Friday, September 28, 2012

Boston Scientific at a Crossroads: The Case For Bowing Out (Part 2 of 2)

In Part 1, I discussed some of the unfortunate events that led to Boston Scientific (BSX) falling from its once-lofty position alongside Medtronic (MDT), Johnson & Johnson (JNJ) and other major med-tech players. Through a mix of mismanagement, excessive appetite, and competitors' successes, Boston Scientific has found itself languishing for years.

Now, though, the company appears to be serious about change. Company-wide restructurings are underway, the company sold its once-promising neurovascular business to Stryker (SYK), and both management and investors await what they hope will be successful new product launches in the coming years. While all of this is taking place, though, there is a steady drumbeat in the rumor mill that Boston Scientific will not be independent for long.

In this section I mean to examine what the buyout environment for Boston Scientific could be like and who could be interested in this company.

Who Might Step Up?

Rumors about Boston Scientific selling out are widespread, and have been for quite a while. Clearly there is still some value in the company's portfolio of assets and if current management cannot harvest that, somebody else will.

Johnson & Johnson is the most commonly named candidate to acquire Boston Scientific. Clearly the deal would make a certain amount of sense – JNJ wanted to get into cardiac rhythm management (CRM) years ago (but wisely refused to outbid Boston Scientific for Guidant). The acquisition of Boston Scientific would not only serve that goal, but would re-energize JNJ's faltering stent business and boost the company's efforts in areas like endoscopy and urology, while adding businesses like neuromodulation and cardiac surgery.

Would JNJ do this deal? The company was apparently willing to pay $11 billion or so for Smith & Nephew (SNN) and Johnson & Johnson could certainly afford more for BSX. But does JNJ want another “problem child” when it already has so many challenges of its own? At a minimum, it would be a bold move, but it could really add some life to JNJ.

Who's Next?

Here is the problem with the “Boston Scientific is going to get bought” idea – after Johnson & Johnson, there really is no obvious candidate. Medtronic may want to increase its presence in the drug-coated stent market (the Endeavor is basically an also-ran) and may value some of the other parts of BSX's business, but there would be massive antitrust issues from the CRM overlap. And while Medtronic may be strategically comfortable with the idea of jettisoning the BSX CRM business to a third party, these kind of three-part deals are tricky and relatively uncommon.

The only other really credible candidates would be Abbott (ABT) or Covidien (COV). A deal with Abbott would offer much the same problem as a Medtronic merger, only with the stent business as the antitrust concern. In fact, Abbott got a huge boost into the drug-coated stent business years ago when BSX had to allay antitrust concerns over its purchase of Guidant and sold assets and IP to Abbott. That said, Abbott has been a savvy and opportunistic acquirer over the years and it would be a high-potential move for a company that has some growth concerns of its own to address over the next few years.

As for Covidien, it is a long-shot but a credible one. Covidien has already shown that it is willing to take on the challenges of acquiring companies that have stumbled but still own promising technology. That said, Covidien may find it needs more time to digest what it has already acquired before taking on such a large task. Still, Covidien says it wants to move into higher-margin and higher-value products, and this is one major way to do it.

If Covidien is a long-shot, there are a few other possible wild card bidders. Roche (RHHBY.PK) would seem to have enough challenges getting its diagnostics and life sciences businesses back in order, to say nothing of reassuring investors in the wake of the Avastin setbacks. Philips (PHG) and Siemens (SI) seem content to stay focused largely on the “big iron” markets of healthcare.

Danaher (NYSE: DHR) and 3M (NYSE: MMM) could be the other relevant dark horses. Both have larger healthcare businesses than investors commonly realize and the means to do a deal. In that regard, though, 3M is probably the better bet. Danaher is only about three times the size of Boston Scientific (in market cap terms, in revenue terms Danaher is only twice as big). Not only does Danaher have the not-inconsiderable task of integrating and rehabilitating Beckman Coulter (BEC), a deal for Boston Scientific would be incredibly destabilizing to Danaher in terms of its business and market mix.

For 3M, though, the company would have to face the possibility of analysts and investors going berserk. 3M sells products like stethoscopes, orthodontic supplies, and surgical masks and there would likely be skepticism in abundance about 3M's ability to handle high-ASP, R&D-intense product lines.

Private Concerns

If Boston Scientific were to get a buyout offer, private equity might actually be the likeliest bidder. It is easy to get excited about the margin potential of products like the Promus Element as well as corporate efficiency drives that could reap literally hundreds of millions of dollars in savings. That is music to the ears of private equity investors.

It is hard to see what else a private equity buyer could do for Boston Scientific, though. Management seems to be aware of the levers it can pull to improve the business, so it really comes down to time and market sentiment. If BSX management cannot deliver encouraging early returns on its restructuring and/or the Street fails to show sufficient appreciation, a well-heeled private equity group may just make a move.

What Would A Deal Take??

On its own, if things go right, Boston Scientific could be worth twice as much (or more) in five years' time from a combination of revenue growth, margin improvement, and multiple expansion. It seems extremely unlikely, though that a strategic bidder would offer something close to that sort of largesse – a 40% premium (similar to what Beckman received) might be the most that Boston Scientific and its shareholders could realistically expect.

What Should Boston Scientific Do?

Whether or not Boston Scientific should take a bid is of course dependent on a bid being made. If the rumors ultimately prove to be true, investors will have a tough decision – take what is likely to be a 30-50% premium to the current price, but a guaranteed premium, or hope that the company can at long last deliver on its promise. That's no easy question and the “right” answer has a lot to do with each investor's goals and expectations. On balance, though, it may be hard to turn down a premium bid; particularly when the company in question has so much work to do to rebuild shareholder value.

Disclosure: I am long RHHBY.PK, MMM.

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