Nearly two decades ago, Boeing’s then-bungling but otherwise brilliant CEO embarked on a radical cost-cutting mission to help the global aerospace giant (empowered by its 1997 merger with struggling McDonnell-Douglas Corp.) regain lost market share. The chieftain’s game plan relied heavily on outsourcing, which at the time was growing exponentially among aerospace manufacturers for its bottom-line benefits.
Specifically, the strategy entailed outsourcing aircraft components to suppliers, leaving Boeing to essentially become the primary assembly point for its planes—particularly the 787, the first to be made entirely of composites rather than aluminum. Boeing bigwigs mostly turned to outsourcing to reduce the 787’s development time from six to four years and the cost from $10 billion to $6 billion.
Outsourcing, however, was just one of the ways in which Boeing trimmed corporate fat after the McDonnell Douglas merger. It also took a common-sense approach to fiscal prudence, in part by jettisoning unprofitable aircraft it had inherited from its former rival, installing a $1 billion automation system at its manufacturing facilities, and cutting 13,000 of its 31,000 total suppliers over four years, mainly smaller firms that duplicated equipment.
The latter method proved quite effective, almost to a fault: The company ultimately pared its cache of suppliers by 80 percent over seven years.
“Boeing leveraged its acquisitions of McDonnell Douglas and Rockwell as well as the related post-merger integration to radically transform both how it did business and its supply chain,” said Bryan W. Hughes, director of medical technology for P&M Corporate Finance LLC, a Chicago, Ill.-based investment bank that provides merger and acquisition services to North American and European companies. “Suppliers went from being viewed as ‘vendors’ to having to manage everything from raw materials through fabrication, assembly, critical certifications and, in some cases, management and oversight of quality and delivery from other suppliers in the chain.”
It should to medtech manufacturers, where scale-driven acquisitions increasingly are creating opportunities for vertical integration and greater supply chain synergies. As OEMs consolidate, so too, must suppliers, lest they risk extinction, industry experts contend.
“You see the OEMs grabbing a product or company but in our contract manufacturing space, it’s going on as well,” Tom O’Mara, executive vice president of Kentwood, Mich.-based contract manufacturer Autocam Medical, told MiBiz earlier this year. “Our customers (are) looking to deal with fewer suppliers. It’s just less complicated. With the regulatory environment that we’re living in, there has to be more controls all the way down to the sub-tier heat-treat supplier. As we see this consolidation, it just cascades down.”
Descending, in fact, from a surprisingly steady torrent: Consolidation reached a frenetic pace in 2014 as medtech companies forged 96 deals—an 18.5 percent increase compared with the previous year’s sum, GlobalData statistics indicate. Total merger and acquisition (M&A) value jumped 47.2 percent to $39.3 billion, with roughly one-third of that amount funding the $13.6 billion marriage of Thermo Fisher Scientific Inc. and Life Technologies Corp.
The momentum accelerated through the first 10 months of 2015 as medtech OEMs closed four megadeals (those worth more than $10 billion) and more than a dozen smaller transactions. Medtronic Inc. led the parade of monumental mergers with its $50 billion purchase of Covidien plc; that pact, along with the $14 billion Zimmer Holdings Inc.-Biomet Inc. coupling, $13.8 billion Danaher Corporation-Pall Corporation alliance and $12.2 billion Becton Dickinson and Company-Carefusion union, helped to more than double last year’s total deal value, according to data from United Kingdom-based market intelligence firm Evaluate Ltd. Company analysts predict total M&A value could top $100 billion this year for the first time ever.
That prognosis may not be too far-fetched: In addition to the four megadeals—worth $90 billion collectively—OEMs also completed a slew of smaller purchases (through Oct. 31) that are likely to tip the scales in the Evaluate forecast’s favor. Presumed contributors to the grand milestone were Hill-Rom Holdings Inc.’s $2 billion bid for privately held diagnostics giant Welch Allyn; Cardinal Health’s $1.9 billion purchase of Johnson & Johnson’s cardiac device business unit Cordis; Boston Scientific Corp.’s $1.6 billion pickup of Endo International plc’s AMS men’s and prostate health business unit; Cyberonics Inc.’s $1.24 billion procurement of Sorin SpA; and 3M’s $1 billion score of Polypore International Inc.’s Separations Media business.
Medtronic, not surprisingly, added to the tally as well, accommodating five new companies under its corporate umbrella through Halloween (four other deals are still pending). Displaying an insatiable appetite for growth, the firm became the industry’s most acquisitive organization, expanding its platform in diabetes care, cardiovascular care, and ENT technology.
“Over the last two to three years, as the healthcare landscape has changed, companies have pursued more transformational deals as a means to reshape the value and technology they deliver to patients and providers,” Hughes said. “A large driver of the need for scale in these transactions has been a response to the increased scale and ‘power’ of both payers and providers. Although less obvious on the provider side, consolidation driven by M&A has also accelerated over the last several years. Each market is different, but generally [the consolidation] is being driven by key issues like bringing down [total] costs, transitioning to value-based care and achieving scale. For medical device companies, [M&A] transactions are a means to keep up with this broader consolidation. Deals help maintain the balance of power with providers and payers, while continuing to innovate and deliver the best products for patient care.”
Deals also help medtech firms navigate a tricky reimbursement environment, shed underachieving business units and expand their offerings. The Pall acquisition, for example, will enable Danaher to leverage the $20 billion global filtration market and capitalize on growing demand for its cohort’s life-sciences portfolio, responsible for more than half of its $2.78 billion in annual revenue last year. Danaher is wisely bulking up its life-sciences business, intent on cashing in on the biotechnology sector’s propensity for biologics (drugs made from living cells).
“Pall’s life sciences segment is highly complementary to ours,” President/CEO Thomas P. Joyce Jr. told analysts during a May conference call about the merger. “This is an opportunity to improve an already high-quality business with DBS [Danaher Business System]. We’ve identified approximately $300 million of cost synergies over the next several years, which represent approximately 10 percent of Pall’s current annual revenue. Ultimately, we believe this will be a high-impact opportunity ...”
And a potentially lucrative one. Like most of its fellow buyers, Danaher pursued its prize on the tantalizing promises of earnings potential and cost synergies. Indeed, cost synergies can be a deciding factor for deals, particularly in cases of significant savings where—to borrow a phrase from Hughes—“one plus one equals something greater than two.”
In Boeing’s case, the sum was exponentially higher—up to $1 billion, according to The Wall Street Journal. Medtronic’s math yields nearly the same amount, with expected savings topping $850 million, while Zimmer Biomet Holdings estimates its savings to total $350 million by 2018. Hughes, however, contests the latter figure, claiming the company’s true combined savings is closer to $450 million due to sales or product “dis-synergies” and the closing of its Carlsbad, Calif.-based dental headquarters and manufacturing facility.
Clearly, the consolidation of Zimmer Biomet’s dental operations accounts for just a fraction of the combined firm’s post-merger savings total. But, like Boeing, Medtronic, Danaher and other bulked-up OEMs, Zimmer Biomet now has more clout to negotiate better deals with suppliers—pacts which in some cases, command exorbitant price cuts. Suppliers that don’t play along risk being blacklisted.
“Boeing rolled out its controversial Partnering for Success program in 2013, asking suppliers for 15 percent to 25 percent cost reductions,” Hughes noted. “Those suppliers that don’t ‘play ball’ so to speak—which by some estimates is as high as 35 percent of the overall base—have been put on no-bid lists. The impact on M&A has been significant. Many suppliers have been forced to pursue transactions to gain scale, expand capabilities or provide higher value services. The theory for suppliers is two-fold: First, with scale, we can better absorb some of this cost pressure, and second, with more proprietary capabilities, it will be harder for Boeing to put us on a no-bid list.”
Though that theory holds up well in the medtech arena, suppliers also are incorporating M&A into their long-term strategic plans to guard against irrelevancy. OEMs, many of whom have morphed into global conglomerates, now are reluctant to consider partnering with customers that don’t have a broad array of capabilities and a global footprint.
Such requirements have been a driving force behind much of the M&A in the medical device supply chain in recent years. Flextronics International Ltd., mostly known for manufacturing electronics, purchased Swiss medical plastics processing firm RIWISA in the second half of 2013 to broaden its precision injection molding and high-speed automation services. The year before that, the company acquired full-service EMS provider Stellar Microelectronics to include microelectronic design and manufacturing services in its offerings as well as branch out into the aerospace and defense industries.
The same motives prompted the $665 million merger of Jabil Circuit Inc. and Nypro Inc. in 2013. Jabil executives lauded the move for its potential to create new business opportunities in healthcare products and consumer packaging—segments worth roughly $205 billion.
Similarly, Lubrizol Corporation entered previously unchartered territory with last summer’s purchase of Franklin, Wis.-based contract manufacturer Vesta Inc. Acquired in 2007 by private equity firm RoundTable Healthcare Partners, Vesta has grown largely through acquisition, having snapped up thermoplastic medical tubing maker ExtruMed LLC in 2009 and silicone products maker SiMatrix Inc. in 2011. Both proved to be smart investments, as they give Lubrizol access to silicone and various other thermoplastics used in medical devices.
“...the expertise and capabilities of Vesta give us the ability to provide a more valuable offering to customers on a global basis,” Deb Langer, general manager of Lubrizol LifeSciences, said of the rationale behind the deal.
Geographical diversity likely attracted Galway, Ireland-based Creganna Medical to Precision Wire Components LLC. The merger added manufacturing facilities in Tualatin, Ore., and Heredia, Costa Rica, to Creganna’s global footprint (comprised of the United States, Europe and Asia). It also allowed the company to expand its offerings to include wire component and coiling technologies.
Tecomet found a similar binary benefit with its $450 million takeover of Symmetry Medical Inc.’s OEM Solutions business, strengthening its capabilities in surgical instrumentation, orthopedic implants and sterilization case and trays, and gaining more than 450 customers and 13 facilities in the United States, United Kingdom, Ireland, France and Malaysia—a footprint that normally would take decades to build organically.
Greatbatch Inc. bypassed years of home-grown corporate construction as well with its $1.7 billion acquisition of minimally invasive device/component maker Lake Region Medical. With more than 9,000 workers and roughly $1.5 billion in annual revenue, the combined company is now considered one of the world’s largest medical device OEM suppliers serving the cardiac, neuromodulation, vascular, orthopedics and advanced surgical markets.
“Many of the largest customers of [medtech] suppliers are merging and that’s both increasing concentration for many suppliers but also putting them in a position of needing to provide a broader skill set, a broader geographic footprint and a broader set of capabilities,” Hughes concluded.