Why Now Is A Great Opportunity To Take Profit On Takeover Target Smith & Nephew plc

Smith & Nephew plc (LON:SN) is not an opportunity at this price, argues this Fool.

| More on:

The content of this article was relevant at the time of publishing. Circumstances change continuously and caution should therefore be exercised when relying upon any content contained within this article.

When investing, your capital is at risk. The value of your investments can go down as well as up and you may get back less than you put in.

Read More

The content of this article is provided for information purposes only and is not intended to be, nor does it constitute, any form of personal advice. Investments in a currency other than sterling are exposed to currency exchange risk. Currency exchange rates are constantly changing, which may affect the value of the investment in sterling terms. You could lose money in sterling even if the stock price rises in the currency of origin. Stocks listed on overseas exchanges may be subject to additional dealing and exchange rate charges, and may have other tax implications, and may not provide the same, or any, regulatory protection as in the UK.

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More.

Smith & Nephew (LSE: SN) (NYSE: SNN.US) is on a roll. If you are invested and you are perhaps tempted to cash in now, you may well be right. Here’s why. 

Performance/Premium

S&N shares have risen 7% since 23 December, when it was rumoured once again that S&N would be taken over by Stryker for about £13bn ($20bn). According to Bloomberg sources, S&N’s equity could be valued at almost 1,400p, for an implied 20% premium from its current level.

How realistic is such a price tag, though?

Firstly, S&N stock should trade below 900p to draw interest from investors, in my view.

Secondly, S&N is a prized asset but its shares had already gained 30% of value before Christmas Eve on the back of takeover rumours rather than meaningful operational improvements in 2014.

Value 

S&N’s share price rallied (+25%) to 1,100p in less than eight weeks to 10 June 2014. In those days, Zimmer had agreed to acquire Biomet for $13 billion, so investors decided to pay up for other takeover targets such as S&N in the sector. 

Based on S&N’s enterprise value (EV) divided by revenue, and EV/adjusted operating cash flow, the shares already trade in line with their mid-cycle multiples — and also trade at an implied 25% discount to peak-cycle multiples. In short, they are pretty expensive. 

While consolidation for medical device makers is on the cards, it’s unlikely that any buyer would be willing to offer a meaningful premium to S&N’s current valuation of 1,165p — although, admittedly, S&N could be broken up, while certain assets could be flipped to private-equity firms at a marked-up price. 

Another issue is that a tax-inversion deal isn’t likely to happen any time soon, although a smaller number of bigger players are competing in a sector where Medtronic and Johnson & Johnson may also decide to grow their asset base inorganically and, equally important, could deploy lots of cash held abroad.

S&N Is Not Cheap 

A full bid at 1,400p a share would value S&N at almost £13bn, for an implied forward adjusted operating cash flow multiple of about 11x — which seems a rich valuation for a business whose cost-cutting potential is more attractive than its organic growth prospects at this point in the business cycle. 

S&N stock is currently valued at a high multiple of 29x forward earnings, and trades 5% above the average price target from brokers, which are bullish, of course, about M&A prospects in a sector where rising costs point to more deal-making to preserve operating margins. Both S&N and larger players must also preserve market share as hospital consolidation in the US leads to lower budgets, which in turn puts pressure on suppliers’ profits. 

Yet do you recall what happened to the value of Shire when merger talks with AbbVie collapsed in October 2014? I would bet on a similar, painful outcome for S&N shareholders this year… 

Should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be assessed. Consider taking independent financial advice.

Alessandro Pasetti has no position in any shares mentioned. The Motley Fool UK has recommended Glaxo and Shire. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.

More on Investing Articles

Investing Articles

After it crashed 25%, should I buy this former stock market darling in my Stocks and Shares ISA?

Harvey Jones has a big hole in his Stocks and Shares ISA that he is keen to fill. Should he…

Read more »

happy senior couple using a laptop in their living room to look at their financial budgets
Investing Articles

How’s the dividend forecast looking for Legal & General shares in 2025 and beyond?

As a shareholder, I like to keep track of the potential dividend returns I could make from my Legal &…

Read more »

artificial intelligence investing algorithms
Investing Articles

Could buying this stock with a $7bn market cap be like investing in Nvidia in 2010?

Where might the next Nvidia-type stock be lurking in today's market? Our writer takes a look at one candidate with…

Read more »

Investing Articles

Is GSK a bargain now the share price is near 1,333p?

Biopharma company GSK looks like a decent stock to consider for the long term, so is today's lower share price…

Read more »

Snowing on Jubilee Gardens in London at dusk
Investing Articles

Could December be a great month to buy UK shares?

Christopher Ruane sees some possible reasons to look for shares to buy in December -- but he'll be using the…

Read more »

Young mixed-race couple sat on the beach looking out over the sea
Investing Articles

Sticking to FTSE shares, I’d still aim for a £1,000 monthly passive income like this!

By investing in blue-chip FTSE shares with proven business models, our writer hopes he can build sizeable passive income streams…

Read more »

Growth Shares

BT shares? I think there are much better UK stocks for the long term

Over the long term, many UK stocks have performed much better than BT. Here’s a look at two companies that…

Read more »

British Pennies on a Pound Note
Investing Articles

After a 540% rise, could this penny share keep going?

This penny share has seen mixed fortunes in recent years. Our writer looks ahead to some potentially exciting developments in…

Read more »