ArthroCare Bid Signals Ortho Consolidation

If completed, Smith & Nephew’s acquisition of ArthroCare would help it diversify into the ENT market, but the deal may not get done as analysts speculate that competitors Stryker and J&J could step in with counteroffers. But the interest surrounding Austin, TX-based ArthroCare emphasizes the pressures being put on large joint makers to find new ways of making money in orthopedics.

Pricing pressures on hip and knee implants in the US and Europe continue to drive manufacturers to find ways of diversifying their sales streams or distinguishing themselves from their competitors. Smith & Nephew PLC made the latest move with a $1.7 billion offer to acquire ArthroCare Corp.[See Deal]If completed, the purchase would expand Smith & Nephew’s sports medicine business while helping it diversify into the ear, nose, and throat market. The deal may not get done as analysts speculate that competitors Stryker Corp. and Johnson & Johnson could step in with counteroffers. But the interest surrounding Austin, TX-based ArthroCare emphasizes the pressures being put on large joint makers to find new ways of making money in orthopedics.

Hip and knee makers are struggling against the downward price pressure brought on by the Affordable Care Act in the US and similar pressures in Europe. The response in recent years had been to establish inroads in emerging markets like China either through the development of distributor relationships or acquiring homegrown companies as Stryker and Medtronic PLC did with their acquisitions of Trauson Holdings Co. Ltd. and China Kanghui Holdings, respectively.[See Deal][See Deal] (See (Also see "Stryker Enters China Race With Trauson Bid" - In Vivo, 22 Jan, 2013.).) Smith & Nephew itself put together a string of smaller deals including two in Brazil where it acquired a share of wound care distributor Politec Saúde in November, and sports medicine, orthopedic reconstruction, and trauma distributor Pró Cirurgia Especializada. It also bought certain assets of its Turkish orthopedic and endoscopy products distributor, Plato Grup, in July; and in May, S&N agreed to purchase Indian company Sushrut Surgicals, which targets the mid-tier trauma market. (See (Also see "Acquisitions Signal Smith & Nephew’s Emerging Market Strategy" - In Vivo, 23 May, 2013.).)

With emerging market options largely exhausted, hip and knee manufactures could begin moving toward broadening their own offerings in domestic markets. Stryker’s decision to pay $1.4 billion for robotic surgical maker MAKO Surgical Corp. made such a point, giving the company a unique product to market to hospitals that buy its implants. [See Deal] Matt Miksic, managing director and senior research analyst at Piper Jaffray, says he’s been “struck” by how much enthusiasm he’s noted in large joint makers keen on adding similar technologies. “I think whether it’s robotics or customization of implants, the interest in those things is going to continue to ramp up,” he says. He points to deals that Biomet Inc. and Zimmer Biomet Holdings Inc. signed with OrthoSensor Inc. for technologies that allow surgeons to better see how well implants and soft tissue are balanced.[See Deal][See Deal]

Smith & Nephew’s acquisition of ArthroCare represents another approach, finding faster growing industries related to orthopedics. Wright Medical Group NV, for example, sold off its hip and knee business to Shanghai-based MicroPort Scientific Corp., to focus on extremities and orthobiologics. [See Deal](See (Also see "MicroPort’s Wright Bid Creates New Ortho Player" - In Vivo, 25 Jul, 2013.)and (Also see "Can MicroPort Master Orthopedics?" - In Vivo, 19 Feb, 2014.).) ArthroCare develops and markets products based on its Coblation radiofrequency tissue removal technology for sports medicine, ENT, and other markets including spine, wound care, urology, and gynecology. In a conference call with analysts, Smith & Nephew executives highlighted the potential synergies between the Coblation device for resection procedures and S&N’s mechanical resection blades. The company also pointed to the complementing strength of ArthroCare’s shoulder knotless suture anchors and S&N’s joint repair offerings.

“To give you an idea of how this all comes together, a surgeon performing a rotator cuff procedure in the shoulder might typically use a Smith & Nephew blade or bur to resect the bulk of the soft tissue, or bone,” said Mike Frazzette, president of S&N’s Advanced Surgical Devices unit. “Then, possibly, an RF wand would also be used, in conjunction with the mechanical resection, to control bleeding and augment structural soft-tissue shaping, shrinkage, and removal.” From there, Frazzette explained, a surgeon will often use suture anchors for the repair portion of the procedure. “The complementary ArthroCare portfolio will now allow us to address the customer segment that prefers to use knotless anchors,” he said, noting that in the US, more than 40% of procedures were performed using knotless anchors in 2013.

The agreed price of $48.25 per share represents a 6% premium over ArthroCare’s closing stock price of $45.38 on January 31, the last trading day before the deal became public. It is also a 20% premium over the 90-day volume weighted average price of ArthroCare’s shares prior to the announcement. The transaction is expected to close around mid-2014 and to start being accretive in 2015. UBS AG analyst Martin Wales believes the acquisition could be 8% to 9% accretive to profit after tax and 6% to 7% accretive to earnings-per-share in 2017. S&N is anticipating $85 million in synergies, with 25% of these likely to come from revenue synergies, as the global footprint of ArthroCare's portfolio is expanded, and 75% from cost synergies, according to Wales. “ArthroCare’s ear, nose, and throat business could also provide additional upside to the deal,” he says.

In addition to marketing Coblation devices for ENT procedures, through its acquisition of ENTrigue Surgical Inc. in 2013, ArthroCare offers balloon dilation devices and other tools for endoscopic sinus procedures. The firm was reportedly up for sale in 2009, but the DOJ fraud investigation put that effort largely on hold. With the legal resolution, Smith & Nephew surfaced as one potential likely buyer, because ArthroCare is already an equipment supplier for the UK orthopedic firm. (See 01140113013.)

Analysts expect to see further consolidation of orthopedic players as the market for hips and knees – which had been the sector’s bread and butter – becomes increasingly competitive. Prior to the announcement of the Smith & Nephew bid for ArthroCare, Richard Newitter, device analyst at Leerink Swan, says companies will have to push for deals that drive efficiencies either in manufacturing or sales. Manufactures will be pursuing ways to leverage their organizations. “For example, if you have trauma and fixation, and hips and knees, and spine, and drug-eluting stents, and neurovascular, and neurology and capital equipment, now you can maybe start to have discussions at the hospital that position you better than some other competitors that might not have that breadth of offering,” he says. “Companies that can offer more services to the hospital, that have more touch points at the hospital, ultimately will be better positioned” as pricing pressures continue.