Stryker Corporation bought MAKO Surgical Corp. for $1.65 billion. Zimmer Holdings, Inc. is paying $13.3 billion for Biomet, Inc..
Both transactions have far reaching effects on the future of orthopedic care.
But there is another, quiet, perhaps forgotten billion dollar acquisition that is also working its way to closing. Interestingly enough, this other billion dollar deal could trigger yet ANOTHER billion dollar orthopedic industry transaction.
Furthermore, as we’ve dug into the SEC filings for this deal, we think it is arguably a more telling indicator of changing orthopedic treatment paradigms, shifting distribution channels and alternative care providers than either Stryker’s or Zimmer’s deals.
In case you’ve forgotten, Smith & Nephew, plc (SNN) hopes to close the $1.7 billion ($48.25/share) purchase of ArthroCare Corporation (ARTC) in mid-2014, subject to regulatory approval from the United Kingdom.
When they do close, this deal will bring together two major sports medicine and arthroscopic treatment companies, as well as tee up the other major MIS (minimally invasive surgery) firm—ConMed Corporation—and give strategic heft to two major orthopedic trends—the accelerating growth of outpatient care and MIS.
The Sleeper Deal
With ArthroCare, Smith & Nephew moves to the front ranks in both sports medicine (which is a half a billion business for SNN pre-ArthroCare) and arthroscopy (a $440 million business pre-ArthroCare) and will essentially control RF Coblation technology.
Combined, the two firms create a powerful gravitational pull on these rapidly evolving outpatient markets.
Sports medicine/arthroscopic products are among the fastest growing categories in orthopedics and support, quite powerfully we think, the broader trends to outpatient and increasingly diversified points of care.
According to Plovanic, with ArthroCare blended in, sports medicine sales will jump 12% this year and 20% next year. Arthroscopic sales will increase 23% this year and 25% next year. But not factored into Plovanic’s analysis is the effect of size and new technology, which we think could put upward pressure to his forecasts.
Smith & Nephew has distributed some of ArthroCare’s older products for years although they did not have access to ARTC’s latest generation Coblation product, Ambient (Ambient is capable of providing “real-time temperature of the operative environment”).
Tortuous History
Getting to “yes” on this agreement was tortuous.
But, given ArthroCare’s troubled history, it was perhaps inevitable.
A year ago (May 2013) just before merger discussions started, ArthroCare’s former chief executive officer and former chief financial officer were indicted for allegedly leading a $400 million fraud scheme—said the U.S. Department of Justice (DOJ).
In May, the former head of ArthroCare’s spine division David Applegate pleaded guilty to his role in the scheme. In July, ArthroCare’s former senior vice president of strategic business units John Raffle also pled guilty.
While all of this was playing out (which occurred 2008 through 2009) ArthroCare’s stock plummeted to prices that were unimaginably low—less than $4/share. Lawsuits popped out like cherry blossoms in spring.
The company’s CEO and other executives quit, leaving the board to clean up the mess. David Fitzgerald, who’d served on ArthroCare’s board since 2003 and was 75 years old at the time, stepped up and began his service as the company’s president and CEO. Prior to ArthroCare, he’d been 25 years at Pfizer, Inc., serving as president and chief executive officer of its Howmedica Orthopedics division during his last fifteen years.
Background of the Deal
Most analysts expected that ArthroCare would ultimately be sold. But the baggage of lawsuits and Department of Justice investigations were big hurdles.
In early 2013, as the DOJ investigations to beginning to look solvable, ArthroCare formed a committee of its board of directors to review its strategic alternatives. Gregory A. Belinfanti, Terrence E. Geremski and Peter L. Wilson, with James G. Foster as an alternate were its members. Piper Jaffray was the outside advisor.
At the committee’s direction, Piper contacted three medical device manufacturing companies (Smith & Nephew was left off the list) to see if they’d consider buying ArthroCare.
Two months later, however, it was “no sale” at two of the prospects and the third only wanted ArthroCare’s crown jewel—the ENT business. No one wanted sports medicine.
Then, somewhat unexpectedly in late October 2013, Mike Frazzette, Smith & Nephew’s president of Advanced Surgical Devices, asked for a meeting. About two weeks later, Frazzette and Cyrille Petit, Smith & Nephew’s chief corporate development officer, met with David Fitzgerald and Todd Newton, ArthroCare’s executive vice president, chief financial officer and chief operating officer, in Austin, Texas.
Smith & Nephew laid their cards on the table. They were interested in buying the whole enchilada (or words to that effect). Sports medicine, ENT…everything.
Three days later Piper Jaffray, at the Transaction Committee’s direction, re-contacted the two companies who’d passed on ArthroCare a few weeks earlier, plus three new firms to ask if they’d consider or reconsider buying ArthroCare.
With a real buyer at the table, three other firms decided to take a longer look at ArthroCare and signed confidentiality agreements. By the end of November 2013, there were four potential buyers for ArthroCare.
At this stage ArthroCare decided to disclose what would eventually become its block buster announcement. With Piper attending, ArthroCare described the material terms of a pending deferred prosecution agreement with the U.S. Department of Justice. That agreement would be made public a couple of months later and have a dramatic impact on the merger negotiations.
But the prospect of settling with the DOJ wasn’t enough. Three of the potential acquirers decided to pass on the deal leaving only Smith & Nephew.
By December, the deal was Smith & Nephew’s to win or lose.
Setting a Price
On December 10, 2013, SNN’s Petit called Fitzgerald and presented a preliminary non-binding acquisition offer to buy ArthroCare for $43.00 per share in cash, contingent on completion of due diligence.
Petit reiterated during the call that Smith & Nephew would be unwilling to participate in any auction process and would require a 60-day exclusivity period as a condition to continued discussions or negotiations. The $43.00 per share bid was approximately 11.54% above ArthroCare’s $38.55 per share closing price on December 10, 2013.
On December 13, 2013, ArthroCare’s Transaction Committee asked Fitzgerald to tell Petit that $43.00 per share was financially inadequate and to try to get the price up to at least $50.00 per share.
In addition, the committee instructed Piper Jaffray to shop the deal some more. So Piper contacted two more medical device manufacturers each of whom had prior experience in making large acquisitions. The committee also considered taking the deal to private equity firms and other financial investors.
Within a week, Piper passed along the word to the committee that the other two medical device companies had both passed.
The number of companies who’d looked at ArthroCare and passed was now up to seven.
On December 18, 2013, Smith & Nephew raised the offer price to $45.50 per share in cash, which was about 14.04% above the then current market price on December 18, 2013. But nowhere near $50.
For the next two days, ArthroCare’s board talked the new offer through with Piper and its other advisors. So, again, ArthroCare’s board asked management to try to negotiate a higher price and, if possible, also a reduced termination fee and to eliminate or reduce the time of any exclusivity period.
Counter Offer and Counter, Counter Offer
The next day, December 19, Piper contacted Smith & Nephew’s bankers (JP Morgan and Centerview) and told them to expect a counter offer of $47.00 per share and a termination fee equal to 2.5%. Then, five days before Christmas, Fitzgerald personally delivered the counter offer to Petit.
Petit’s counter, counter offer was $46.00 per share and a termination fee equal to 3.5% and an exclusive negotiating period ending February 5, 2014. He also told Fitzgerald that that was Smith & Nephew’s best and final offer—$46.00 per share was 16.75% more than ArthroCare’s $39.40 per share closing price December 20, 2013.
There were no other bidders—other than the public. And they would weigh in shortly.
On December 26, 2013, the two companies entered into a written exclusivity agreement and the due diligence process began.
The Public Buyers Take Charge
On January 7, 2014, ArthroCare announced a deferred prosecution agreement with the Department of Justice. The closing price on the day following the announcement jumped to MORE than Smith & Nephew’s offer. It was now $46.57, an increase of approximately 14.48% from the $40.68 per share closing price the prior day.
On January 13, 2014, Piper called JP Morgan and Centerview and asked them to raise the offer price—again. Smith & Nephew said they would. Some day.
Nothing came on January 14. The exclusivity period was expiring so ArthroCare’s board extended it to January 24 to give SNN time to raise their offer.
Nothing came on the January 15. So Fitzgerald spoke with Petit by telephone and Petit said to expect a new price proposal which would be higher than the then-market price.
On January 21, when ArthroCare announced the dismissal of other DOJ charges, the stock price rose again, this time to $47.72.
No new price came that day. Nor the next. And on January 23 Petit called Fitzgerald with the bad news. He would not be able to update the price at that time.
On January 24, the exclusivity period was set to expire again.
That very morning, Petit called Fitzgerald and said that they would revise their bid after Smith & Nephew’s January 29 board meeting and that the new offer would be higher than the then-current price per share of common stock, which was $47.05 per share.
As promised, Petit called Fitzgerald on January 29 and raised the offer to $48.00 per share in cash. Petit also told Fitzgerald that the offer would expire the following day at 12:00 p.m. unless agreed to by the company. Smith & Nephew’s offer of $48.00 per share was 4.78% higher than the $45.81 per share closing price.
The Final Gambit
The final gambit was interesting. ArthroCare’s transaction committee discussed Petit’s final offer and decided to direct Fitzgerald to ask for $50 per share—not because it believed that $50.00 per share was the fair value of the company, or the minimum bid that it would accept, but rather as a means to elicit from Smith & Nephew the highest price that it was willing to pay to acquire the company.
It worked.
On February 1, 2014 Petit and Olivier Bohuon, Smith & Nephew’s chief executive officer called to propose $48.25 in cash per share.
The merger agreement was executed the evening of February 2, 2014.
On February 3, 2014, before the opening of trading on the London public stock markets, Smith & Nephew issued a press release announcing that they were buying ArthroCare.
