Tom Salemi

The announcement that a consortium of private equity investors would take orthopedics giant Biomet Inc. private grabbed headlines as just the latest in a string of high profile buyout bids in this sector. But the $10.9 billion bid could say as much about the orthopedics industry as it does about the star power of private equity investors.

Biomet’s board of directors unanimously approved the merger agreement to sell the company to the syndicate of the Blackstone Group, Goldman Sachs Capital Partners, Kohlberg Kravis Roberts & Co. and TPG. The parties (who won’t publicly comment on the deal until it closes) have until the end of October to complete the purchase, which would pay Biomet shareholders $44 per common share, representing a 27 percent premium over Biomet’s closing price on April 3, 2006. That’s the day before speculation about a sale started circling Biomet. [See Deal]

Technically, only a shareholders vote remains but a few additional obstacles still stand in the way including at least two lawsuits filed by shareholders seeking to quash the deal (or bump up the price). Furthermore, the company also faces shareholder suits pertaining to alleged backdating of stock options,a practice coming under heavy fire on Wall Street. A review by the company’s board of directors revealed that the company had tied options to dates upon which shares were trading at low prices. A special committee of the board of directors is also investigating this issue.

Biomet, of course, remains one of a handful of orthopedics companies that had been subpoenaed by the US Department of Justice to appear before a grand jury as part of an investigation into sales and marketing practices in the industry.

Putting those hurdles aside as it’s unlikely none of those will kill the deal, the Biomet acquisition might serve as a model for other private equity investors. With hundreds of billions under management—and another significant year of fund-raising anticipated—private equity shops remain hungry for opportunities to commit large sums of money in companies with considerable cash flow. Orthopedics companies definitely fit the bill.

In fact, it’s worth noting that Biomet is actually the third orthopedics company to be acquired by private equity investors. Earlier in the year, Blackstone Group paid $870 million to take Encore Medical Corp. private. [See Deal] The acquisition reaped significant rewards for Encore investors including Galen Partners, which had invested in the orthopedic implant and rehabilitation supply company through a 2001 Private Investment In Public Equity. (See "Encore Medical Goes Private," IN VIVO, July 2006 Also see "Encore Medical Goes Private" - In Vivo, 1 July, 2006..)

Meanwhile, Warburg Pincus and The Vertical Group once again teamed up to acquire an orthopedics company. This time, the pair purchased Tornier Holdings SAS. (See "Tornier: Building an Extremities Play in Orthopedic," IN VIVO, November 2006 Also see "Tornier: Building an Extremities Play in Orthopedics" - In Vivo, 1 November, 2006..) Historically, the two firms have been active—and successful—investors in orthopedics with investments in Wright Medical Group Inc. and Kyphon Inc.

A deal by Warburg Pincus and Vertical group certainly isn’t unusual. But the timing of the other two purchases—both involving The Blackstone Group and its $14.6 billion fund—demonstrates a growing interest by firms not accustomed to medical device investing. "There’s not a lot of opportunity for private equity firms in medical devices as a whole," says John J. Viscogliosi, one of the principals of the Viscogliosi Brothers LLC, a merchant bank and investor focused on orthopedics. "So this is an opportunity for them to diversify into the medical area in a company outside of just services and hospitals."

Just how many other private equity firms follows this lead remains to be seen. On one hand, the orthopedics industry appears ripe for the picking. Mortimer "Tim" Berkowitz III, president and managing director of HealthpointCapital Partners, a private equity fund focused on the orthopedics industry, says the time has come to begin consolidating orthopedics companies.

Berkowitz offers the cardiovascular industry as an example. In 1995, half of the world’s cardiovascular industry was managed by the big five: Johnson & Johnson, Medtronic Inc., St. Jude Medical Inc., Boston Scientific Corp. and Guidant Corp. Today, the "Big Four"—minus Guidant—account for roughly 95% of the industry.

Switching to orthopedics, Berkowitz suggests that seven leading orthopedics companies account for half of the world’s business, with 1,500 considerably smaller companies managing the other half. If orthopedics follows the same route as the cardiovascular industry, there’s significant room for consolidation.

But the cardiovascular industry went through its maturation without the benefit of private equity dollars. Clearly, orthopedics can do the same but private equity firms likely will play a role as they look for companies to invest their considerable capital.

Moreover, the medical device industry—and pharmaceutical companies for that matter—might benefit from the shielding provided by being a private company. Investigations by the Department of Justice are serious for any company, but company executives could more easily muddle through the strains associated with government oversight, such as investigations or changes in Medicare reimbursement as private companies.

But private equity investors aren’t only interested in rescuing troubled companies. They want growth. Panelists assembled at this month’s J.P. Morgan conference say they worry less about quarter-to-quarter earnings than public investors do, but they still want growth stories. They also typically go in with plans to make some significant changes, either through addition or subtraction. As one panelist said, "If we’re going to let the company do what it always did, what’s the rationale for the investment?"

It’s difficult to tell what strategy Biomet will take when the private equity deal closes. Dane Miller, Biomet’s founder and CEO until his retirement last spring, will lead the company once again, this time as an investor alongside the private equity syndicate. No doubt, changes are coming but how drastic they could they be? After all, hip-and-knee replacement is perhaps the least dynamic of all orthopedics industries. First, innovation is glacial so no game-changing technology is on the horizon. Second, the customer base—surgeons—is very brand-dependent so converting new customers is exceeding difficult. Third, even with the overall aging of the population, growth rates on knee and hip replacements typically fall in the single-digits.

In truth, it’s these very qualities that make orthopedics a perfect place for private equity investors, who in general are more comfortable with bread-and-butter industries like retail or health care services, to dip a toe. Watching these investors—and their chosen chief executive Miller—take Biomet to a new level will be interesting, in part because Miller is the same dynamic leader who led Biomet into its present state.

But change can happen, at least on a smaller scale. Looking at past successes, Galen Partners scored on its initial investment in Encore by encouraging the company’s growth into the rehabilitation market. After the Galen investment, Encore devised a three-pronged strategy that shifted its emphasis away from its historic joint business and added orthopedic soft goods, and rehab. Zubeen Shroff, managing director at Galen Partners, says Encore and its investors opted for the broader strategy rather than engage in an expensive bid to acquire multiple implants. Plus, the broader strategy better served the company’s physician customers.

"The average physician in this specialty needs to do more than cut," Shroff says. "There is a whole tier of implanters who do two to three hundreds a year. But most of the implants are still done by guys who do no more than 100 cuts a year, and they still need to do more than an implant or a cut. They need to write prescriptions. They need to do physical therapy."

Encore grew largely through a series of acquisitions, both large and small, that could bring the company’s revenues to $450 million this year. Blackstone paid $6.55 for each of the company’s shares, representing a 31 percent premium to market. (Galen had paid $1.02 for its shares in 2001.)

Blackstone’s acquisition enabled Encore to continue its growth strategy. In November, Encore acquired Cefar AB, a provider of electrotherapy and rehabilitation devices based in Malmo, Sweden. Encore intends to merge its own European electrotherapy subsidiary Compex Technologies Inc., with Cefar, creating what it says will be the largest electrotherapy company in the world outside of the United States. [See Deal]

Could the deal have been done without Blackstone’s dollars? "Encore could have done the deal," Shroff says. "Would they have? The fact is the capital markets were not appreciative and for whatever reason the public market was not willing to create a currency for the company to do the next round of acquisitions."

But private equity investors are willing and they’re able. Still, the question remains, will it happen. In orthopedics, the Biomet bid will take the time and resources of most of the industry’s top-tier investors. The big names left off the list include 3i Group and Apax Partners but certainly others could step up to fill out a major syndicate.

Still, smaller deals are more likely and there are more players interested in those deals. HealthpointCapital will concentrate on lower-tier deals its $300 million fund, its second. Roundtable Healthcare Partners, with $400 million for its second fund, certainly is capable of stepping up as well. Plus, Wall Street is beginning to value companies operating in Biomet’s strata, such as Zimmer Holdings Inc. and Stryker Corp.

Biomet Deal Opens Door for PE Buyers

More from Archive

More from In Vivo