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Would a NuVasive Deal Make Sense for Smith & Nephew?

Would a NuVasive Deal Make Sense for Smith & Nephew?
Wall Street is abuzz with speculation that Smith & Nephew may be looking at NuVasive as a potential M&A target, but medtech analysts point out several reasons why such a deal just doesn't make sense for the larger orthopedic device company.
NuVasive has been in the news this week after it was reported that Smith & Nephew was interested in acquiring the company for more than $3 billion. Neither company has officially commented on the rumored deal.

Smith & Nephew is no stranger to the rumor mill. Deal rumors have swirled around the London-based medical device firm for years, only this time Wall Street is abuzz with speculation that Smith & Nephew is targeting NuVasive for more than $3 billion.

Financial Times (FT) reported the potential deal Friday. Neither company has officially commented on the rumored deal. Financial analysts, on the other hand, have been quick to offer their take on a potential tie-up between Smith & Nephew and NuVasive.

Needham & Co.'s Mike Matson noted in a recent report that NuVasive would fit well with Smith & Nephew because Smith & Nephew is a diversified orthopedics company that lacks a spine business and NuVasive is a pure-play spine company. On the other hand, Matson said he does not believe that such a deal would be all that accretive to Smith & Nephew's revenue growth or earnings per share.

"And we're not sure it makes sense for [Smith & Nephew] to use all of its 'dry powder' on a deal that isn't going to increase its revenue growth much," Matson said in his report.

He also pointed out that investors might question the larger company's desire to enter a low-growth market by acquiring a company that has seen its growth slow significantly in recent years.

Canaccord Genuity medtech analyst Kyle Rose also weighed in on the speculation. Rose said the FT report caught him off guard Friday, not by the idea of M&A but by the idea that Smith & Nephew would use nearly all of its acquisition bandwidth on a spine acquisition.

"Regarding the materiality of this deal report, at first blush, we do not find the potential of such a marriage to be compelling particularly given the potential for it to be disruptive to the turnaround in both commercial performance and investor sentiment," Rose noted. "That said ... we think it's a good excuse to dust off our crystal ball, dig into our M&A model, and provide our thoughts on what this acquisition may look like."

Rose played both sides of the coin, providing reasons the deal may make sense as well as reasons the deal does not make sense.

One one hand, the analyst noted, Smith & Nephew management went out of its way during the company's fourth-quarter earnings call to let investors know its intent to ramp up M&A activity. The company also noted it was not restricting M&A to the existing $40 billion end-markets it currently competes in but would also evaluate the broader $400 billion medtech market, Rose reported.

Another factor favoring the potential deal is the fact that Smith & Nephew's CEO has a strong background in spine as he previously led Johnson & Johnson's Dupoy's global spine business. And interestingly enough, Smith & Nephew's new president of orthopedics, Skip Kiil, was most recently the head of global commercial at NuVasive.

Canaccord medtech analysts have long viewed NuVasive as a top asset in the mid-cap space with a strong commercial position and long-term operating prospects. Rose also pointed out that spine is a focus of every orthopedic device player except Smith & Nephew, and looking at the U.S. market, he said Medtronic, Johnson & Johnson, and Stryker currently capture the top three share positions followed closely by NuVasive. 

On the flip side, Rose said the speculated deal is "a bit too big" for his liking. Even though Smith & Nephew has clearly stated its intent to be acquisitive and the balance sheet has room for a large acquisition, the analyst said a series of progressively larger acquisitions would position the company for better success. Large M&A transactions in the space have been challenging, Rose said, pointing to the 2012 acquisition of Healthpoint for about $800 million and the $1.7 billion acquisition of Arthrocare in 2014 as examples of deals that did not live up to medium-term expectations.

"We believe accelerating fundamental execution in existing core markets will create more value over the medium-term than the risk/reward presented by a large, transformative acquisition and entry into an entirely new market," Rose said.

The rumored deal is also "a bit too soon" for his liking. 

"While the new CEO was clearly brought in to turnaround the organization with an eye toward M&A, we would be surprised to see him use nearly all of the allocated M&A bandwidth on a spine acquisition just seven months into the seat," Rose said. "What's more, we remind investors that the previous CEO had stepped away from the business for an extended period of time and the search took nine-plus months for a replacement, meaning it likely took time for the M&A/diligence/screening activity to pick back up again when the new CEO took over, which again reinforces our view that the timing doesn't feel right here."

Another strike against this deal, in the analyst's opinion, is that the spine market doesn't seem to check the right growth boxes. A key point of Smith & Nephew's turnaround philosophy is to bring the corporate growth rate in-line with its current end markets, about 4%, and use M&A to diversify into faster-growing market segments," Rose said. While NuVasive is growing in the range of 5% to 7% year-over-year, Rose said the broader spine market is growing in the range of 1% to 3% and he does not believe the target company provides the growth exposure Smith & Nephew seems to be aspiring toward.

"What's more, spine deals are notoriously challenging given the importance of the distributor/customer relationship and disruption caused in the commercial channels during integration," Rose said. "On the positive side, [Smith & Nephew] does not have an existing spine business which lowers the risk of integrating a sales force, but the spine market, and the distribution channels therein, are both culturally and structurally different than [Smith & Nephew's] existing recon/sports/trauma organization, which may impact [Smith & Nephew's] ability to capitalize on operational leverage objectives in the early period post-acquisition."

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