Biomet’s Surprising Trauma Move

The $280 million binding offer by Biomet, Inc. for DePuy Orthopaedics Inc.'s trauma business was greeted by most analysts in orthopedics without comment. We know, because we asked.

But our publisher, a former Wall Street analyst, commenting in Ft. Wayne, Indiana's The Journal Gazette, expressed surprise at Biomet's decision.

Source: The Journal GazetteOur publisher, Robin Young, also co-founder (with his brother Benjamin Young) of the orthopedic-data firm PearlDiver Technologies, Inc. is a frequent commentator in the national and regional business press regarding medical companies and technologies. 

“Deal Doesn’t Add Up”

In last week’s Journal Gazette story about the Biomet bid, reporter Sherry Slater quoted Young on the Biomet offer as saying, "I'm looking at this thing, and it doesn't add up...I wouldn't have done it." Slater wrote that Young said the company hasn't made money in years and that Biomet, which has $2.8 billion in annual sales, should strive to turn a profit on existing operations.

Young concluded in the story, "But that’s not to say DePuy’s trauma business isn’t a smart investment for a company that could easily afford it, such as competitors Zimmer Holdings Inc. or Stryker Corp."

Biomet Defends Bid

Biomet spokesperson Bill Kolter rebutted Young's assessment in the story by saying that the company had more than adequate financial wherewithal to purchase DePuy’s trauma business and disagreed with Young’s assessment noting that Young was not a financial expert.

Slater quotes Kolter: “Your source may be an ‘industry expert’ but he is not a financial expert. There is a significant difference between reported and adjusted earnings. Biomet is thriving financially.”

Kolter, in a written response to Slater’s questions, said Biomet generated free cash flow of more than $200 million in fiscal 2011 with adjusted earnings before interest, taxes, depreciation and amortization of more than $1 billion, or 37% of sales. Adjusted financial numbers “remove any one-time or unusual amounts to arrive at a better picture of the performance of the underlying business.”

As of the end of last quarter, said Kolter, Biomet had more $380 million in cash and cash equivalents on hand, more than enough to cover the $280 million cash offer.

Addressing Biomet’s financial condition, Journal Gazette reporter Slater noted that Biomet's most recent Securities and Exchange Commission filing dated January 13; show about $3 billion in equity and about $8 billion in debt. She also pointed out that Biomet reported an $843.5 million loss for fiscal 2011, which ended May 31. That followed a $47.6 million loss reported for fiscal 2010 and a net loss of $749.2 million for fiscal 2009.

Special items for fiscal 2011 included a $941.4 million charge for goodwill and intangible assets impairment related to a continued slowdown in the European market.

Biomet Clarifies Public Remarks

On April 5, the Gazette published the following news brief with the caption: "Biomet rep clarifies bid remarks."

Biomet Inc. spokesman Bill Kolter on Wednesday toned down a statement he made Tuesday about Robin Young, founder of the Warsaw-based orthopedic-data firm PearlDiver Technologies, Inc. and publisher of Orthopedics This Week, an online industry journal.

Kolter recanted the statement on Wednesday and said Biomet officials respect Young’s credentials. “Our comment was meant to highlight our disagreement with his perspective, not to demean his credentials, ” Kolter said in a statement.

So back to the question Young raised about the deal not adding up.

“To put this in the most basic terms, among the potential buyers of DePuy’s trauma business, Biomet was, to me, the least likely buyer, ” said Young. “Other firms, like Zimmer or Stryker or even Smith & Nephew, have stronger balance sheets and have been reporting the kinds of operating earnings that would lead me to think they would not only buy the business, but invest in it over the long haul. Had any other major orthopedic company been the bidder, I would have understood.”

“But Biomet? It raised a series of questions. To be perfectly clear, Binder and his team may have excellent answers to the questions. But they are not immediately apparent.”

From There to Here

The future of Biomet has been a source of speculation ever since company Founder Dane Miller, Ph.D., stepped down unexpectedly in 2006 after acknowledging "friction" with his board of directors which included former Vice President Dan Quayle's wife, Marilyn Quayle.

After Miller’s departure, the company hired Morgan Stanley to help it explore its strategic options and by the end of 2006 the company announced that a group of private equity owners, including The Blackstone Group, Goldman Sachs, Kohlberg Kravis Roberts & Co. and TPG Capital, would take the company private for $10.9 billion. Dane Miller would serve on the new board.

Source: WikimediaThe company was now out of the hands of the local founders and public shareholders and in the hands of some of Wall Street’s largest dealmakers.

Are there plans to take the company public again? In an October 2008 story in the Gazette, Binder reportedly said that when the time comes he thinks Biomet’s most likely move is going public, but he couldn’t say when that might happen. Miller, agreed, and a representative for the private-equity consortium declined to comment.

Young said he’s assuming that this bid to purchase DePuy’s trauma business is consistent with the financial goals of Biomet’s owners.

“Highly Leveraged”

In February 2007, the company announced that Jeff Binder would take over the role of president and CEO. In an OTW interview in May 2007, Binder told us that the private equity sponsors had to, by contract, approve his appointment.

According to a 2011 Biomet 10-K filing, the company "incurred significant indebtedness and became highly leveraged." The purchase was financed through notes bearing interest rates between 10 and 11%.

Over a three year period from 2008 to 2011, the filings show the company's shareholder's equity dropped from $4.836 billion to $3.175 billion and over $1.56 billion in interest payments were reported by the company.

What does the acquisition of DePuy’s trauma division mean given this balance sheet?

Biomet has the most levered balance sheet among major orthopedic companies, said Young. “And that means that as a percent of operating cash flows, Biomet has fewer dollars to reinvest in its business than its competitors. It means that Biomet’s management has less room for error and must, in effect, outsmart the competition in order to match industry growth rates. Biomet must be more efficient than Stryker, Zimmer, et al.”

Biomet Trauma

In his May 2007 OTW interview, Binder noted challenges at Biomet Trauma and Biomet Spine.

Said Binder: “Our Parsippany-based business, Biomet Trauma and Biomet Spine, which used to be called EBI, is a business that has been struggling quite a bit...I think that business has a lot of potential. It’s a business that’s in a great high growth space. It’s a business that has not executed up to our expectations over the course of the past few years and I think it’s a business that you will see get back to being a growth driver for us over the course of the next couple of years."

Biomet's Trauma business, according to Wells Fargo Analyst Larry Biegelsen, reported quarterly declines over previous years’ sales of -3%, -9%, -5% -20%, -6% and -1% sequentially between the company's first quarter of fiscal 2011 to the second quarter of fiscal 2012.

In the fourth quarter of 2011, Biegelsen reported that DePuy's trauma sales were $50 million and a slight increase over the previous year.

In announcing the offer for DePuy's trauma division, Binder said the DePuy trauma team has, "done a great job of building a successful business." He added, “This transaction will provide Biomet with a much stronger presence in the global trauma market and greatly expands our Sports, Extremities and Trauma business, which is a meaningful growth driver for Biomet."  

Young said he agrees with Binder’s comment. ”No reason not to. I’m sure that is why Biomet made the bid.”

Does acquiring DePuy’s trauma business make Biomet stronger?

This acquisition shores up Biomet’s Trauma business, said Young. “On its face, it would appear that Biomet thinks that filling out the trauma product line and picking up additional distribution could stabilize its trauma unit.” 

“I don’t know if Biomet will successfully acquire DePuy’s trauma division, ” concluded Young, “If they do, I would certainly expect that it WOULD increase operating cash flows. Having said that, however, I am surprised that Biomet is making such a large purchase given its record of operating losses and its very high debt load. I would have expected the firm to start reporting profits before it went shopping.”