Merger Activity Brings This Health Care Industry Into Focus

Merger Activity Brings This Health Care Industry Into Focus

The health care sector is in focus on this week's news that surgical robot maker MAKO Surgical would be acquired by medical device giant Stryker for $30 per share. The $1.65 billion deal represents an 85% premium to MAKO's closing price the night before the announcement.

Did Stryker make the right move by absorbing MAKO Surgical? And if so, what does it mean for other surgical robot manufacturers?

The deal makes sense; the price may not
It's perfectly understandable why Stryker would do this deal. Stryker has seen business dry up this year and really needs something to move the needle. Revenue over the first half of the current fiscal year is up a scant 3%, and diluted earnings per share are actually down 23% in the same period as a result of significantly higher costs. MAKO's growth potential had to be attractive for Stryker, which is looking more and more like a lumbering giant. Now, Stryker will be able to meaningfully extend its reach into the lucrative and fast-growing surgical robot industry.

Indeed, MAKO presents a compelling growth avenue for Stryker. The company has registered impressive 22% revenue growth through the first half of the year. In addition, the volume of procedures utilizing MAKO's products has increased this year. Clearly, this is a company with positive momentum ahead of it.

In addition, MAKO has a clean balance sheet. The company holds nearly $63 million in cash and short- and long-term investments on its books, with negligible long-term debt to speak of. This helps significantly reduce the risk on Stryker's part.

At the same time, it's reasonable to call into question the massive premium that Stryker is paying for MAKO. While it's absolutely true that MAKO is growing revenue, profitability remains a constant concern. MAKO has not been able to demonstrate that it can be profitable with any sort of consistency, making such a huge buyout premium a questionable move. After all, at a $30 per share price tag, Stryker is paying more than 12 times 2012 sales for MAKO.

With M&A activity in the surgical robot space, the next question is naturally what this means for industry giant Intuitive Surgical , which has its own complicated situation investors need to sort through.

All eyes now on Intuitive Surgical
Intuitive Surgical is a very large company, one that holds a $15 billion market capitalization, making it an acquisition target for only the largest health care companies. While you can never rule out such a possibility, it seems likelier that Intuitive Surgical will remain a stand-alone entity. Therefore, the task for Intuitive Surgical is to turn itself around and reengineer growth.

That's going to be a difficult proposition for Intuitive Surgical this year, as it navigates a tough operating environment, one marked by increasing regulatory scrutiny. This has been a brutal year for Intuitive Surgical and its shareholders as it struggles under the weight of an FDA inquiry. Intuitive Surgical represents one of the worst-performing stocks this year, losing about one quarter of its value while the markets register strong double-digit gains.

All of this is because of the previously mentioned FDA inquiry into Intuitive Surgical's da Vinci surgical robots that first appeared earlier this year. Inspections conducted in April and May revealed links between the da Vinci robots and several deaths, calling the safety of Intuitive Surgical's robots into question.

Not surprisingly, when the FDA announces an inquiry, it's bad for business. This caused Intuitive Surgical to warn investors that growth this year would be heavily restrained, and those predictions are coming to fruition. These fears were realized when Intuitive Surgical posted weak second-quarter results, which showed that revenue clocked in at $578 million and earnings per share missed analyst expectations.

In the end, the deal makes sense
While we can quibble with the huge premium Stryker is paying for MAKO, it needed to do something to move the needle. Buying MAKO before it resumes profitability, which should happen next year by most accounts, is a shrewd forward-thinking move on Stryker's part. Should Stryker have waited until MAKO proved it could be consistently profitable, the price tag for a takeover would likely have been even higher.

Furthermore, I continue to view Intuitive Surgical fondly as well. For all its troubles and concerns over growth, Intuitive Surgical has still grown its business this year. Sooner or later, the FDA inquiry should subside without a devastating effect on the company, and what we'll be left with is a truly revolutionary technology and a stock on sale. As a result, the surgical robot industry stocks should be looked favorably upon by investors.

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Bob Ciura has no position in any stocks mentioned. The Motley Fool recommends Intuitive Surgical. The Motley Fool owns shares of Intuitive Surgical. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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