Medtronic to buy Kyphon to expand spine business

By Debra Sherman

CHICAGO (Reuters) - Medtronic Inc. (MDT.N) said on Friday it would pay $3.9 billion to acquire Kyphon Inc. KYPH.O in a bid to expand its growing spinal treatment business.

Medtronic -- the world's largest maker of medical devices including artificial spinal discs, heart pacemakers and insulin pumps -- would pay $71 cash for each Kyphon share, a 32 percent premium over Thursday's closing price. Kyphon shares rose in value by almost one quarter on the news.

The transaction, slated to close in the first quarter of 2008, is expected to be neutral to Medtronic earnings in the first full fiscal year after closing and boost earnings thereafter. Medtronic expects the deal, which carries a $95 million break-up fee, to generate revenue, cost and tax benefits.

"Long-term investors will like this deal," said Piper Jaffray analyst Tim Nelson. "With Kyphon, Medtronic will cover the complete arena in spine."

During a conference call with analysts, Medtronic Chairman and Chief Executive Art Collins noted that Medtronic's current spinal product offerings focus on invasive procedures, like spinal fusion, aimed at the younger patient suffering from scoliosis and degenerative disc disease.

Kyphon's products, he said, address the faster-growing older population suffering from vertebral compression fractures and spinal stenosis. Its products primarily employ minimally invasive techniques and procedures.

The deal, which does not preclude Medtronic from pursuing more acquisitions, would allow the company to broaden its product line, expertise and customer base, he said.

But many analysts fretted over the price.

"Medtronic's acquisition of Kyphon is consistent with our view that Medtronic will continue to diversify through M&A, further delaying improvements in shareholder returns as the price paid was dear in our view," Morgan Stanley analyst Glenn Reicin wrote in a research note.

Robin Young, editor of the trade publication, Orthopedics This Week, added: "Of course they're paying too much, but this is an extremely strategic deal. No two firms have been as smart or right in trying to predict where this (spine) market is headed. If it works, it'll be one of the big successful transactions in orthopedics and we'll look back on it as a hallmark deal."

Jeffrey Jonas, portfolio manager for Gamco Medical Opportunities Fund, characterized the deal as neutral to positive, noting Medtronic was paying a hefty price of six times sales.

"But they're getting some great products that will fill in gaps in their spinal portfolio. And Kyphon's growth is phenomenal ... 30 percent per year, and (Medtronic) will get lots of synergies."

Joanne Wuensch, an analyst with BMO Capital Markets, said in a research report: "We believe that this acquisition is an excellent fit for Medtronic, combining leading technology, a rapidly growing top line, a top-notch sales presence, and creating a stronghold in the spinal industry."

Michael Barr, an analyst with Victory Capital Management, which owns shares of Medtronic, said he hopes the deal doesn't represent a departure from the company's stated policy of making smaller acquisitions.

"I'm a return-on-capital investor and I don't like to see too many big deals. I can't put this in the category of too big, but I hope there aren't more. This deal definitely puts the spotlight on (calendar) 2008 earnings," Barr said.