Michael Harrison's Outlook: Smith & Nephew's O'Donnell sets his sights on another transforming takeover
Carphone and Voda back in talks; A trial that does Germany no favours
Friday 03 November 2006
Sir Christopher O'Donnell's last attempt to turn Smith & Nephew into the world's leading orthopaedic specialist ended in failure after it was outbid for the Swiss manufacturer Centrepulse in 2004. Will the UK company best known for its artificial hips and knees have better luck a second time around now that it has been forced to declare its interest in Biomet of the US?
Despite S&N's formal statement yesterday that it has only held "very preliminary talks", there is no doubt that it would love to get its hands on Biomet at the right price. Hips and knees have become a huge growth market as the baby boomers reach retirement and decide that their creaking joints need not stop them skiing and running around a squash court at 65. Who knows where the market will end up if biology replaces metallurgy and S&N starts growing replacement joints rather than building them.
S&N is increasing its sales at twice the rate of the overall market but it is still a distant fourth. A deal with Biomet, if Sir Christopher could pull it off, would be a transforming one, doubling the size of S&N and turning it into a £10bn company. It would also enable S&N to compete on an equal footing with the big three US makers of hips and knees - Johnson & Johnson, Stryker and Zimmer, its nemesis in the Swiss auction, giving the UK company a 20 per cent market share.
For anti-trust reasons, its US rivals might find it difficult to enter the auction. But that would not prevent a whole string of other medical technology companies without a presence in orthopaedic joints from taking a look now that Biomet's advisers Morgan Stanley have put the business on the block. Nor would it prevent private equity casting its long shadow.
As an existing player, there are some cost savings S&N could extract which are not available to other buyers. But in the biggest cost area - the sales force - the savings would be quite modest as orthopaedic companies which lose salesmen tend to lose sales.
Logical though a deal would be, S&N is probably right to be cautious. There are only two currencies in which it can pay - cash and shares. In a straight cash auction, private equity would always be able to outbid S&N. And, as it discovered to its cost during the Centrepulse bid contest, S&N's paper is worth a lot less than that of US healthcare companies.
Sir Christopher made it plain yesterday that S&N was not prepared to overpay. It would like to do a deal but it does not have to do one. After his Swiss roll, Sir Christopher must be worried about being turned over again.
Carphone and Voda back in talks
After their lovers' tiff last month, Charles Dunstone has obviously been on his Cath Kidston phone to Arun Sarin. The result: barely three weeks after Vodafone dropped Carphone Warehouse as its UK retail outlet for contract sales, precipitating a slump in the latter's share price, the estranged couple are back together talking about a pan-European deal. Clearly, money is thicker than water in the mobile industry and while Vodafone believed it was getting a raw deal from Carphone back home, its footprint on the Continent means that the two companies cannot afford to ignore one another.
The precise form the "pan-European framework agreement" will take is not clear although it will cover both subscription and pre-pay.
Alas, Carphone's insistence that it will not be harmed by the loss of Vodafone as a contract customer in the UK is still not believed by the market. Yesterday the shares lost another 4 per cent, even though neither margins nor footfall have been affected, nor will they be as the Christmas pre-pay handset boom gets into full swing. The shares look as though they have almost certainly been oversold. But Carphone can do nothing about that, other than continue with its strategy and its bold expansion into broadband, where the acquisition of AOL's customer base has turned it into the number three player in the UK behind BT and NTL.
For those of a nervous disposition, this is another reason to shun the stock. But the Dunstone logic looks compelling. After £70m of start-up losses this year, the broadband business is forecast to make between £30m and £40m next year. By then, Carphone expects to have one million subscribers on its own lines rather than leased BT capacity as the pace of local exchange unbundling quickens. That is crucial because for every £9.99 that Carphone takes from a TalkTalk customer on monthly tariff, half of that goes to BT to pay for the leased capacity.
Inertia and apathy remain an issue for Carphone as does the poor customer service its "free" broadband offering suffered from at the beginning. Although it now claims that waiting times for connection are down to five weeks, the anecdotal evidence suggests that some customers are having to wait a great deal longer.
The next important test will be to migrate the 1.5 million subscribers that the AOL deal brings to Carphone on to the network and into the unbundled exchanges. The good news is that they will all be able to keep their e-mail address - another of the factors that has helped BT keep such a large share of the market.
As Carphone grows and e-mail portability becomes as commonplace as number portability, BT will have little option but to respond, driving down the cost of broadband further. With its early-move advantage, Carphone should not have to worry.
A trial that does Germany no favours
The best entertainment to be had in Dusseldorf this week is not at any theatre or cinema but in the city's central court, where Josef Ackermann is appearing once again and by popular demand in the Mannesmann affair. This courtroom has witnessed the trial of many murderers and no doubt some of those queuing in the cold morning air yesterday for a seat in the public gallery wished a similar punishment on the chief executive of Deutsche Bank.
His crime? As one of the six non-executive directors on the board of Mannesmann when it was bought by Vodafone in 2000, he approved the payment of nearly €60m in golden handshakes to departing executives.
Mr Ackermann and his fellow defendants have already been tried once and acquitted but Germany's Federal Court of Justice decided to order a retrial on the novel grounds that they had failed to prove their innocence.
The initial prosecution was a show trial motivated by a desire for political revenge on a board which had failed to keep Mannesmann in German hands. This second trial is a plain embarrassment. The justification for the payments can be argued about until hell freezes over but the fact is they were approved by Mannesmann shareholders and came out of the pocket ultimately of Vodafone shareholders. Large though they undoubtedly were, they reflected the huge increase in value Mannesmann's chief executive Klaus Esser succeeded in wringing out of his opposite number Sir Chris Gent on behalf of all those German pension funds. Sir Chris was awarded a £10m success fee simply for pulling off the £100bn takeover - with hindsight a criminal price to have paid. His punishment was to be slapped over the wrist by the corporate governance police, not the prospect of ten years in jail.
With luck, Ackermann and his fellow cast members will strike an out-of-court settlement and pay their dues, bringing this tawdry episode to a close and allowing them, and Germany, to move on.
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