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Zimmer hopes deal accelerates products

The possibilities might sound like science fiction: personalized artificial hip implants and intelligent surgical instruments.

But with Zimmer Holdings Inc.’s pending $13.35 billion acquisition of Biomet Inc., medical advances that once seemed years away could be coming closer to reality.

Zimmer officials are talking about almost doubling their annual budget for research and development of new products to $360 million after the deal closes – assuming the deal closes – early next year.

David Dvorak, Zimmer president and CEO, also has pledged to retain both companies’ sales forces, which would increase his ability to get a broader array of medical devices in front of more prospective buyers.

That’s if U.S. and European regulators decide the deal won’t place too much market share in one entity. Zimmer’s share in the worldwide knees market would increase to 40 percent from 27 percent.

Although the combined orthopedics company would be a primary player in the $45 billion musculoskeletal industry, the merger isn’t being driven simply by a desire for dominance.

Analysts say the Zimmer-Biomet deal is a matter of survival, a way of giving the manufacturers more market share and bargaining power when dealing with hospitals that demand discounts on orders.

Orthopedic device-makers also continue to battle the federal government over the 2.3 percent medical devices tax, which was imposed to help pay for the Affordable Care Act.

Jeff Windau, an equity analyst in St. Louis with Edward Jones, said combining operations with Biomet allows Zimmer to remove one competitor from the mix.

“I think pricing is a big issue” because of stiff competition, he said in a phone interview.

Additional factors making it tough to make a profit in orthopedics are government regulation and lower Medicare and Medicaid reimbursements paid to health care providers, the analyst said.

Hospitals are demanding deeper discounts on devices to offset the cuts from Medicare and Medicaid. And consolidation in the health care industry has led larger providers to hold out for volume discounts on orthopedic devices and the instruments used to implant them.

According to a study last year by the Boston economic and financial consulting firm Analysis Group Inc., the average inflation-adjusted prices for artificial hips fell 23 percent from 2007 to 2011. During the same period, prices for artificial knees declined 17 percent, the study showed.

The Advanced Medical Technology Association, a national industry group representing medical device companies, said the data reflect the competitive marketplace that forces members to cut prices.

The Zimmer spokeswoman handling all communications regarding the merger de­clined to be interviewed – or provide anyone else to be interviewed – for this story.

All company comments are taken from news re­leases, Securities and Exchange Commission filings and conference calls with analysts.

Making it pay

With Dvorak’s commitment to protecting the sales staffs from cuts and increasing research and development spending by 76 percent, Zimmer officials will have to look elsewhere for the $270 million in net annual savings by the third year after the acquisition. Anticipated first-year savings are about $135 million, the company said.

Windau, the analyst, has seen how these deals tend to play out.

When two companies are combined, he said, savings typically come from cutting jobs in information technol­o­gy, accounting and procure­ment. Companies also often seek savings by consolidating man­u­fac­tur­ing operations into fewer buildings.

Remember how Zimmer has been squeezed by cus­­­tom­ers demanding low­er prices on bigger orders? Zimmer probably hopes to use the same strategy when ne­go­ti­ating with its raw ma­te­r­ials suppliers, Windau said.

“I’m sure they’re looking at all those potential activities,” he said of Zimmer officials.

Zimmer employed more than 9,000 at the time of the acquisition announcement, in­clud­ing an unspecified num­ber in Warsaw. Bio­met, which is owned by private-equity investors, did not reveal its employee count in the April 24 announcement. The company’s website does not provide annual reports after 2006. Biomet ceased public trading in 2007.

Is bigger better?

Windau is cautiously optimistic about how much Zimmer and Biomet will gain from joining forces because, he said, five major orthopedic competitors remain.

“It’s not necessarily a big game-changer for the company,” he said of Zimmer. “They’re still going to face a lot of the same issues they face today that are a negative to growth.”

Make no mistake, Windau considers the merger a good fit. He described Zimmer and Biomet as similar companies that “know each other very well.”

The combined company, by the way, will have a new name created from a combination of the Zimmer and Biomet names. And it will remain headquartered in Warsaw.

Dvorak has said repeatedly that the deal is about growth. Zimmer and Biomet officials are working together on transition teams to develop plans for each business unit to grow at or above the market average in each geo­graphic area and each pro­duct area, he told analysts on July 24.

“Both companies share a common set of values and a track record of success in­te­grat­ing acquisitions, which gives me a great confi­dence that we will achieve a smooth transition and capital­ize on the opportunity to create a new company that is comprised of the best of Zimmer and Biomet,” he said in a state­ment.

Raj Denhoy, who was an analyst with Jefferies & Co. in April, blessed the corporate marriage after it was announced.

“The financial aspects of it are hard to find fault in,” he told Reuters news service. “In health care, being a larger company that has a broader product offering seems to be the way that things are evolving. You’re selling to hospitals as opposed to individual surgeons, and hav­ing that larg­er footprint is believed over time to be important.”

The sales games

Growing sales would al­so help the balance sheet. Win­dau said Zimmer has not pushed overseas sales as hard as some of its competitors have.

That creates an op­por­tu­nity for geographic growth.

In the second quarter, 54 percent of Zimmer’s sales were in the Americas. The re­main­der was in Europe and an area broadly reported as Asia Pacific.

Zimmer also expects growth in various product cat­e­gories. During the three months ended June 30, the company’s revenue primarily came from two categories: knees, 42 percent of total sales, and hips, 29 percent.

While discussing the deal with analysts, Dvorak said acquiring Biomet opens new markets, including “meaningful entry into sports medicine,” and creates cross-selling opportunities with one salesperson representing products originally de­signed by both manufacturers. Growth opportunities have also been identified for spine-related and other products.

“Enhancing the market com­pet­itiveness of some of the small businesses of each com­pany was one of the rea­sons behind this combina­tion,” Biomet President and CEO Jeffrey Binder and Dvorak said in a joint letter to employees.

James Crines, Zimmer’s ex­ec­utive vice president of fi­nance and chief financial of­fi­cer, said the company is al­lo­cating $400 million for in­te­gration costs, which includes a retention program de­signed to reward sales staff who stay with the new company.

The most recently announced projections are for an­nual earnings per share to in­crease by $1.15 to $1.20. Zimmer’s 2013 diluted earnings per share were $4.43.

Combining the companies will also create a more di­verse and predictable revenue stream, Dvorak said. That should please Wall Street.

But the way Dvorak sees it, everyone – not just investors – benefits from combining the two companies.

“We look forward to com­bin­ing the strengths of both teams,” he said, “to restore mobility, alleviate pain and improve the quality of life for patients around the world.”