Reports surfaced over the weekend that Johnson & Johnson (JNJ) had submitted a bid for Smith & Nephew (SN.) of £7 billion, or 750 pence per share, that was rejected by the target late last year. Although not confirmed by J&J, as we believe Smith & Nephew is worth about 765 pence per share we think that rumoured bid would have been merely fair, and Smith & Nephew shareholders may be wise to hold out for a higher offer from either J&J or another suitor. From the perspective of J&J's credit rating and fair value estimate, we don't expect the potential deal would cause major changes if it were completed at £7 billion.
Strategically, we think Smith & Nephew's business could be a good fit with J&J, which already operates large orthopaedic, sports medicine, and wound-management businesses. However, we worry that it may be deemed too good a fit by antitrust regulators. For example, in orthopaedics, a combined J&J-Smith & Nephew would become the leading provider of knees and hips in the world, controlling about one third of the market. While not necessarily deal breakers, we think combined market share statistics like those may face intense scrutiny by antitrust regulators around the globe, especially given the difficult entry dynamics associated with the orthopaedics industry. A more palatable deal to regulators, in our opinion, would be the combination of Biomet (private) and Smith & Nephew, which would bring two smaller orthopaedic device makers together, creating a more level playing field between them and the orthopaedic leaders--Zimmer (ZMH), Johnson & Johnson, and Stryker (SYK). Overall though, with reports of rumoured deal terms entering the market, we wouldn't be surprised to see Biomet or other private investors enter the fray, which could help boost future bids for Smith & Nephew as well.
Damien Conover, CFA, contributed to this note.