The med-tech world has not been shy about accepting the notion that future growth will be predicated, at least in part, on good exposure to emerging markets. Stryker (NYSE:SYK) is the latest to back that view with cold cash, spending $764 million to acquire Chinese orthopedics company Trauson Holdings (OTC:TRHDF). Coupled with improving fundamentals in the core recon market (hip/knee replacements), Stryker continues to look like a solid stock in the med-tech sector.
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Paying up for More EM Exposure
Stryker has had its issues with international exposure. The company's mid-single-digit exposure to emerging markets such as China and India is below the med-tech industry average, and Stryker has also been struggling in Europe of late. With this move, management is showing that it's prepared to take steps in the right direction.
Stryker's agreement to acquire Trauson for $764 million in cash (or HK$7.50 per share) represents paying about 13 times sales, based on analyst estimates for 2012 revenue. While that sounds steep, it's not out of line relative to what Medtronic (NYSE:MDT) paid for Kanghui Holdings, and Trauson's revenue has been growing over 20%.
Stryker is buying an appealing asset here. In addition to having good revenue growth and very solid margins (roughly 46% operating margin), Trauson is the leading company in the Chinese trauma market and the No.3 player in the spine market. Trauson is also a leader in the value segment of China's orthopedics market. While the company doesn't have a large ex-China presence right now, I see significant potential for "value-priced" orthopedic implants around the world in the coming decade.
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A Long-Term Move, but More Is Needed
To be sure, Trauson is only a step in the right direction for Stryker. Trauson will only add about 1% to Stryker's sales, so the company will still be a relative laggard in its EM exposure. This deal also does nothing to improve the company's issues in Europe, and fixing that business is not an elective procedure. As I said, I like Trauson's business, and I think Stryker can do a lot with it in China's nearly $16 billion market. But it will take time (and investments) for this to really change Stryker's underlying growth potential.
Still, at least Stryker has answered the bell. Medtronic bought Kanghui and Johnson & Johnson (NYSE:JNJ) bought Guangzhou Bioseal. Other companies such as General Electric (NYSE:GE) have opened health care research centers in China, so I'm glad Stryker is not getting left behind. What's more, it's a good use for cash parked overseas that could not have been repatriated to the U.S. without paying taxes.
Business Looks Back on Track
Prior to a recent industry conference presentation, Stryker previewed some positive data on revenue. It looks like organic revenue growth came in better than expected in the fourth quarter with a 6% improvement. Recon was particularly strong (up 7%). While I'm hopeful that this is a sign that the recon market is getting better, I won't dismiss the possibility that Stryker picked up some business from a JNJ recall and less-intensive sales efforts from Zimmer (NYSE:ZMH) ahead of a new product launch.
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The Bottom Line
I remain more positive on Stryker than the sell-side analyst community as a whole. My estimate of 4% future revenue growth and slightly better (5%) free cash flow growth suggests a DCF-based fair value of about $70 per share for Stryker. That's not a huge target relative to today's price, and likewise valuation metrics such as EBITDA/EV (8.5 times) and EV/revenue (2.5 times) don't scream "must buy today". But I continue to believe that Stryker is a good long-term buy, and I'm hopeful that improving industry/market trends will continue to support the stock.
At the time of writing, Stephen D. Simpson did not own any shares in any company mentioned in this article.