessing the one that does happen is another thing entirely.

Leading the market rumor columns this week has been fever pitch speculation that J&J’s hotly-contested battle with Zimmer in the worldwide orthopedic markets has led to an opportunistic takeover approach for S&N that was swiftly rebutted by the latter. Denials of any dealings were formally issued by both management teams but that didn’t stop a market – thirsty for a megadeal deal to kickstart 2011 – from driving up S&N’s shares by over 10 percent in just one day of trading.

When the J&J rumor died down, it was time for another suitor to return from a hiatus – a possible offer from private equity-owned Biomet. This one at least has some traction. S&N almost merged with Biomet a few years ago but was outbid by a private equity consortium but whether the two companies would still want each other – and be allowed to do so – is a moot point. Medtronic is another party that has been named as a potential suitor, although they seem to be more focused on expanding their cardiovascular business rather than achieving sizeable growth in orthopedics.

And then there’s the hotly anticipated return of the private equity market, a sector that was so massively wounded by the credit downturn over the last few years. Billion-dollar bids have been relatively scarce in all markets, let alone orthopedics, but there are signs that investors are slowly returning to the fold. Could this be the deal clincher?

So why is S&N the focus of such unrelenting attention? Well for some of its rivals it represents a chance to secure market leadership or solidify their position as a worldwide player. For all its perceived faults, the company continues to record strong revenues from orthopedics, wound care, and endoscopy, and enjoys strong growth margins in both the US and Europe. It’s also shown itself to be highly resilient. Europe’s largest medical device group has survived the blow of losing out to successive battles with Zimmer and private equity groups for Centerpulse and Biomet, respectively, as well as the retirement of its talisman, Sir Christopher O’Donnell in 2007. It even sorted out the debacle of its Plus Orthopaedics acquisition intact.

In the cold light of the day, however, is this the right time to pounce on S&N anyway? Indeed, there are clear antitrust issues with most of the companies that have looked at S&N. It’s doubtful that either Zimmer or DePuy would be allowed to swallow S&N whole, whilst other companies like Stryker overlap S&N in areas such as Endoscopy and would face scrutiny too. With all the major orthopedic companies (including S&N) treading a fine line with authorities overselling practices in the industry is it worth tackling with authorities in both the US and Europe at this moment?

And the regulatory climate isn’t going to be as easy to negotiate as it used to be, particularly as UK observers have suddenly woken up to the comparative ease at which UK companies have been picked off by foreign predators. The UK government is under increasing pressure to make it a little bit harder for US companies to take over the remaining crown jewels of UK business. Already much of the gain in S&N’s share price over the five days since the media attention reached a fever pitch has been lost as reality sets in that it may not be a good time for a US company to swallow up another top UK company.

So whilst J&J may indeed have eyes on S&N it remains to be seen whether the two companies are on course for an inevitable tie-up. It’s probably more likely that if J&J does go for S&N it would be in a defensive manner – similar to the way it sought to defend its share of the cardiovascular market when it got involved with the battle with Boston Scientific for control of Guidant. In that case, J&J used its hefty cash resources to force Boston Scientific into paying well over the odds for the Guidant business and saddling its rivals with a hefty debt burden it’s still trying to shake off to this day. A far-fetched scenario? Well, anything can happen in the orthopedic industry, but it would certainly prefer to have S&N to itself rather than see a combined Biomiet/S&N or ambitious private equity group emerge as another major rival.

All this is itself speculation and shows that, as far as S&N is concerned, anything could happen and the story finale is still to be written. One can’t help but feel that the well-thought-out plots of the speculators, whatever they may be, will turn out to be half as exciting as the actual ending. It certainly shows that being an S&N shareholder is not an uninteresting past-time and that such speculation will keep on occurring, whatever the denials that are issued.

Becky Kim