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Thursday, 25 December 2014

Either or

U.S. investors see yet another big acquirer as hip

U.S. investors are seeing yet another big acquirer as hip. Zimmer’s $13.4 billion deal for rival Biomet promises savings. But the maker of knee and other joint replacements and other medical devices is giving too much away for that to justify a 15 percent, or $2.3 billion, pop in its market value, before the stock slipped back slightly in Thursday morning trading. This time, enthusiastic share buyers are betting on growth.

Biomet earned about $1 billion of EBITDA, as adjusted by the company, in the year to last May, according to an initial public offering prospectus filed in March. The adjusted definition leaves out some fairly normal business expenses, such as stock-based compensation and litigation costs. But taken at face value and put on the same multiple as peers, it suggests the Biomet enterprise may be worth about $11.5 billion.

Zimmer thinks the deal should yield about $270 million of annual savings. Taxed and capitalized on a multiple of 10, these are worth almost $2 billion in present value terms. On paper that covers the extra value Zimmer is paying over to Biomet’s private equity owners Blackstone, KKR, TPG and Goldman Sachs. But it doesn’t explain why the acquirer’s value rose sharply.

Over the past six years, buyers in M&A deals have met a mixed reception, with their stock going up only about half the time, according to Thomson Reuters data. Lately, though, the market has been kinder. This year, there have been 34 U.S. deals worth more than $1 billion. The acquirer’s stock has gone up in three-quarters of these situations. Fairly sensible dealmaking is one reason, hefty cost savings are another. This time, though, investors and Zimmer’s managers are more excited about growth.

As Zimmer said during its conference call, hospitals are consolidating and using fewer vendors to save money. Buying a big competitor will give Zimmer more sway in negotiations as well as broadening its product range. The company thinks as a result of this merger it will expand at the same pace as the market over the next few years and then faster once it fully incorporates Biomet.

Growth from mergers is not, however, as bankable a promise as cost savings. The warm reception for Zimmer’s deal suggests a sense of optimism among investors. That in turn probably means more deals are coming.

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U.S. medical device maker Zimmer said on April 24 that it had agreed to buy rival Biomet in a deal valued at $13.35 billion, including assumed debt. Biomet was taken private in 2007 for $11.4 billion by a consortium of private equity owners including Blackstone, KKR, TPG and Goldman Sachs. Biomet, which in March filed for an initial public offering, had sales of $3 billion and an operating loss of $165 million in the year to May 2013. Revenue has increased on average by 4 percent per year over the past four years.

Zimmer will pay $10.35 billion in cash and will issue $3 billion of common stock to Biomet’s equity holders. At closing, Zimmer stockholders are expected to own approximately 84 percent of the combined company, and Biomet shareholders are expected to own approximately 16 percent.

The cash portion will be funded by Zimmer’s existing cash and the proceeds of a newly committed $3 billion senior unsecured loan and newly issued senior notes.

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