Background
In June, 2014, the world's #2 maker of medical devices, Medtronic, agreed to buy Covidien, a smaller company in the same industry.  The deal was valued at $42.9 billion, and it was a cash and stock deal.  The deal was done at a 29% premium over Covidien's June 13, 2014 closing price. The deal was described by Medtronic's CEO as a "strategic and operational alignment" and there were immediate benefits to be accrued by moving the company out of the country, to Covidien's headquarters in Dublin (Cortez & Welch, 2014).  The company disputes the tax argument, noting that it did not believe its 18% tax rate would change much with the move (Kelly & Roumeliotis, 2014).  Mostly, the value of the deal was the expected $850 million in annual savings that was expected to accrue from synergies in back office operations, supply chain, distribution and manufacturing (Cortez & Welch, 2014).

Medtronic was founded in Minneapolis in 1949 and built up a medical equipment business that spanned the globe.  It was the #2 supplier in the industry, after Johnson & Johnson.  Medtronic is still 2nd to Johnson and Johnson after the merger.  Medtronic's initial breakthrough in the industry came with a battery-powered pacemaker and eventually it began plowing more money into research and development  in order to succeed as an innovator in the industry.  

Covidien has a history dating to 1903, but the modern company was formed in 2007 when it was spun off from Tyco in 2007.  Covidien was Ireland's largest business, with a global presence and over 39,000 employees. The company had a market cap before the merger of just  $18.4 billion (Coyle, 2014).  Covidien, having been spun off by an American company, was trading on the NYSE at the time.

Both companies sold medical devices, so this was a merger of two competitors, though arguably with complementary product lines.  The medical devices industry is comprised mainly of large, global players.  Depending on the country, they either self-distribute or they work through wholesalers, servicing a variety of hospitals, medical clinics and physician's offices.  The products in this industry are a mix of commodities – standard goods which are easy to produce and for which there is little differentiation, and innovative products.  The latter category usually have some form of patent protection, though this varies by country.  Companies that focus on that strategy are differentiated, and they compete with both marketing and R&D spending.  The biggest markets for medical devices in the world are the developed countries, where health care spending per capita tends to be much higher, and where demand for high-end devices is much higher.  There are hundreds of thousands of different medical devices and supplies, so the industry can be fragmented depending on the product.  Major players will produce thousands of unique products, and work through their wholesalers to reach specific target markets.

Synergy in this industry reflects a few things.  First, it can reflect in the product mix.  Redundant products can be cut and the remaining one produced at a larger scale.  The product mix of two firms in this industry can be complementary as well, which leads to marketing and distribution synergies.  There are also patent synergies.  Much of the value of medical equipment companies, especially ones that focus on R&D, lies with their intellectual property.  By pooling resources, labs, researchers and patents, there is greater potential for the development of innovative new products.  This is something of a wild card, because new products are an unknown in terms of how successful they will be, but there is definitely potential for synergies at the R&D side.  Marketing and production economies of scale, as well as in administration , are other areas where synergies can be won.

The tax angle is something of a debate, but it does form the backdrop to this merger.  At the time of the merger, the sentiment was that US corporate taxes were becoming uncompetitive, mainly as other countries sought to simplify their tax codes, and...…and will be tough to achieve.  Some of the operational synergies cited are incremental in nature -10% here, 20% there.  Medtronic would broaden its product scope with the deal, because the product lines are complementary. 

There has not been enough time since the deal closed in January to truly know if the expected synergies are materializing.  The latest quarterly statement is from the end of January 2015, so does not include Covidien.  The only real gauge as to the success of the deal, then, is the stock market performance.  The enterprise value is $108.28 billion, which is up from the roughly $100 billion when the deal was announced.  The stock price has increased since October, accounting of course for some of the increase in the price of the deal.  But since the deal received its final approval in January, Medtronic stock has continued to rise. It currently sits at $77.61, up from the price at the close of the deal. With very little information on which to go, the deal looks like it has been a success thus far, but realistically it is too early to tell.

Conclusion

The Medtronic purchase of Covidien, announced last year and just finalized in January of this year, is an interesting deal for a couple of reasons.  First, Covidien was in healthy financial condition, and did not particularly look like a takeover target.  As such, Medtronic needed to pay a significant premium – 29% - to get the deal done. That has risen even further on the basis of the increase in value of Medtronic's stock since the deal was announced.  For shareholders of Covidien, the deal has been a good one. The other reason that this deal is interesting is that it seems uncertain that the synergies between the two companies are going to be sufficient to justify the acquisition premium.  There are some synergies, but a savings of $850 million per, discounted at 12%, only delivers value of $4.8 billion over the next ten years, which is…