A recent deal in the medical devices sector illustrates one potential peril of M&A: overpaying. The deal is between Kinetic Concepts, Inc (NYSE: KCI) and LifeCell Corp (NASDAQ: LIFC). Overview deal terms are described in the Wall Street Journal:
Kinetic Concepts, Inc agreed to buy LifeCell Corp. for $1.7 billion to expand the company's reach in tissue repair with the maker of AlloDerm.
LifeCell Chairman and Chief Executive Paul Thomas said joining with Kinetic Concepts will speed the availability of LifeCell's products internationally and that Kinetic Concepts' standing in the advanced-wound-care market will help get LifeCell's line into that segment.
AlloDerm, used to repair damaged tissue in hernias and breast reconstruction, generated $167 million in sales last year and is LifeCell's best-selling product. The combined company is expected to generate sales of approximately $2 billion this year and to employ more than 7,000 people.
Kinetic Concepts, based in San Antonio, said it will pay $51 a share for LifeCell, an 18% premium to Friday's price in 4 p.m. composite trading on the New York Stock Exchange.
At first glance the deal seems to fit well since both companies sell wound management products to hospitals without real overlap in product lines (though equally, there is not huge opportunity for cost cutting).
But take a look at what's happened to KCI's share price since the acquisition was announced at the start of April 08 (see right).The price has dropped from just below $50 to around $38 (as of 2nd May).
Why could this be so? At the time the deal was announced, KCI had a trailing PE ratio (ttm) of around 15x. This has now fallen to a PE ratio of 11x. Meanwhile, LifeCell currently has a PE ratio of 64x, expected to fall to 50x in 2008. Looking at it another way, KCI paid $1.7 billion for a company with $26 million of net income for 2007, while its own valuation before the deal was announced was $3.4 billion, with $237 million net income for 2007. KCI's valuation has now dropped to $2.8 billion; there goes $600 million.
KCI claim earnings will be accretive from 2010 and that there is a strong strategic fit. Earnings for LifeCell would have to increase 6x for this to happen, so KCI management must be pretty optimistic about their acquisition. But it looks like KCI investors are voting with their feet, and feel the ticket price is just a bit too high? I guess we'll know by 2010.
A similar but even more dramatic recent example that I have been involved in commenting upon over the past 9 months is Mylan's acquisition of Merck Generics. This has really upset shareholders becuase of its substantial negative impact on the share price. Mylan is now making a qualified admission that it overpaid for the respiratory part of the business.
Posted by: John Ansell | May 14, 2008 at 12:20 PM