Smith & Nephew Wants to Buy ArthroCare, but Could the Deal be Threatened?

In one of the first jackpot medical device deals of the year, Smith & Nephew plc announced plans to buy ArthroCare Corp. for $1.7 billion. The deal would give orthopedic giant Smith & Nephew products for minimally invasive surgery used in sports medicine, a sector growing faster (and with less price pressure) than traditional knee and hip replacement procedures.

ArthroCare shareholders would receive $48.25 per share in cash, which is 6.3 percent higher than ArthroCare’s closing price on Jan. 31 just before the deal was announced, and a 20 percent premium over the last 90 days. But some say that may not be enough.

ArthroCare, based in Austin, Texas, makes products used in arthroscopic surgery on shoulders and knees. Sports medicine typically involves minimally invasive soft-tissue surgery from sports or work-related injuries. ArthroCare specializes in soft-tissue surgery. It makes devices, instruments and implants that improve surgical procedures, including a radio-frequency technology that, according to the company, dissolves soft tissue with less damage than traditional heat-driven processes.

According to London, United Kingdom-based Smith & Nephew, cost reductions and additional sales will boost its annual profit picture by about $85 million in the third full year after the purchase is complete. Integration costs will be around $100 million over a three-year period.

Calling the deal “compelling,” Olivier Bohuon, CEO of Smith & Nephew, said the move also “rebalances Smith & Nephew in areas of higher growth.” He noted that his company’s sports medicine business currently is growing by a high single-digit percentage, compared with a low single-digit growth range for replacement hips and knees.

“We wanted to acquire in high-growth businesses, and sports medicine is definitely one of them,” he said.

The companies are no strangers to doing business together. Smith & Nephew’s sports medicine arthroscopic business sells ArthroCare’s Colblation RF technology through a licensing agreement. The acquisition will eliminate payments to ArthroCare, which amounted to approximately $24 million in 2012.

“ArthroCare and Smith & Nephew know each other well from our licensing and supply arrangements, and this is a natural transaction for both companies,” said David Fitzgerald, president and CEO of ArthroCare. “The board [of directors] believes that this transaction is in the best interest of our shareholders.”

Among the strategic reasons for the purchase that Bohuon noted, were:

• Creation of a comprehensive resection and repair portfolio with “exciting growth” prospects;
• Combination of ArthroCare’s latest-generation of radio frequency technology and Smith & Nephew’s mechanical blade portfolio to give customers greater choice; and
• ArthroCare’s shoulder anchor innovation “strongly” complements Smith & Nephew’s strength in knee repair, forming an “extensive, integrated portfolio.”

ArthroCare also comes with an ear, nose and throat business, which Bouhon said has development opportunities outside the United States. The company also has a small presence in spine, wound care, urology and gynecology.

ArthroCare had net sales of $368 million and earnings of $94.6 million in 2012. Total revenue for the first three quarters of 2013 was $276 million, an increase of 2 percent compared with the same period the previous year.

In January, ArthroCare resolved a long-standing investigation by the U.S. Department of Justice, paying a $30 million fine to settle allegations of securities fraud by former management. The settlement made the buyout more likely, Raj Denhoy, an analyst at Jefferies LLC, told The Wall Street Journal at the time.