Zimmer Biomet Plus ConMed?

Would ConMed Corporation be a good acquisition for Zimmer Biomet? Two top Wall Street analysts, Mike Matson, CFA, and David Saxon, CFA, think that it’s a logical combination.

Matson and Saxon, who are analysts at Needham & Company, LLC, sent a note to their clients explaining why they thought that ConMed would be a good fit for Zimmer. While they made a strong case for their suggestion, they also made it very clear that they were engaging in a “purely hypothetical exercise on our part and not in response to any news or speculation of a potential deal.”

Here are some of the highlights from that note and OTW’s subsequent discussion with Mike Matson.

Zimmer’s Management Has Hinted at M&A Focus

Matson and Saxon noted that Zimmer management has indicated that it plans to focus more on M&A in 2020 and beyond as its free cash flow improves and its leverage ratio declines. Zimmer entered 2019 with a leverage ratio of approximately 3.2x. Zimmer management also previously noted that it was open to smaller “tuck-in” deals that could be integrated into is existing distribution channels.

Matson and Saxon estimated that Zimmer’s weighted average market growth rate is approximately 3% and think that it will need to acquire higher growth assets to increase that growth rate.

ConMed Would Be a Strategic Fit for Zimmer

Zimmer Biomet is a publicly traded medical device company headquartered in Warsaw, Indiana. It designs, manufactures, and markets orthopedic reconstructive products; sports medicine, biologics, extremities and trauma products; office-based technologies; spine, craniomaxillofacial and thoracic products; dental implants; and related surgical products.

ConMed is a Utica, New York-based global technology company that has two businesses: Orthopedic surgery and general surgery. Matson and Saxon noted that ConMed’s orthopedic surgery products would strengthen Zimmer’s existing sports medicine and powered instrument businesses.

Specifically, they noted that Zimmer’s acquisition of ConMed would:

• increase Zimmer’s share in the mid-single digit growth sports medicine market
• broaden its sports medicine product portfolio
• expand its powered instrument portfolio
• allow for cost synergies because of the existing overlap between the two businesses

The analysts also noted that while ConMed’s general surgery business is outside of orthopedics and does not have much overlap with Zimmer’s existing businesses, it could be a starting point for diversifying Zimmer’s business into markets that have better pricing and volume. Additionally, Zimmer CEO Bryan Hanson has extensive experience in this area.

Hanson joined Zimmer after serving as a member of Medtronic’s Executive Committee and as the Executive Vice President of Medtronic’s Minimally Invasive Therapies Group, where he was overseeing and providing strategic direction to its approximately $9 billion business. Hanson previously served as Group President of Covidien’s Medical Devices business where he transformed two of Covidien’s largest divisions (Energy-based Devices and Surgical Devices) into a single global business unit.

Strong Financials

Matson and Saxon noted that based on ConMed’s current stock price, Zimmer would likely be able to acquire ConMed from less than $4 billion, depending on the magnitude of a premium. The analysts estimated that if the acquisition closed around the end of the year, the deal would be neutral to Zimmer’s earnings per share in 2020 and begin to have a growth effect in 2021. They estimated that the deal could add approximately 50 basis points to Zimmer’s organic revenue growth, provided that ConMed can sustain its approximately 7% revenue growth.

Matson and Saxon noted that ConMed does have significantly lower margins than Zimmer. ConMed has mid-50% gross margin compared with Zimmer’s low-70% margin. ConMed also has an approximately 10% operating margin compared with Zimmer’s high-20% margin. However, the analysts predicted the opportunity for cost synergies such as consolidating plants or the elimination of public company costs.

Overall, the analysts projected that Zimmer’s acquisition of ConMed would result in relatively no change in share price in the first year, an approximately 3% increase in earnings per share in the second year, and an approximately 6% increase in earnings per share in year three. Additionally, they estimated that Zimmer’s leverage would be approximately 4x at the close of the deal if it was financed with 100% debt.

ConMed Has Considered Selling in the Past

ConMed management and board have indicated that it was open to the sale of the company in the past. In 2013 and 2014, ConMed was targeted by a group of activist investors. One of the investors, Jerome Lande, was appointed to ConMed’s board in 2014. ConMed’s current CEO, Curt Hartman, was also appointed at that time.

ConMed previously tried to sell itself in 2014. However, that sale did not go through. On July 23, 2014, ConMed published a press release stating that “the Board determined that the various strategic alternatives available at this time do not adequately reflect the intrinsic value of the Company or its future growth prospects.”

Matson and Saxon concluded, “Since CNMD had previously tried to sell itself, Jerome Lande remains on its board, its revenue growth has significantly improved, and its stock price has significantly increased, we think a sale of the company is increasingly likely in the next few years.”

Matson’s Additional Thoughts

OTW spoke with Mike Matson to get his additional thoughts on what a ConMed acquisition could mean for Zimmer.

OTW asked Matson what prompted him and Saxon to write the report. Matson explained that it began as an analytical exercise after Zimmer announced that it was thinking about doing more deals. Matson said, “Since Zimmer is a fairly large company, any acquisitions that it makes need to be large enough to move the needle. If you go down the list, there are not that many mid-cap, publicly traded, orthopedics-related companies out there. When you go down the list, ConMed is probably the one that fits the best and is most beneficial to its growth profile.”

Matson noted that, “While a company like Wright Medical would theoretically be more additive to Zimmer’s growth, that wouldn’t work out because there would likely be antitrust issues with that acquisition.”

He continued, “Another alternative would be for Zimmer to identify an earlier-stage, smaller company with rapid growth. Even with a smaller amount of revenue, it would still move the needle because it’s growing so rapidly. However, I’m not aware of any company that fits this profile.”

Matson explained how he made the ConMed connection. “What really made it click is that ConMed is half orthopedics and half general surgery. On one hand, you might think that it doesn’t fit because Zimmer wouldn’t want the general surgery business. But then it occurred to me that Zimmer CEO Bryan Hanson came from Covidien, so he knows that general surgery space very well. It’s a better market these days—the pricing pressure is not as bad—it would be an opportunity to kill two birds with one stone. Hanson would be getting a bigger sports medicine business and also gain a new business outside of orthopedics that he could expand over time, creating a new business for it that he knows so well.”

What’s Next

OTW asked Matson about the feedback he’s received on the note. While he has not heard from the companies, Matson has spoken to a few institutional investors who agreed that the acquisition made sense, that the two companies are a good fit with each other, and it would make sense for Zimmer to pursue it.

Will Zimmer management take this note into consideration and consider a ConMed acquisition? Only time will tell.