Picture a lion tamer in the ring.
He might command the big cats to balance on a ball or jump through flaming hoops.
But there’s one thing he’ll never do: turn his back on an animal that is his natural enemy.
Likewise, when competing companies consider business deals, they take extraordinary precautions to protect themselves from each other. But instead of whips and chairs, they rely on lawyers and clause-filled contracts.
Such is the case with Biomet Inc.’s $280 million binding offer for DePuy Orthopaedics Inc.’s worldwide trauma business – those instruments and implants used in emergencies rather than planned surgeries, such as hip replacements.
DePuy isn’t selling its trauma business so it can focus on another niche. The company will use that money – and a lot more – in its $21.3 billion purchase of Swiss orthopedics maker Synthes. Synthes is the world leader in trauma products. And to reduce the possibility of a monopoly, European regulators are requiring DePuy to sell its existing trauma business before buying Synthes.
The 100-plus page binding agreement between Biomet and DePuy keeps DePuy from talking to other suitors, locks in employee wages for two years after the deal closes and specifies the exact screw, staple, plate and pin designs that are part of the sale.
Experts in mergers and acquisitions say crafting a tight contract is the best way for sellers and buyers to guard against sabotage.
Of course, all the legalese in the world won’t protect a buyer if a deal is ill-conceived.
Two of the M&A experts interviewed questioned the wisdom behind Biomet’s acquisition offer, which would put the manufacturer in direct competition with DePuy for orthopedic trauma products.
Biomet’s lawyers have sharpened their clauses to protect the company in the impending deal.
Proposed deals can go wrong in several ways.
For example, a potential buyer could come in, examine his competitor’s operation and then decline to make an offer. By that point, however, the “buyer” could have learned various trade secrets that would give him a future edge when designing products or calling on clients, the experts said.
Luckily, there’s a clause for that.
A reverse termination fee is a fairly new phenomenon in acquisition contracts, said Thomas Lys, who teaches mergers and acquisitions at the Kellogg School of Management at Northwestern University in Chicago.
The potential buyer has to pay it – usually 4 percent to 6 percent of the total deal value – if he looks at the books, then walks away.
A forward termination fee – usually 3 percent to 4 percent of the deal’s value – is slapped on the seller if it shops the business to other companies after receiving the formal offer, Lys said.
“The tighter you write the prenuptial, the less problem there will be going into the future,” he said. “It’s not very romantic.”
The green light
The April 2 deal between Biomet and DePuy forbids both Warsaw-based parties from walking away – with one exception. DePuy wouldn’t be forced to sell if it didn’t receive regulatory approval for its Synthes acquisition.
That deal was approved April 19, giving Biomet’s acquisition of the DePuy trauma business the green light. DePuy is a subsidiary of Johnson & Johnson.
In its decision, the European Commission said Johnson & Johnson’s promise to sell its existing trauma business ensures “the merged entity would continue to face competition” and leaves doctors and patients with a sufficient choice of alternatives.
Although the regulatory hurdle has been crossed, other issues can arise after a deal closes, said Robert Bruner, dean of the Darden School of Business at the University of Virginia.
“The sellers might loot the company of its cash and assets; they might steal intellectual property or convince key clients to shift to another firm; or they might spread malicious rumors about the intentions of the buyer,” he wrote in an email.
Well-crafted acquisition contracts prohibit such actions by the seller or prevent them by including carefully structured incentives to promote positive behavior, he said.
George Geis is faculty director of the mergers and acquisitions executive program at UCLA’s Anderson, Calif., campus.
Like other academics interviewed, Geis hasn’t studied the specifics of Biomet, DePuy or their negotiated contract. Several equity analysts who do study the companies declined to comment on the pending acquisition for various reasons.
But based on years of experience, Lys can offer some observations from basic information about the deal.
DePuy wants to better position itself in the marketplace, Geis said. That’s evident from its offer to spend almost 100 times more to buy a global trauma business than it will receive for the one it’s selling to Biomet.
For its part, Biomet might be thinking the new business will couple well with the company’s existing assets, creating a synergy. This could allow Biomet to deploy the assets in a way DePuy couldn’t, Geis said. That asset might be an executive who the company believes has the right vision to grow the business, for example.
“The other possibility is that Biomet is suffering from what we call hubris,” or an inflated sense of its ability to make money from a situation that others wouldn’t consider promising, Geis said.
A spokesman for Biomet twice declined requests to comment for this article. A DePuy spokeswoman also declined to comment.
A third potential factor in Biomet’s strategy could be that DePuy is so eager to sell that it’s offering a great price on the business, Geis said.
Of course, he added, the reality could be some combination of those factors.
Often, acquiring companies make assumptions that might not materialize, Geis warned. For example, when Quaker Oats acquired the Snapple beverage brand, Quaker Oats believed Snapple’s independent distributors boost Gatorade, a brand Quaker Oats already owned. But that didn’t happen. Sometimes company officials assume there will be synergies that don’t materialize, he said.
In this deal, Biomet is making various assumptions. If those assumptions are reasonable, and if the sale price is reasonable, Geis said, “It could work out.”
A dose of doubt
Lys, of Northwestern University, expressed doubt, however.
“I don’t know what the buyer is thinking, but this seems like a difficult deal to pull off,” the professor said.
Because DePuy is acquiring Synthes, it will remain in the global trauma market, working in direct competition with Biomet.
“That’s a very dicey situation because now the seller has incentive not to wish me well. That’s a problem,” Lys said. “My advice to the buyer is: Be careful.”
DePuy could “scorch the earth” by mistreating customers it hopes to lure away from Biomet in the future, Geis said.
Although it might seem unlikely that DePuy could win back customers in such a scenario, Biomet’s lawyers clearly think the buyer needs to be protected from that situation. Multiple paragraphs in the contract outline how DePuy must conduct business until the closing date.
Specifically, the company is barred from poisoning business relationships, failing to protect patents and trademarks, failing to maintain buildings and equipment, firing employees or, conversely, granting workers huge raises.
Lys believes Biomet needs to insist on guarantees from DePuy.
“You know a lot about the stuff you sold me, and I know very little about you,” he said, summing up Biomet’s situation after DePuy starts running the Synthes business.
Another factor could make it difficult for Biomet to benefit from its purchase, Lys said. Often, an acquisition reduces the number of competitors in a marketplace, he said. That allows the buyer to raise prices, making it easier to post a profit.
But, in this case, DePuy will still be selling trauma products. That will keep Biomet from following one typical path to profit after the deal closes.