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| Zimmer's Pulsavac Plus device to clear debris during orthopedic surgery--Courtesy of Zimmer |
Thanks to Zimmer's $14 billion acquisition of Biomet, now Zimmer Biomet ($ZBH) will have $4.7 billion in cash at its disposal over the next few years and will be free to spend the proceeds on U.S. M&A activity, share buybacks and debt reduction, says Jefferies equity analyst Raj Denhoy in an analyst note.
Of the three value-creation activities, additional share repurchases beyond those already planned are the company's lowest priority, according to the analyst, while paying back debt early generates a limited return given its 3% cost. Instead, more M&A activity could be on the way for the orthopedics specialist, as it seeks accelerated top-line growth.
In January, Zimmer projected constant-currency revenue growth of 1.5% to 2.5% in 2016. Denhoy believes that the dis-synergies from the Biomet deal are behind the company, and said it should return to "market growth" by the end of the year, but that's only 3% to 4%, a reflection of the mature markets for hip and knee implants.
"The prospect of accelerating revenue growth is perhaps more intriguing, as Zimmer has historically traded at a discount to its medtech peers--partially we believe because of the perception that the company was satisfied with remaining in the lower growth markets of hips and knees. An M&A driven expansion into other areas, or increasing its size in the existing SET (Surgical, Sports Medicine, Extremities and Trauma) or Spine segments, could cause a recalibration of that view," Denhoy wrote.
Despite the growth concerns, the analyst believes the "windfall" from the company's $14 billion acquisition of Biomet is not being appreciated. The combined company will generate a total of $8.7 billion in free cash flow by 2020, Denhoy said.
"Ordinarily not all of that cash would be available in the U.S., as Zimmer generates about 45% of its cash outside the U.S., but through the Biomet acquisition the company structured intercompany loans with its foreign subsidiaries. This structure will allow it to repatriate close to $4bn of overseas cash with minimal, if any, tax burden," he wrote.
In addition, the company mentioned in an SEC filing in February that it has booked a $1.5 billion tax liability to repatriate $4.4 billion to the U.S. in future periods, suggesting a tax rate of 34% on the transaction. By contrast, now-Ireland's Medtronic ($MDT) paid a 5% tax rate to bring $9.8 billion to the U.S. thanks to corporate inversion.
Regardless, the $2.9 billion in post-tax remitted earnings and $4 billion of low-tax intercompany loans give the company $6.9 billion of cash that's easily accessible outside the U.S. "When combined with US cash flows and netting out debt repayments, dividends, and already modeled buybacks, the company will have $4.7bn in cash it can freely access for value creating activities over the next few years," Denhoy wrote.
Zimmer's been a reluctant dealmaker since the Biomet buy, though it recently made a small move, acquiring Ortho Transmission to get its hands on technology for anchoring artificial limbs that restore mobility among amputees.
The technology will complement Zimmer's work on transcutaneous (across the skin) limb attachment conducted in collaboration with the U.S. Department of Defense, the company said.
And the Defense Logistics Agency just awarded Zimmer a $380 million, fixed-price contract to deliver various orthopedic devices to the Army, Navy, Air Force, Marine Corps and federal civilian agencies through 2021.