Zimmer Tops on Q1 Earnings, Announces $13.4B Acquisition

Zimmer Holdings (ZMH) reported first-quarter 2014 adjusted earnings per share of $1.50, up 6.4% year over year and 3 cents higher than the Zacks Consensus Estimate. After including one-time items, the company reported earnings of $1.29 a share, a marginal increase of 1% year over year.

Revenue Details

In the first quarter, revenues stood at $1.16 billion, up 2.0% (up 3.2% at constant exchange rate or CER) year over year. However, the top line missed the Zacks Consensus Estimate of $1.18 billion.

Revenues generated in the Americas were $638 million (up 1% year over year at CER). The same in Europe grossed $327 million (up 4% at CER) while in Asia-Pacific the figure was $196 million (up 8%).

Segments

Zimmer’s biggest segment – Reconstructive Implant recorded revenues of $872 million, up 4% year over year at CER. This was due to an improvement of 2% in the Americas combined with an 8% increase in Asia Pacific and 4% sales growth in Europe.

Revenues derived from Knees (within Reconstructive) were up 4% year over year at CER to $487.9 million, while Hips recorded flat sales of $331.7 million compared with the prior-year quarter. Revenues from Extremities increased 9% year over year to $52.1 million.

Among the other segments at Zimmer, spine recorded an increase of 1% at CER to $48.3 million whereas trauma declined 3% to $79.7 million in the reported quarter.

Mega Acquisition Announcement

During the first quarter earnings call, this leading player in musculoskeletal space also disclosed that it has entered into a definitive agreement to acquire Biomet, Inc. – provider of surgical and non-surgical products used primarily by orthopedic surgeons and other musculoskeletal medical specialists, for a transaction value of $13.35 billion.

According to Zimmer, the successful completion of this acquisition, which is expectedin the first quarter of 2015, will be beneficial for healthcare investors as the merged entity willsuccessfully advance innovation and help create a more diversified and predictable revenue mix consistent with the comprehensive portfolio.

The company believes this impending acquisition will be perfectly in line with its strategic framework that focuses on growth, operational excellence and prudent capital allocation.

Moreover, Zimmer expects enormous financial benefits out of this takeover. According to the company, upon completion, the transaction is expected to be accretive to Zimmer's adjusted earnings per share in double digits in the first year. Moreover, by the third year, the net annual synergies are expected to reach approximately $270 million with roughly $135 million anticipated in the first year itself.

The combined entity will also likely generate operating cash flow of more than 1.5 times Zimmer's stand-alone estimates. Accordingly, with strong cash flow, Zimmer is expected to maintain a stable dividend of 15% to 20% of net income following the closure of the transaction.

2014 Outlook Revised

Zimmer reiterated its full-year 2014 revenue guidance in the range of 3.0% to 5.0%.The currency movement is expected to lower revenues by 0.5%, which in turn would lead to 2.5% to 4.5% revenue growth on a reported basis.The current Zacks Consensus Estimate for revenues remains at $4.79 billion.

However, based on an increase in the anticipated number of weighted average shares outstanding for 2014 due to the impending acquisition of Biomet, the company updated its adjusted earnings guidance. The company currently expects adjusted earnings in the range of $4.90 to $5.10, a decline from $6.10 to $6.30 guided earlier. The current Zacks Consensus Estimate of $6.21 remains way above the guided range.

Our Take

We believe, with the grand $13.35 billion acquisition of Biomet, Zimmer will be able to create a market leader in the $45 billion musculoskeletal industry thereby improving the merged entity's position in the competitive niche. We are impressed with the company’s strong strategic and financial goals which the combined entity expects to reach after closing of the deal. However, for the time-being, we remain on the sidelines and wait for further details on the same.

Zimmer reported a mixed first quarter with bottom-line beat and top-line miss. Barring trauma revenues, which continue to remain as a key disappointment, we are encouraged by the balanced segmental sales growth which acted as a major upside for the company.

Currently, Zimmer carries a Zacks Rank #3 (Hold). Medical products companies such as Enzymotec Ltd. (ENZY), Perrigo Company Public Limited Company (PRGO) and St. Jude Medical Inc. (STJ) are worth considering. While ENZY sports a Zacks Rank #1 (Strong Buy), PRGO and STJ both hold a Zacks Rank #2 (Buy).

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