The M&A flurry continued Wednesday morning as medical devices giant Stryker (click ticker for report: ) announced it would acquire MAKO Surgical (MAKO) for $30 per share, or roughly $1.65 billion. The deal represents an 83% premium to MAKO’s Tuesday closing price, but the value remains below MAKO’s peak in late 2011 and early 2012.
MAKO remains unprofitable, though the firm has experienced solid revenue expansion during the past few years, going from $34 million in revenue during 2009 to $103 million during 2012. The firm isn’t expected to earn a profit in 2013, though revenue is estimated to jump 23% from the year-ago period. Given existing conditions, MAKO might not turn a profit until at least 2015, in our view.
Does MAKO at least generate free cash flow?
MAKO, which makes the robotic surgical arm known as Robotic Arm Interactive Orthopedic (RIO) for the MAKOplasty procedure, is still very much in the growth phase, so the firm has yet to generate any free cash flow. Stryker is taking a leap of faith that revenue growth will continue and potentially accelerate as a part of its much-larger operations. MAKO also fits nicely within Stryker’s existing implantable orthopedics operations.
Of course, there will be some operational synergies to provide cash savings given their overlapping SG&A costs, so the 83% premium may not look nearly as rich if Stryker is able to achieve improved operating margins.
Could Intuitive Surgical become a target?
All controversy aside, Best Ideas Newsletter portfolio holding Intuitive Surgical’s (click ticker for report: ) financial results considerably outpace those at MAKO. We believe revenue will grow 7% year-over-year to $2.3 billion in 2013, but more importantly, we expect the firm to generate over $700 million in free cash flow. Unlike MAKO, Intuitive Surgical is a proven cash cow, and even if system sales growth remains lower than the pace of previous years, the firm’s recurring revenue model will provide it with plenty of cash flow going forward.
Given the rich premium Stryker was willing to pay for a significantly smaller and unprofitable robotic surgery maker, we think the exceptionally-profitable Intuitive Surgical could make an interesting acquisition target. Intuitive Surgical currently trades at a sizeable discount to our fair value estimate, and opportunistic buyers could look to scoop up the company while financing remains inexpensive.
The only issue for a would-be buyer is size. MAKO cost less than $2 billion, which Stryker can pay comfortably out of its $4.65 billion cash balance. With a current market capitalization just shy of $15 billion and our belief that shareholders will demand a sizeable premium, it will be hard for any company to stomach Intuitive Surgical. Only major devices companies like Medtronic (click ticker for report: ) or Johnson & Johnson (click ticker for report: ) could afford the required price tag, in our view. GE (click ticker for report: ), fresh off divesting some of its non-core assets, is another potential acquirer. The latter is most intriguing to us.
Valuentum’s Take
We would love to say that Intuitive Surgical deserves an even higher premium than what Stryker paid for MAKO, but such a deal will be made complicated by Intuitive’s sheer size. Nevertheless, Stryker’s confidence in robotic surgery alleviates some of the fear we have about the efficacy and value proposition of robotic surgery. We continue to hold shares of Intuitive Surgical in the portfolio of our Best Ideas Newsletter.
Medical Devices: AFFX, BIO, BRKR, CPHD, ISRG, LIFE, MDT, MSA, SIRO, STE, STJ, VAR, WAT, ZMH