Medical Device Consolidation Frenzy: Here's How To Play It

By now we all know how Medtronic knocked Johnson & Johnson (NYSE:JNJ) from its indisputable position as the top firm in the medical devices space, thanks to the $43 billion Covidien merger last year. It’s really amazing to see how a single mega consolidation reshuffled the dynamics of the entire medical devices space.

And after that the industry hasn’t taken a breather. Deals like Zimmer-Biomet (NYSE:ZBH) , Johnson & Johnson -Synthes and Thermo Fisher-Life Technologies and many more gave birth to unprecedented leaders in their respective niche markets. A number of untoward factors in the global economy over the past one and a half years did nothing to stop the pace of these consolidations.

In fact, going by the last available EvaluateGroup data, the first half of 2015 saw 86 mergers and acquisitions, totaling $83 billion, a rise of 166% from the year-ago period. Although the next report is not yet released, the unofficial talk is that the full year target of $100 billion of M&A valuation was effortlessly reached with the legacy continuing into 2016.

Behind M&A Boom in Turbulent Times

Over the decades, medical device companies resorted to acquisitions to harness their strength and diversify offerings. The medical device majors struggling with their core businesses are often on the lookout for emerging therapies through acquisitions and alliances, which help them to stay on the top with respect to market capitalization. Small scale players, on the other hand, capable of cultivating new value offerings, are often seen to develop themselves as potential acquisition targets for the stalwarts.

Historically, this has been the key distinctive feature of the medical device market. But what is surprising is the fact that these transactions have grown in pace in defiance of mounting economic concerns. Delving a little into this has made the whys and wherefores clear.

Large deals are more strategic now: According to many economists, earlier consolidation opportunities were not necessarily strategic. Instead, those were more focused on building a particular solution. However, big players are now exploring opportunities to capture an entire disease area or certain emerging problems so that the consolidated company can come out with the best possible solution set. Becton Dickinson's $13 billion acquisition of CareFusion is a perfect example of such a consolidation.

Increasing consolidation outside U.S.: Since 2014, M&As by U.S. firms have significantly increased outside the nation. While this was partly because of growing regulatory demand, tax-related hazards, reimbursement and pricing pressure, the fact remains that the competitive nature of the U.S. market has left no space for these players. A report by Financier Worldwide Magazine stated that “investments in the sector, particularly in cost-efficiency technologies, are witnessing a gradual spike as efforts to cut reimbursements as well as healthcare costs take shape.”

Dearth of venture funding: As if the smaller MedTech players didn’t have trouble enough, the growing difficulties related to the venture funding landscape have made their lives even worse. 2015’s data by Evaluate MedTech shows that the value of venture financing dropped 14% in in the first half with a 13% decrease in deal count. This was in fact part of an ongoing trend of falling investment observed over the past few years, affecting the early-stage businesses the most. This funding situation is getting more challenging day by day, forcing smaller companies to join the big hands to survive and pursue product development.

Complex and Time Taking Product Approval Process: The highly regulated U.S. medical device industry is hampered by stringent and complex procedures leading to product approval delays. In fact, according to a report based on a survey of over 200 medical technology companies (FDA Impact on U.S. Medical Technology Innovation), the U.S. FDA takes significantly more time to review compared to its European counterpart. These complications often drive MedTech companies to consolidate with their larger peers to brace themselves from the loss generated from these delays.

Recent Mega Consolidations at a Glance

A glance of the recently developed M&A agreements shows that each of these deals falls in line with at least one of the above-discussed reasons.

Abbott Laboratories (NYSE:ABT) - St. Jude Medical (NYSE:STJ) : in April, Abbott announced its decision to consolidate with St. Jude Medical for a deal value of $25 billion. Post completion, this will create a leader in high-growth cardiovascular markets, including atrial fibrillation, structural heart and heart failure as well as earn a leading position in the high-growth neuromodulation market.

DENTSPLY International (NASDAQ:XRAY) - Sirona: A $5.5 billion acquisition that closed in March. The consolidation is aimed at forming a leading global manufacturer of professional dental products and materials.

Thermo Fisher (NYSE:TMO) - Affimetrix: Thermo Fisher, following the Life Technologies buyout, has undertaken several meaningful acquisitions as part of its strategy to effectively deploy capital. The latest in the league was the company’s acquisition of Affymetrix for a value of $1.3 billion. The acquisition is expected to boost Thermo Fisher’s biosciences and genetic analysis portfolio.

Thermo Fisher - FEI Company (NASDAQ:FEIC) : Thermo Fisher’s plan to buy FEI Company for $4.2 billion will enable it to access FEI’s industry leading high-performance electron microscopy platform used for protein study, which in turn facilitates life-science research.

Medtronic (NYSE:MDT) – HeartWare (NASDAQ:HTWR) : This June, Medtronic entered into an agreement to buy Heartware International Inc. for a total value of $1.1 billion. This acquisition is expected to significantly boost Medtronic’s cardiac rhythm and heart failure business, alongside providing a strong foothold in the global niche.

How to Gain from the Race to Merge?

The increasing trend of strategic mega consolidations and sector convergence among medical device companies reveal ways of how they’re seeking new sources of revenues and R&D opportunities at optimum costs and minimum risks.

While nothing can be said conclusively about where the sector is headed, an opportunistic investor may take advantage of the changing dynamics by investing in stocks of the companies for which the benefits from consolidation are clear or a turnaround is underway.

Here are 3 such stocks:

Bayer (DE:BAYGN) AG (OTC:BAYRY) : This Zacks Rank #2 (Buy) company’s recent decision to buy agrochemical giant Monsanto Company (NYSE:MON) for a colossal $62 billion is expected to provide accretion to Bayer’s core earnings in the mid-single-digit percentage in the first full year of the closing of the transaction, followed by double-digit percentage growth thereafter.

Another Zacks Rank #2 holder Zimmer Biomet Holdings, Inc.’s spine portfolio is expected to get a major boost with the impending acquisition of the French spine device maker LDR Holding Corp. (NASDAQ:LDRH) , for a total deal value of $1 billion.

NuVasive, Inc. (NASDAQ:NUVA) , a Zacks Rank #1 (Strong Buy) company, is also a solid pick in this respect based on its recent agreement to acquire privately held Biotronic NeuroNetwork for a deal value of $88 million. This acquisition will not only enhance NuVasive’s spine service line partnership offerings, but also double the size of its service platform with a complementary geographic footprint.

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