Even granting that this is a challenging time for the orthopedics industry (and healthcare device providers in general), Smith & Nephew (NYSE:SNN) is struggling a little more than most. The company has been losing share in orthopedic implants like hips and knees and disappointing investors with regards to cash flow production, and the stock has been chopping around in a $20 range for about three years now. While the news on November 28 of the company's Healthpoint Biotherapeutics acquisition does bring in advanced wound care products with very good growth, Smith & Nephew is having to pay a pretty hefty price for this growth injection and this just isn't a sustainable long-term plan.
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Buying a Good Product That Most People Haven't Heard of
Wound care is not an especially well-appreciated segment of the healthcare market, so it's altogether understandable if most investors aren't familiar with "bioactive wound healing" or Healthpoint Biotherapeutics. Nevertheless, Smith & Nephew will be paying $782 million in cash to acquire Healthpoint and its portfolio of products build around bioactive debridement, dermal repair and wound regeneration.
The principle asset of Healthpoint is Collagenase Santyl pointment, an enzymatic debrider for dermal ulcers and burns. This product alone makes up about three-quarters of Healthpoint's sales and has been growing quite well for the company. Other products of note include Oasis for leg ulcers and Regranex for diabetic foot ulcers. Healthpoint also had a product in Phase 3 studies (HP802-247) for venous leg ulcers.
Smith & Nephew indicated that Healthpoint was on target for $190 million in sales this year, up about 25% from last year. While the company provided less information on recent margins, it seems as though Healthpoint is not strongly profitable at this point - though due at least in part to a lack of scale.
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It's Logical to Get Bigger Here
With about 90% of Healthpoint's sales in the United States, this will double the company's U.S. wound care business, and grow the overall wound care business by about 20%. That will elevate wound care to about 30% of the total, so orthopedics will still be a significant part of the story post-deal.
Expanding the wound care business makes plenty of sense for Smith & Nephew. For starters, while Kinetic Concepts and Smith & Nephew have both faced challenging reimbursement decisions in wound care, it's not a market with a significant elective procedure component. What's more, it's also a market still in need of (and willing to pay for) better technology and better outcomes - persistent wounds/ulcers are a major problem for patients with limited mobility, and particularly those with diabetes.
This also happens to be a market where Smith & Nephew has scale and influence. This deal will significantly close the gap with Kinetic Concepts in terms of overall market share, and should give the company a meaningful boost in bioactive wound healing - one of the strongest growth segments in the market. Together, these two companies will have close to 50% share, with 3M (NYSE:MMM) and Convatec a ways back. What's more, this is not an easy buy ((Johnson & Johnson (NYSE:JNJ) largely exited professional wound care in 2008)), but it is one that I believe is still worthwhile and can reward a disciplined player with scale.
It's also worth noting that Smith & Nephew isn't getting anywhere fast in orthopedics. While companies like Johnson & Johnson, Zimmer (NYSE:ZMH) and Stryker (NYSE:SYK) generally saw about a 2% growth in their reconstruction businesses (hips and knees) in the third quarter, Smith & Nephew saw a 2% decline, with particular weakness in hips. Now some of this can be tied to Smith & Nephew's greater exposure to Europe (where reimbursement pressures are more intense), but it can also be tied to the fact that Smith & Nephew's products are longer in the tooth and the company has not been as innovative as its rivals.
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The Bottom Line
Although I like the Healthpoint deal, paying more than four times sales makes for an expensive deal these days ((though not out of line given what Shire (Nasdaq:SHPG) paid for Advanced BioHealing in 2011)). Healthpoint is a good enough asset to be worth this price, but the point stands that Smith & Nephew needs to step up its R&D/innovation game, as it cannot afford to keep buying growth at this sort of multiple.
Though I think the deal is a good one for Smith & Nephew, it doesn't change my feeling that this is a stock better left out of investors' portfolios. There are too many quality names out there ((like Medtronic (NYSE:MDT) and Covidien (NYSE:COV)) to go with Smith & Nephew instead, and if investors want to take some risk and invest in companies that need to improve their execution, St. Jude (NYSE:STJ) and Stryker look like better candidates for that sort of move.
At the time of writing, Stephen D. Simpson has owned shares of 3M since 2007.