Merger Mania Strikes Device Industry

Medical Device & Diagnostic Industry Magazine | MDDI Article Index

Originally published January 1996

Greg Freiherr

Rapid consolidation of medical device companies is changing not only the number of industry players, but also the roles they will play in the future. In the past 12 months, Johnson & Johnson (J&J; Brunswick, NJ) has demonstrated a voracious appetite, acquiring four medical device companies. Its most recent prey was the cardiac and interventional products manufacturer Cordis (Miami). Similarly, in its quest to become a single source for minimally invasive cardiovascular products, Boston Scientific Corp. (Watertown, MA) has made deals for six companies since August 1994. Among other medical device deals made in the past year were two each by Medtronic (Minneapolis), Picker International (Highland Heights, OH), and Sterile Concepts (Richmond, VA). According to industry experts, the consolidation has only just begun.

"In the next 18 months not only should we see continued consolidation, but I think it is essential," says Jack Cumming, senior partner and president of WDI Capital Markets, a health-care advisory and investment banking company on Hilton Head Island, SC. "There should be a score of acquisitions happening."

Cumming believes the current fever has been prompted by managed care's unprecedented consolidation of providers, most notably the acquisitions made by Columbia/ HCA (Nashville, TN) and the merger of hospital chains such as NME and AMI to form Tenet Healthcare Corp. (Santa Monica, CA). "As provider purchasing has been put in fewer hands, the size of the contracts has gotten larger. That means that the smaller, even best-of-breed manufacturers are having a harder time competing against the larger companies," Cumming explains.

Many companies have responded by creating larger, more diversified companies, choosing one of two routes--merger or acquisition (see Table I). "You see a lot of the larger companies involved in these recent mergers," says Thomas Gunderson, medical device analyst for Piper Jaffray, Inc. (Minneapolis). "There are two trends that go along with the involvement of these major players. The obvious one is that they are trying to leverage sales and marketing and product breadth to come into the larger hospitals that have also merged and be on a more equal footing. The second trend-- especially in the case of companies like Boston Scientific--is that they are taking advantage of the world market. Boston Scientific's merger with SciMed [Maple Grove, MN] opened a top-notch distribution system in Europe and Japan. The rest of Boston Scientific's mergers will get leveraged in," Gunderson explains.

Mergers are virtually always friendly, because they are forged among two or more companies of relatively the same size. Typically, no single company in the deal has access to the deep pockets necessary to finance a battle for control. Acquisitions, however, involve a large company absorbing a smaller one. These acquisitions are often friendly, as happened November 6 in the cash acquisition by Marquette Electronics (Milwaukee) of E for M Corp. (Torrance, CA). But sometimes a company launches a hostile takeover, as in the case of J&J's acquisition of Cordis. On October 19, J&J offered a $100-per-share cash buyout or $105 stock swap. Initially Cordis was not interested and began erecting defensive measures to keep J&J at bay, measures that included a poison pill defense.

J&J countered with a threat to solicit written consents from shareholders to remove and replace the Cordis board to effect the merger. In defiance, the board issued a statement November 1 that its directors had voted unanimously to reject both the cash and stock swap offers. Then, five days later, after J&J increased its offer by just 4%, the Cordis board reversed its position and accepted the merger. "On the whole, the industry does not favor hostile takeovers," Cumming notes. "But J&J has a very strong interventional group; they are a well-managed company."

Cordis was the most recent in a string of J&J acquisitions in 1995, which included Menlo Care, Inc. (Menlo Park, CA), a vascular access products company; Mitek Surgical Products, Inc. (Westwood, MA), and Joint Medical Products (Stamford, CT), a developer and marketer of hip and knee prostheses.

TAKING THE BAD WITH THE GOOD

The current wave of consolidations promises to transform the industry both negatively and positively. Some industry analysts fear that creativity will be the sacrifice. Nimble innovators acquired by large corporations must operate in large corporate structures, which are traditionally antithetical to innovation. Although the architects of at least some consolidations try to maintain the structure of the acquired company and thereby preserve the innovative spirit that made it attractive, the acquired company is inevitably saddled with new paperwork and protocol.

Another victim of merger fever is often the workforce, especially middle managers, administrators, financial and regulatory staff, and salespeople. "Layoffs are almost always the aftermath of these things," Cumming says. But not in every case. In its acquisition of Associated Medical Products (AMP; Minnetonka, MN) and Medical Device Concepts (MDC; Temecula, CA), Sterile Concepts gained access to production facilities in the upper Midwest and western United States. "The products they made were virtually identical to what we made; they just had different customer bases," says Randy Graham, vice president of administration and CFO at Sterile Concepts. By shifting production to these other facilities to meet regional demand, Sterile Concepts has been able to cut shipping costs. The company no longer sends trays from its Virginia plant to Minnesota or California, just as AMP and MDC facilities no longer ship products to the East Coast. "By the time we finish rationalizing our business between the various facilities, we will probably see production volume increase by 30­40% at the Temecula facility, so we will probably increase the staffing there on the manufacturing side," Graham says.

The acquisitions markedly expanded the company's market share, first from 13 to 16% with the acquisition of AMP and then to 19% with the takeover of MDC. Increased market share allows for economies of scale. Streamlining produces cost savings, and the acquisition of complementary products expands the product line, giving the sales staff more to offer. And intangibles come along with acquisitions and mergers. Size conveys respectability and--perhaps most important in an uncertain market--credibility in the eyes of prospective customers, a belief that the company will successfully ride out storms that come over the horizon.

Last April, when Raytheon (Lexington, MA) agreed to purchase E-Systems (Dallas) for $2.3 billion, the package included E- Systems Medical Electronics (E-Med), a vendor of medical image management systems. Don Alvarez, E-Med's director of marketing and Pacific Rim sales, was happy about the acquisition. "It's going to help me do what I want to do," he said. Being part of a huge company with deep pockets provides E-Med with the credibility that many companies in the teleradiology and picture archiving and communications systems (PACS) field lack, Alvarez explained.

Just as consolidations are changing individual companies, they are also shaping the device industry as a whole. Along with the concept that bigger is better comes the exploitation of this new size and technological breadth. Companies are placing a new premium on offering comprehensive solutions to customer needs. Corporate consolidation means the consolidation of installed bases and the potential for efficiencies in providing service to customers. Efficiencies in distribution and broader product lines mean less-costly products and more comprehensive, cross-technology purchases for hospitals and clinics.

By merging with an international company, a small firm can expand globally, using the distribution channels of the new parent. Consolidations are attractive to large corporations because they give them a cost- effective opportunity to expand their product lines. Acquiring existing products enables companies to avoid committing time and money to R&D and getting regulatory approval.

BUYING BENEFITS

Within this broad outline of opportunities exist key criteria that are often considered deal makers or breakers. For a large company, a merger or acquisition often must provide an increase in market share or produce manufacturing synergies and efficiencies. For a small company, a major benefit is often expanded distribution. But the parent company can also benefit. In its acquisition of E for M Corp., which primarily markets cardiac diagnostic equipment, Marquette Electronics picked up a subsidiary of E for M, Germany-based Hellige GmbH. The German outlet enables expanded product distribution in Europe.

Distribution channels established by a large company can provide benefits in other ways, especially if unique or innovative products are involved in the acquisition. On November 2, Medtronic acquired Micro Interventional Systems (Sunnyvale, CA), a small company that had distinguished itself for the development of catheters that are the diameter of a standard paper clip and that can be threaded into blood vessels in the brain to treat blockage and vascular malformations. William W. George, Medtronic president and CEO, described the acquired company as a "top emerging interventional neuroradiology company with growing sales worldwide and a solid reputation in the treatment of stroke."

Earlier in the year, Medtronic had acquired PS Medical (Goleta, CA), a manufacturer of shunts for removing excess cerebrospinal fluid from around the brain. As with the products from Micro Interventional, Medtronic plans to use PS Medical shunts to broaden its offerings in the neurological business. Medtronic will maintain the sales forces of both companies, because their representatives have the expertise to sell to and open these markets. "These are sales forces very focused on niche markets, so you are not going to shoot yourself by getting rid of the people who sell these products," Cumming notes. "Cross training the parent company's sales force only works to a certain degree."

Alternatively, the union of Scinticor (Milwaukee) and global power Picker International exemplifies how using the sales force of a larger company can strengthen the sales of an innovative technology. The deal, which was signed September 21, brought to Picker a unique nuclear medicine system called the SIM-400, opening the door to a market previously outside the company's reach, according to Josh Gurewitz, Picker marketing manager for nuclear medicine. "Standard gamma cameras don't count fast enough to do these types of studies," Gurewitz says. "So now anyone interested in doing accurate, quantitative first-pass cardiac exercise studies needs to look at the Scinticor device--from Picker."

Despite the advantages of the technology and its modest price of around $200,000, the product has struggled in the marketplace. Fewer than 200 have been installed in the United States and fewer still have been sold internationally. The reason, says Gurewitz, is that Scinticor had neither the sales force nor the distribution channels necessary to promote the system adequately. Picker, he says, will change that.

Because Scinticor stock was privately held by individual and corporate investors, the details of the deal are confidential. Mergers among publicly traded companies are more open to exploration and more common, because stock prices of these companies have been depressed in recent years.

TAKING STOCK

Low stock prices have made it easier for large companies to make overtures to shareholders for control of target companies. Conversely, a low stock price can be a disincentive to buy a company. Sterile Concepts had seen its stock plummet from the high teens in late 1994 to just over $10 a share last summer. But that did not stop the company, which in the past year acquired two competitors in the custom procedure tray business--both for cash. "Our stock price was trading for such a low multiple that both of these transactions, had they been done for stock, would have been diluted," Graham says. "But we have a very strong balance sheet and we had substantial leverage capacity through our credit line."

Stock trades, however, offer many advantages. One is the tax-free exchange of assets. Another is that exchanging stock preserves capital. In some cases, mergers accomplished by stock swapping are extraordinarily equitable, as in the case of the union between Tokos Medical Corp. (Santa Ana, CA) and Healthdyne Technologies (Marietta, GA). The $300-million merger, scheduled to have been completed before the end of 1995, was accomplished with a one-for-one exchange of shares, which was possible because both companies' stocks were trading at about $10 at the time of the deal. "But what really drives the transaction are the strategic objectives of both companies and their belief that coming together makes sense from a marketing and a financial perspective," says Bob Byrnes, Tokos chairman and CEO.

Both companies are involved in the home-health-care market with a specialty focus in obstetrics and specifically in identifying and managing obstetrical cases. The companies also complement each other. Tokos's strength is working with managed-care organizations; Healthdyne's expertise is in the management of a growing business.

Once it was clear that a merger would be in the best interests of both companies, the question arose as to how to structure the deal. Basing the merger on a stock swap, Byrnes says, was important because "we both believe in the future and upside of the company, and we wanted our shareholders to participate in that upside."

The use of stock swaps to fund mergers starkly contrasts with the leveraged buyouts (LBOs) that were in vogue during the 1980s. LBOs often saddled the acquiring company and shareholders with enormous debt or required the consolidated company to sell off assets after taking the company private. Either result could impair the company's performance and require an increase in product prices--a death knell for any company in today's cost-conscious marketplace.

STAYING POWER

In a marketplace that is demanding more from its vendors and their equipment, particularly capital equipment, the staying power of a company has become one of the top considerations when hospitals and clinics contemplate making purchases. One indicator of that staying power--and the vendor's commitment to the customer--is market share. Not surprisingly, some companies have given a great deal of weight to that factor in their decision making.

Thermotrex (San Diego) acquired Bennett X-Ray (Copiague, NY) in October as part of a corporate strategy to dominate the mammography marketplace. Thermotrex kicked off this strategy in November 1992 with the acquisition of Lorad (Danbury, CT), a leading vendor of mammography equipment. The acquisition of Bennett X-Ray thrust the company into the role of undisputed market leader. "In number of mammography units, it would probably be double the next closest competitor, which would be GE," says Cumming.

French nuclear medicine company Sopha Medical Systems, Inc., put an international twist on the market share theme with its acquisition last spring of Summit World Trade, parent company of Summit Nuclear. The two companies merged after about six months of negotiation. The new combined company holds a 20% share of the worldwide nuclear medicine equipment market and has combined annual revenues of approximately $100 million, with an installed base of about 1400 gamma cameras and 2500 nuclear medicine computers.

MAXIMIZING MARKET SHARE

There is no better way to advance market share than to add a truly complementary line of products. Cordis angioplasty devices, for example, open coronary arteries; J&J stents keep them open. In a letter to Cordis chairman, president, and CEO Robert C. Strauss soon after the takeover bid was announced, J&J chairman and CEO Ralph S. Larsen stated that the combination of the two companies "will allow us to provide a comprehensive line of superior products and services. . . . In light of customer preferences for broad-line suppliers, this combination will protect and enhance both companies' leadership positions while allowing for more powerful product offerings."

The complementary fit of Cordis and J&J products is immediately evident. But the pairing of products from device company Medrad, Inc. (Pittsburgh), and drug company Schering AG (Berlin, Germany) is less obvious--yet viable. From the merger, Schering AG hopes to gain an advantage over its competitors by packaging its contrast media with Medrad's disposable syringes to create a simpler, more efficient administration system. The company believes that providing customer-oriented, value-added services could be a decisive factor in future sales in the heated contrast-media marketplace.

The complementary fit of companies does not have to be defined purely by hardware. As the marketplace demands more from vendors than simply products, OEMs are growing increasingly interested in the expertise and service skills held by companies that do not sell products. That was the case in mid-1995 when Picker International selectively bought the service organization and refurbishment assets of LINC Equipment Services (Lincolnshire, IL), a leading supplier of refurbished medical imaging equipment. "This is our first step in the development of a broad array of multivendor asset-management offerings that we are going to present to the marketplace," says Bob Trebar, manager of business development and marketing for Picker service. The acquisition, finalized April 14, put Picker in a position to provide service coverage for any medical imaging equipment. "LINC's service engineers are now part of Picker Technology Services," says Douglas Cooley, vice president and general manager of Picker service.

In making the deal, Picker was responding to its competition, namely GE Medical Systems (Milwaukee), which had just won a huge contract from Columbia/HCA to provide asset-management services to the hospital chain's 200 members. The Picker acquisition of LINC assets is only the beginning of a strategic effort that will continue to unfold and that will include making asset management part of the Picker product offering. As part of that offering, customers will receive advice about managing their installed equipment.

PRODUCT POTENTIAL

Advanced NMR (Waltham, MA) went even further in the direction of making its products and service more appealing. The maker of niche magnetic resonance systems bought a customer--Medical Diagnostics, Inc. (MDI; Burlington, MA), a mobile equipment and management service firm that provides magnetic resonance and some nuclear medicine imaging services to small and midsize hospitals. What Advanced NMR gets from the deal is a solution to a dilemma that typically plagues R&D companies--how to get exposure for its products. "MDI is the vehicle that will give us that exposure," says Jack Nelson, chairman and CEO of Advanced NMR. As the company's products, including a mammography system based on magnetic resonance imaging, emerge from R&D and obtain FDA approval, Nelson plans to send them on mobile trailers to MDI customers. "I want to be able to show that I have been to 40 hospitals in Massachusetts and the northeastern region and here are the results," he says. "I am going to go to hospitals throughout the country and say, 'We've taken our products to all these hospitals. Look at what we have done.'"

As structured, the merger between Advanced NMR and MDI promises to encourage the introduction of new products. More commonly, however, mergers have the potential for fostering the opposite. This fact, along with concerns about maintaining a competitive environment, was one of the reasons the Federal Trade Commission (FTC) examined so closely the proposed purchase by Boston Scientific of both SciMed Life Systems, Inc., and Cardiovascular Imaging Systems, Inc. (CVIS; Sunnyvale, CA). The CVIS acquisition was valued at nearly $100 million, the SciMed acquisition at more than $850 million.

The FTC apparently was most concerned by the proposed CVIS acquisition, because combining the two companies might be anticompetitive. Boston Scientific and CVIS held commanding shares of the worldwide intravascular ultrasound (IVUS) market. The deal, which had been delayed three times since it was proposed on August 31, 1994, purportedly to give the FTC more time to conduct its investigation into the transaction, was allowed to go through when Boston Scientific agreed to license IVUS technology to a third party--Hewlett- Packard Co. (Palo Alto, CA). Other recent acquisitions by Boston Scientific include Meadox Medicals, Inc. (Oakland, NJ), a manufacturer of vascular replacement products that have potential for cardiovascular applications; Heart Technology (Redmond, WA), which makes rotational atherectomy systems; and EP Technologies (Sunnyvale, CA), which makes radio-frequency catheter systems for the therapeutic ablation of nerve tracts associated with cardiac arrhythmia.

CONCLUSION

Critics of the current acquisition trend worry that innovation could be snuffed out if small companies are seen as little more than bait for big fish. "That is always a risk," Cumming says. "Smart management recognizes that the new guys don't fit operationally, culturally, or philosophically, but they are left alone because they come up with great products. But some people can't help but tinker and soon what they bought turns into a mess."

The same forces that threaten innovation, however, also encourage it. The interest in buying companies for their new technologies or expertise is an incentive for entrepreneurs to establish new companies, knowing that pioneering ideas will be attractive to large suitors a few years down the road. "For small companies with good ideas, there is a lot of venture money out there," Cumming says.

In the end, Cumming believes that the interest in merging being expressed by increasing numbers of companies is inevitable for the medical device industry. "It is a function of the landscape of the health-care market today," he says. "We are moving toward large integrated networks of providers. With fewer customers, there will be fewer companies that sell these products."