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Zimmer-Biomet deal could stanch their bleeding at hospitals

May 5, 2014

The proposed $13.4 billion merger of Zimmer Holdings Inc. and Biomet Inc. could help slow the price cuts the two makers of orthopedic implants have suffered at the hands of hospitals the past few years.

Across the country, hospitals, including Eskenazi Health and Indiana University Health in Indianapolis, have focused on orthopedic implants as a way to save money. Rather than allowing individual surgeons to order products from any company, hospitals have created a central committee to limit the number of companies they work with and use their combined buying power to win lower prices.

Hospitals have had more and more power to do this because they have been consolidating and, in many cases, now employ the orthopedic surgeons that use Zimmer and Biomet products.

Prices for hip implants dropped 23 percent from 2007 to 2011, and prices for knee implants feel 17 percent during that time, according to a study by the Advanced Medical Technology Association.

No one expects that trend to end, but Zimmer's and Biomet’s combined heft should make their products harder to cut out entirely and make the combined company a stronger force in price negotiations. The combined Zimmer-Biomet would have 39 percent market share in U.S. sales of hip and knee implants, according to a report by Goldman Sachs. Their closest competitors, Johnson & Johnson and Stryker Corp. would have just 23 percent and 21 percent, respectively.

“This is important because although pricing headwinds in orthopedic implants are expected to continue, we believe that greater scale could mitigate some of those headwinds,” Cantor Fitzgerald analyst Jeremy Feffer wrote in a note to investors April 28.

About the Zimmer-Biomet deal, J.P. Morgan analyst Michael Weinstein wrote, “It further consolidates an industry that has been lacking in pricing power for the past decade. Zimmer is stronger as a result of the transaction—both competitively and relative to a customer base that continues to consolidate and gain leverage over the surgeon.”

Also, because Biomet has a stronger presence in the non-hip and knee areas—such as trauma, spine and shoulder implants—the combined company will have a broader portfolio that could also help when negotiating with hospitals, analysts noted.

Sales have been muted for orthopedic implant companies since a 2007 settlement with the U.S. Department of justice curtailed the companies' payments to surgeons that often juiced sales. After that, the prolonged recession caused many consumers—especially in the United States—to delay elective surgeries.

The two companies are expected to have combined sales of $8.4 billion next year, when the sale is expected to close.

Analysts do not expect the combined Zimmer-Biomet to retain every dollar of sales the companies have separately. As the companies thin combined sales forces, some of those lost relationships will lead to lost accounts and lost sales.

Also, the sheer disruption of combining two large companies can allow competitors to gain market share, as occurred after New Jersey-based Johnson & Johnson acquired Synthes Inc. in 2012.

“The company will try to minimize the loss of sales reps and is working to solidify contracts, but an integration of this magnitude could result in more dislocation than expected,” Jefferies analyst Raj Denhoy said in an April 25 note to investors.

But the savings Zimmer and Biomet expect to achieve from reducing sales forces, streamlining distribution and, not least, cutting redundant staff at their headquarters in Warsaw, are expected to more than offset any loss of sales.

The companies said they expect net savings of $135 million in the first year after the deal closes, rising to $270 million by the third year.

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