Smith & Nephew (SN.) designs, manufactures, and markets orthopaedic devices and wound-care solutions. Approximately three fourths of the U.K.-based firm's revenue comes from knee replacements, hip implants, nails, fixation devices, and arthroscopy tools. The remaining 25% of revenue is from the wound therapy segment. Roughly half of Smith & Nephew's total revenue comes from developed European and Asian markets, 40% is from the United States, and emerging markets account for the remainder.
Smith & Nephew reported lacklustre first-quarter results, and we have not made any material changes to our valuation assumptions, though we plan to update our fair value estimate to reflect current foreign exchange rates. While certain factors, including severe winter weather and higher levels of cost-sharing, have had a disproportionate effect on first-quarter seasonality across the board, Smith & Nephew still underperformed compared to its peers. Although we still think the firm enjoys a narrow economic moat, we believe even more strongly that Smith & Nephew's moat trend is negative.
Smith & Nephew's surgical device division saw 1% underlying revenue growth, thanks mainly to strength in the sports medicine unit. We note that sales of S&N's hips and knees were flat, trailing estimated market growth of 2% and 3%, respectively. The wound management segment delivered flat quarterly revenue growth compared with the prior-year period, as weakness in the U.S. market was offset by demand in other markets. Although top-line results were anemic, the firm kept tight control over expenses and stayed on track with its operating margin.
Against the backdrop of rival Zimmer's planned acquisition of Biomet, we think S&N faces a more difficult task of remaining competitive in the U.S. Even though it has introduced a number of innovations that have set its products apart, S&N's smaller base of trained surgeons leaves the firm at a disadvantage as hospitals seek to whittle down vendor lists in order to flex more bargaining power. We estimate the three top-tier orthopaedic implant makers will control close to 80% of the market after the Biomet deal closes, and expect most hospitals will want to contract with all three, or at least two of the three. In our view, this consolidation makes it more challenging for S&N to remain on vendor lists, despite management's protestations to the contrary. We would not be surprised to see Stryker or Johnson & Johnson move to acquire S&N.
.jpg)
