Investopedia: Danaher Hopes To Revive Beckman Coulter

Ending weeks of speculation, industrial conglomerate Danaher (NYSE:DHR) announced a bid for Beckman Coulter (NYSE:BEC) on Monday morning. Assuming that the deal goes through, and that is likely given the Beckman board's support, Danaher will join the likes of Abbott (NYSE:ABT), Siemens (NYSE:SI), and Roche (Nasdaq:RHHBY) as the biggest fish in the diagnostics pond. That said, Danaher is paying a rich premium for the chance to apply its operational magic touch to a company that desperately needs help. 

The Deal
Beckman has been trading on deal speculation since early December, and it was only last week that a Reuters article speculated on private equity bids in excess of $5 billion for the company. At that time, little mention was made of a strategic buyer for the business, though this author has been maintaining that Danaher would likely be the most credible buyer and that a price of eight times trailing EBITDA would be a fair price.

Lo and behold, Danaher has offered $83.50 in cash for Beckman, a nearly $7 billion deal that values Beckman at a trailing EV/EBITDA of just a bit over eight. That bid also represents a 45% premium to Beckman's pre-rumor price, and a pretty generous price for a true turnaround project. Given the operational improvements that Beckman needs and some of the peculiarities of the business, the last large deal in diagnostics (Siemens' acquisition of Dade Behring for 16 times EBITDA in 2007) is really not an apples-to-apples comparison, so Beckman shareholders should not feel too badly abused in this transaction. (For related reading, Does Beckman Bow To The Inevitable?)

What Danaher is Getting
In Beckman Coulter, Danaher is acquiring a diagnostics business with some major heft in many sizable markets. Beckman is a leader in the clinical chemistry market and has been at the vanguard of the fast-growing lab automation market (where expensive and increasingly hard-to-find technicians are being replaced by machinery). Beckman is relatively less of a factor in the faster-growing immunoassay market, but has a large share in the hematology market and a decent foothold in flow cytometry, where it competes with Becton Dickinson (NYSE: BDX) (among others).


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Beckman Bids Shaping Up

According to a Reuters article, Beckman Coulter's (NYSE: BEC) efforts to sell itself have reached the final bid phase, with at least two interested parties.

Unfortunately, they are both private equity groups - one a combination of Blackstone and TPG Capital, the other Apollo and Carlyle. Danaher (NYSE: DHR) apparently was interested and still may be, but there was no confirmation that they were involved in the final round of bidding.

So, why do I say "unfortunately"? Well, if private equity buys this company, they're most likely going to be interested in restructuring it with an eye towards maximum cash-on-cash return. That is almost never good news for employees, and especially employees in the some of the slower-growth "legacy" diagnostics markets of Beckman.

If Danaher buys Beckman (or General Electric (NYSE: GE), or Philips (NYSE: PHG) or whomever else you wish to suggest), there's a better than fair chance that the company will stay intact. Sure, there will likely be some head-cutting, particularly in overlapping areas like finance, IT, middle management and so on. But I think it would be unlikely to see wholesale changes; Danaher isn't going to pay $6B+ and then radically rearrange the entire company. Moreover, I would like to think that a strategic buyer would understand not only the long-term cash flow potential of these slower-growing units, but also the bundling and marketing leverage they could provide in the context of a larger healthcare business.

Even though I don't own Beckman, and wouldn't buy it here, I do hope it ultimately goes to a strategic buyer and not a financial buyer. Sure, I happen to think that Abbott Labs (NYSE: ABT) and Roche (Nasdaq: RHHBY) are better companies and better stocks, but the employees of Beckman are not to blame for where the company sits today and I would hate to see another purging of scientists and technicians out of the healthcare sector.

All of that said, it's really interesting to me that there are apparently so few strategic bidders for BEC. There is a lot of cash and borrowing capacity out there, but companies do not want to bite ... at least not for Beckman Coulter. I guess that supports my thesis that this is not a terribly interesting diagnostics companies, as it is not as though med-tech companies routinely show price discipline in M&A.

Danaher - Wait For Quality To Come Cheap

Some stocks test the patience of investors and their commitment to disciplined investment strategies. Danaher (NYSE:DHR) is a good example. This industrial and life-sciences conglomerate is indeed a well-run company, but the Street knows that. Consequently, Danaher's stock price often forces investors to choose between value discipline and chasing what is likely to be a compelling long-term story. 

The Quarter that Was
Danaher delivered a fourth quarter that was solid, though not spectacular. Revenue rose 15% as reported, with "core revenue" (Danaher's word for organic) up 13%. Revenue growth was led by the test and measurement segment, which delivered 24%, while the industrial segment was hardly pokey at over 15% growth. Dental and environmental were the laggards this time around, with growth a bit above 7% and 8%, respectively.

Margins were something more of a good news/bad news story. Gross margin jumped about 500 basis points from last year, but there was a general expectation among analysts that this would be good. Operating performance was where things were arguably a bit disappointing. Though the company did report good year-on-year operating income growth (and margin expansion), profitability contracted a bit on a sequential basis. The contraction does not seem to be significant enough to be a real source of worry (quarter-to-quarter volatility in restructuring charges can move this number), but it is something for investors to watch. (For more, see The Bottom Line On Margins.)

The Road Ahead
Danaher would seem to be holding a good hand for this phase of the economy, as some slowdowns in industrial might create better growth in life sciences and/or environmental. Thinking more broadly, while there is some argument about which industries are "early phase," "mid phase" or "late phase," Danaher nevertheless looks to have a good spread across these categories.


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Maybe The End Of The Line With JNJ

This earnings report may be the straw that breaks the camel's back between me and Johnson & Johnson (NYSE: JNJ). It has been a while since JNJ has really impressed me, and I find that I often end up telling myself "don't worry, it'll get better ... after all, it's JNJ". Well, sometimes once-great companies don't rebound and just continue to fade.

A Quick Run Through The Numbers
JNJ reported that revenue fell more than 5% this quarter, missing the average estimate and actually coming in below the lowest published estimate. Consumer was the worst performer of all, as sales fell 15%. Within that, woundcare was down 16% and OTC was absolutely crushed (sales down almost 31%) by the never-ending series of recalls. Pharmaceutical sales were down almost 5% and there were almost no signs of life in the segment, with only Prezista showing any meaningful growth.

Devices were ironically the best story this quarter, as sales rose 0.2%. Cordis (drug-coated stents) was weak yet again though, and sales fell 10%. Orthopedic sales (DePuy) were also down (2%), and so was diabetes (down 2%). Ethicon was up 4% and diagnostics grew 7%.

Oddly enough, gross margins were stable this quarter and that's pretty good considering that the company should have seen operational de-leveraging. Moreover, operating margin actually expanded by 1.5%, but almost half of that was from lower R&D spending. I do NOT like to see health care companies cutting their R&D budgets, but even moreso when their current revenue trajectory and near-term pipeline are uninspiring.  At the bottom line, earnings were down 12%

This And That
It annoys me that JNJ does not provide a cash flow statement with its earnings. If other equally large and diverse conglomerates can do so, what is their excuse? I frankly find it dismissive and disrespectful to investors, but I don't expect that they will change. Nevertheless, it means I cannot immediately re-run a DCF analysis on JNJ shares, but I cannot imagine it will be better than my last run-through.

I also take issue with the company's strategy. JNJ overpaid for Crucell; vaccines can be a great business, but Crucell is not going to help the company much in the short-term. And if JNJ did make a bid for Smith & Nephew (NYSE: SNN), it's just another sign (to me, at least)  that JNJ cannot compete on the basis of its own internal R&D efforts. What next, a bidding war for Beckman Coulter (NYSE: BEC)? And then there's the whole mess in Consumer ... though I believe management has actually started handling that better and that's on the way to resolution.

The Bottom Line
On the basis of my last valuation run, JNJ shares are worth about $71.50 - about 15% higher than where the stock will open today. If JNJ were executing well and giving my confidence in management's abilities and direction, I wouldn't mind that relatively low appreciation potential.

But JNJ is *NOT* executing well, and I cannot see any immediately obvious reasons to think that will change anytime soon. Consequently, I think I will be selling these shares. I'd frankly rather pay up for Abbott (NYSE: ABT) or Becton Dickinson (NYSE: BDX) than own JNJ, and if I was going to own a troubled health care company that needed some TLC, why not own Roche (Nasdaq: RHHBY) instead? Obviously, I'm annoyed as I write this, so I need to let the emotion fade a bit and then decide how to proceed. At this point, though, I'm thinking it's time to move on from JNJ.

At this point, I would probably SELL (though not short) JNJ shares.

Disclosure: I own shares of JNJ

2010 - The Year in Med-Tech Deals

Medical technology has always been a sector with a high level of M&A activity in any given year. Large companies are always on the lookout for technologies and assets that can boost their growth rate, while a plethora of single-product/single-market outfits hope for the boon of a big-time payday. That said, 2010 was a bit of a disappointment in terms of deal activity. Though there certainly were notable deals throughout the year, the pace was slower than what most people predicted in late 2009. Perhaps, then, that means that 2011 will be an above-average year as economic recovery puts some life back into this lagging sector. (For more, see Where The M&A Action Is, And What's Next.)

The Gold Star Goes to Covidien 
Covidien (NYSE:COV) was certainly among the most active players this year. Covidien started off by getting rid of most of its respiratory care business and then turning around and buying peripheral and neurovascular specialist ev3 for $2.6 billion. Shortly thereafter, Covidien decided to expand its monitoring business by acquiring Somanetics in a $300 million cash deal. Time will tell whether the company can leverage these deals into sustainably higher growth rates, but it seemed to help Covidien's stock do a little better on a relative basis. (For more, see Covidien - Better Than People Seem To Think.)

St. Jude Quietly Following the Medtronic Model 
St. Jude (NYSE:STJ) still seems to carry a bad reputation from the days when it was the "other" company competing with Medtronic (NYSE:MDT) and Boston Scientific's (NYSE: BSX) Guidant in the pacemaker and ICD business. Nevertheless, St. Jude has quietly been building an interesting collection of businesses, largely through M&A. This year, St. Jude shelled out more than $1 billion to acquire AGA Medical and its cardiac repair business - a logical outgrowth of a company with interests in heart surgery, valve replacement, ablation, and other cardiology niches.


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Roche's Noise May Be A Buyer's Best Friend

It feels like it has been a long time since Roche (Nasdaq:RHHBY) had good news for the Street. Clinical setbacks have led to lower growth assumptions, competition from biosimilars has become a "when, not if" scenario, and the company seems to be falling further behind the likes of Illumina (Nasdaq:ILMN) and Life Technologies (Nasdaq:LIFE) in the high-multiple world of life sciences. Even a relatively broad cost-cutting initiative produced only a tepid ho-hum response from the Street. 

So, with the company now facing the possible loss of breast cancer labeling for its drug Avastin, is it crazy to think that this might be a good time to consider Roche as a value stock buy?

The Latest Bad News: Avastin in Breast Cancer
When Roche announced this summer that a clinical trial of Avastin in breast cancer failed to show much benefit, the clock began ticking on when the company would see a response from regulators in Europe and the U.S.. As expected, particularly given the FDA's recent obsession with safety, regulators are now moving to pull (or at least severely restrict) the use of Avastin in breast cancer.

While European regulators have recommended that Avastin remain available for use in breast cancer, that recommendation extends only to its use in combination with paclitaxel. Other combinations, with Sanofi aventis's (NYSE:SNY) Taxotere and Roche's other drug Xeloda, were struck down. The FDA was more stringent. It issued complete response letters (rejections) for use with other chemotherapy agents and as a second-line treatment, and moved to pull the labeling for breast cancer altogether. This is a relatively uncommon occurrence, as Pfizer (NYSE: PFE) was the first to go through the process of having a drug approved under accelerated approval subsequently pulled when Mylotarg was pulled this summer. 



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Does Beckman Bow To The Inevitable?

If multiple reports from respected sources like Wall Street Journal and Bloomberg are to believed, Beckman Coulter (NYSE:BEC) is on the block. If true, the board deserves applause for bowing out and seeking the best possible source of good returns for its shareholders. 

A Long Way From a Deal 

Beckman itself has not commented on any of the rumors, but multiple reports indicate that the company has tapped Goldman Sachs (NYSE:GS) to manage a potential sale of the company. Some reports have gone so far as to indicate that this is in direct response to the receipt of bids or indications of interest for the company - though apparently from private equity buyers and not other companies. (For more, see Potential Takeout Targets.)

 
Match Game 
The stock has shot up more than one-quarter in response to these rumors, and the market is once again playing the Chinese menu game (pick one from column A and then one from column B). It is unlikely that any of Beckman's current major rivals would want to make a bid. It would not make sense for Abbott (NYSE:ABT) to be eager to buy into the chemistry business (where Beckman is strongest). Siemens (NYSE:SI) and Roche (Nasdaq:RHHBY) would not only have potential antitrust worries to reconcile, but would also have to explain to their shareholders how that deal would complement their stated efforts to produce more growth from their testing businesses from next-gen technology.


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Abbott Labs Showing Meaningful Growth

Abbott Labs (NYSE:ABT) has always been a little different as a medical technology company, with a  history of zigging when other companies zag. For now, that somewhat contrarian philosophy is paying off, as Abbott is one of the very few large-cap medical technology companies to be showing any meaningful growth. 

The Quarter That Was
Abbott came through with 12% revenue growth in the third quarter (or 13% if foreign currency effects are reversed). Pharmaceuticals is still overwhelmingly the largest business at Abbott, and this unit grew more than 23% due in large part to the acquisition of Solvay. Without this deal, growth was probably in the very low single-digits. Elsewhere, the nutritional business was disappointing (down more than 2%) due to a recall, while the diagnostics business was basically on target (up about 2%), and the vascular business was strong (up almost 20%).

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Roche Needs A Shot Of Adrenalin

Paradoxically, a value stock is only a value if there is some growth to the name. True, there is the occasional "wasting asset" stock that is worth more than its current price, but most operating companies need some reasonable amount of growth to deliver that value. That is the problem with Swiss medical technology giant Roche (Nasdaq:RHHBY.PK) these days - while the company has several valuable franchises under its roof, the growth performance has been lackluster and the company seems slow to change this. 


A Look Ahead at a Mediocre Third Quarter
Roche gave investors a preview of results on Thursday. Reported sales fell 3% in local currency terms, which was about 2% below the average analyst expectation. A 2% miss is no reason to panic, but investors should be at least modestly concerned that the business was weaker than expected, more or less, across the board. Pharmaceutical sales were down 5%, as the company saw a fall-off in Tamiflu and very low single-digit growth from its big three of Avastin, Herceptin and Rituxan.

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