TheChek News Flow

* ‘Full’ price offered

* Vascular closure divest possible

Abbott (NYSE:ABT) and St. Jude Medical (NYSE:STJ) reached a deal after an evolutionary series of discussions, a source familiar with the situation said.

The Abbott Park, Illinois-based healthcare group began “serious interaction” with St. Jude about a merger late last year, CEO Miles White told investors last week on a call to announce the companies’ USD 25bn combination. The cash-and-stock transaction was announced on 28 April.

The deal comes months after Abbott denied a late August report in the Financial Times that it was preparing a bid for the St. Paul, Minnesota-based cardiovascular medical device developer. White said on the call that there was “absolutely no truth to the rumor.”

Both companies know each other “reasonably well” and have held conversations over time, the source familiar said, noting that towards the end of last year was when “everything lined up” to seriously evaluate a combination. Abbott and St. Jude have collaborated commercially in the past.

The target’s stock had declined close to 20% by December 2015 since summer highs. COO Michael Rousseau took over as CEO at the start of the year as part of a transition by Daniel Starks from CEO to executive chairman.

St. Jude directed questions about the transaction to Abbott. Abbott did not respond to requests for comment.

An industry banker and an industry investor said that Abbott paid a “full multiple” for St. Jude, but it should prove to be a good deal if Abbott can secure USD 500m in projected synergies.

The investor said there is some concern around revenue growth for Abbott through this deal and its pending acquisition of Alere (NYSE:ALR), a diagnostics company.

“Overall this deal makes strategic sense and is financially accretive but both Alere and St. Jude are growing slower than Abbott on sales and there is a long-term concern around that. St Jude’s growth will accelerate from here, although it has been delayed several times, now we are looking at 2017,” the investor said.

Based on 2016 EBITDA estimates, Abbott paid a 17x-18x valuation for St. Jude, depending on the consensus estimates, the source familiar said. “You have to give them credit for Thoratec, there is a lot of growth there so mid- to high teens multiple, not necessarily above 20x [as some reports have said],” he added. Last year, St. Jude acquired Thoratec for approximately USD 3.4bn, net of cash.

Abbott has been viewed as a growth stock and investors are now trying to understand the growth profile of St. Jude, the source familiar said.

One question is how St. Jude’s cardiac rhythm management (CRM) business will develop. The company’s CRM market has struggled and is expected to experience pressure in 2016, though it continues to generate significant revenue and cash flow, St. Jude CEO Michael Rousseau said on a 4Q15 conference call.

Once the CRM market stabilizes, and other businesses continue to grow and new products enter the market, the growth of the overall product portfolio will increase, the source familiar said.

Abbott has said that the merger would allow for an improved negotiating position with hospitals, which have undergone a wave of consolidation in recent years. Under pressure from insurance companies, hospitals in search of reduced supply-chain costs are turning to fewer medical device vendors.

The argument that Abbott and St. Jude must get bigger to gain leverage over big hospitals will not sit well with antitrust regulators, according to an independent antitrust attorney.

Regulators generally see bilateral monopoly justifications as insufficient, so consolidation on one side of a market does not mean that consolidation on the other side is justified, this attorney said. In fact, regulators may be perturbed by this justification, as it keeps surfacing in health care deals, this attorney said.

The Federal Trade Commission (FTC) has historically taken a narrow analysis approach to medical device mergers, meaning that it looks for overlaps in specific product lines, the attorney said. The relevant geography for medical device mergers has historically been national, the attorney said. Divestitures can usually resolve antitrust concerns, the antitrust attorney said.

In its most recent 10-K, St. Jude named Abbott as one of its primary competitors in its “vascular products” business segment.

The investor said the companies overlap in the vascular closure area with St. Jude’s Angio-Seal being the market leader, closely followed by Abbott’s Perclose ProGlide device. He said the companies will be expected to divest one of these products, which should not be an issue as the market has matured, and is declining today, coupled with pricing pressures.

The source familiar said there is limited overlap between St. Jude and Abbott and that the companies feel comfortable about the regulatory review.

“I don't think they are expecting any major divests,” the source familiar said. The combination carries a divestiture cap of USD 325m in 2015 revenue for either the buyer or seller, according to the merger agreement.

St. Jude’s vascular products segment earned USD 716m off USD 5.5bn in net sales in 2015. It is the company’s fourth-largest segment. Abbott’s sales of vascular products in 2015 amounted to about USD 2.7bn.

The merger has been characterized in news reports as a combination of two of the leading makers of heart-related devices.

When the FTC filed a complaint in the merger of Medtronic (NYSE: MDT) and Covidien, it took issue with overlaps in “drug-coated balloon catheters indicated for the fem-pop artery.” In its complaint, the FTC described the market for these devices as “highly concentrated,” with only one supplier at that time, C.R. Bard (NYSE: BCR).

Medtronic agreed to divest the drug-coated balloon catheter business of Covidien to settle the FTC’s charges.