Smith & Nephew touts acquisitions, offers bulk hospital buying

Smith & Nephew is targeting a serious margin ramp-up and tax rate reductions within the next few years. Maintaining its aggressive acquisition strategy is an obvious means to work toward both those goals. The orthopedics player is also getting serious about catering to big customers; it's rolling out a sales model that offers two products, expected to be sufficient for about 80% of hip and knee implant procedures, through multiyear contracts with a rate discount of about one-third.

Smith & Nephew CEO Olivier Bohuon

The company has done 13 acquisitions worth $2.8 billion since 2010, the largest of which by far was the $1.7 billion deal for sports-medicine-focused ArthroCare ($ARTC) that was completed in May. This strategy has improved revenue growth. In 2011, 35% of the company was operating in high-growth segments; now 50% is in a higher growth segment.

But why stop there? Smith & Nephew ($SNN) is aiming to have two-thirds of its business in high-growth areas, CEO Olivier Bohuon said on the second-quarter conference call. Emerging markets, sports medicine, trauma and extremities, gynecology and advanced wound devices are its higher growth businesses, while reconstruction, advanced wound care and enabling technologies are all defined as lower growth in established markets.

Smith & Nephew is also the first among its competitors to specifically target sales to the hospital. Orthopedic sales and accounts have been focused typically at the surgeon level. Under pressure from large U.S. accounts, which it said comprise 5% to 10% of its customers, the company has rolled out a hospital-focused sales model it has dubbed Syncera.

"Given the pressure to reduce healthcare cost, we believe that it is now the right time to start offering an alternative solution," Bohuon said in describing the strategy. "One which generates attractive economics for the patient, for the payer and for the provider."

The company expects Syncera to initially result in dilution, but ultimately the idea is to maintain its margins by reducing product prices in tandem with lower SG&A resulting from less intensive marketing and individualized training efforts. The expectation is that these will offset each other and result in a "margin which is equivalent to the one we have," Bohuon said. He expects this process will take about a year to play out.

Bohuon said Smith & Nephew already has a number of customers ready to sign these kind of multiyear contracts, which are typically for three years. The company expects that the two products offered under Syncera are suitable for about 80% of hip and knee procedures in the U.S.: Genesis II Knee as well as a hip combination of a Synergy stem and a Reflection cap. The average U.S. price for these implants is $5,500; one analyst on the call pegged the hospital discount under the program at about one-third, a figure to which the company did not object.

"If you take a hospital that has 700 implants a year, over the three-year contract, this hospital will enjoy net cash flow benefit of well over $4 million," Bohuon summed up.

The company said it's also looking to improve upon its current effective tax rate of 28% for 2014. "As a result of a number of operational and structural changes to our business, partly in response to the ArthroCare acquisition, we expect the effective tax rate to reduce by 150 to 200 basis points over the next 2 years, absent any changes to tax legislation," said S&N CFO Julie Brown.

She noted that the U.K.-based company is taking advantage of improved tax legislation in that country, as well as so-called patent box benefits that allow a company to claim tax benefits based on where intellectual property is held. Brown added that tax is always a consideration in M&A transactions, as well. The company has already reduced its tax rate by 200 basis points in the last two years, Brown said.

Investors pushed Smith & Nephew up 4% in early trading on Aug. 1 after its premarket earnings announcement.

- see the full quarter details in the release and slides

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