UPDATED: Stryker bulks up in emergency medicine with $1.3B purchase of Physio-Control

LifePak 1000 external defibrillator--Courtesy of Physio-Control

Stryker ($SYK) is on an acquisition spree. The company announced the $1.28 billion acquisition of Physio-Control International from Bain Capital Private Equity, the company's third M&A deal of the year, and second to cross the $1 billion mark. The latest deal is expected to close at the beginning of Q2.

Shares of Stryker are essentially unchanged on the news. They still sell for about $97 as of market close.

The former Medtronic ($MDT) unit, based in Redmond, WA, will add about $500 million in annual revenue and give Stryker a toehold in the automated external defibrillator, manual defibrillator/monitor, and the CPR-assist device arenas. As with the impending, $2.8 billion purchase of hospital infection control specialist Sage Products, the deal is motivated by a desire to "drive a greater balance between capital and disposables." While the former are more expensive (and the traditional focus of Stryker), the latter provide recurring revenue.

Physio-Control disposables and accessories provide about 40% of its revenues. They include batteries, cables, sensors, cabinets and training tools associated with its defibrillators (an area where it competes heavily with Philips and Zoll Medical) and its fast-selling Lucas chest compression CPR-assist device. In addition, the company sells Big-Data offerings, like the cloud-based Lifenet system for sharing patient information and remote cardiology consults.

The offerings will be integrated into Stryker's EMS (Emergency Medical Services) unit, which relies on capital equipment sales of ambulance cots and accessories, evacuation equipment and stair chairs for all of its revenues.

Bain Capital purchased Physio-Control from Medtronic in 2011 for $487 million. Under Bain's ownership Physio-Control appears to have overcome a consent decree from 2008-2010 that banned AED production at its Redmond, WA, facility.  In FY 2015, revenue grew 6% at constant currencies to $503 million.

Stryker promised growth of at least that level going forward during a conference call with Wall Street, but investors appeared somewhat skeptical given that Physio-Control operates in mature markets, and repeatedly asked where the growth would come from.

"I think that the drivers of growth in this business, first and foremost, will be supported by an aging population, the increasing rate of death and disease from cardiovascular disease and rising wealth in emerging markets. The expectation we have is that innovation and product life cycle will drive growth. And when you think about the installed base of a company like this with some several hundred thousand advanced life support systems and probably 500,000 AEDs out there, the opportunities for upgrades and market expansion are extensive," Timothy Scannell, the group president of Stryker's medsurg and neurotechnology divisions responded.  

Company also officials said the business will benefit from integration into Stryker's sales forces because its EMS unit shares a common call point with customers of Physio-Control devices since they both companies serve first responders and others who handle medical emergencies.  

Physio-Control generates 60% of its revenues in the U.S., compared to 75% for Stryker EMS.

Stryker officials said the timing of the deal as the company's third announced transaction in 16 days is a coincidence, and does not represent a change in M&A strategy. They didn't reveal much to Wall Street when asked about the possibility of a "transformational" deal--an allusion to continued rumors that the company is talks to buy fellow orthopedics player Smith & Nephew. 

"Our initial take is that given the overlap and SYK's selling abilities, 6-7% revenue growth seems possible over the next 3-4 years in a market that is growing 2-3%, but we expect the Street to be skeptical until proven otherwise. The Physio and Sage deals remind us of BSX's acquisition of Bayer's Peripheral assets last year and SYK's acquisition of Boston's neuro assets in 2010. In both situations revenue growth for the acquired business accelerated in mature markets from leveraging broader, more effective distribution and new product introductions," wrote Bank of America equity analyst Bob Hopkins in a research note. He said Physio-Control has a 45% share of the manual defibrillator market and 18% share of the AED market. 

A more skeptical view was voiced by Joanne Wuensch at BMO Capital Markets. According to Barron's she wrote: "We believe Stryker's acquisition of Physio-Control will be received with mixed reviews: 1) as part of Medtronic, the perception was that this franchise addressed a mature, saturated market; 2) while Stryker management emphasized the synergies with its EMS efforts (creating a clear leader in the emergency medical segment, expanding beyond emergency cots), this is not a part of the revenue profile that most investors have focused on; 3) while the company ended 2015 with $4.1 billion cash on the balance sheet and a debt to capitalization ratio of 29%, it plans on funding this cohort of acquisitions with $3.5-$4.0 billion of debt). On the flip side: 1) it is nicely accretive to the top and bottom line; 2) it is synergistic with the Medical division, which includes patient care (beds), patient handling (stretchers), and EMS (rugged cots in ambulance); and 3) balances out the EMS franchise, including a disposable revenue stream (right now it is 100% capital)."

- read the release
- here's more from Barron's

Editor's Note: This article has been updated with additional information from Bank of America equity analysts and a Stryker conference call with Wall Street. 

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