Apax’s bid for Smiths is too little too late

TOO little, too late. That is the upshot of Apax’s £2.45bn bid for Smiths’ medical division, which sent the firm’s share price up by 7.72 to £13.81 yesterday.

Too little because although the offer – almost half of Smiths’ market cap – seems high, it does not account for the huge break-up premium a buyer would have to pay.

The medical business accounted for around 35 per cent of operating profit last year and 31 per cent of Smiths’ £2.8bn sales. So on the face of it, Apax is offering a hefty mark-up.

But without medical, Smiths faces an uncertain future. Unless management were to pursue an all-or-nothing break-up strategy and find buyers for its four remaining divisions, the rest of the group could be downgraded. It is far from guaranteed that the remaining four businesses could find buyers willing to pay anything near the mark-up being offered by Apax.

Paradoxically, the amount that Apax is willing to pay only serves to illustrate that Smiths can’t afford to let medical go unless it gets an offer it can’t refuse (likely north of the £3bn mark).

Too late because chief executive Philip Bowman has already started to turn the division around. When he joined Smiths in 2008, the medical arm would have been the last one expected to attract a bid. It was plagued by supply chain and IT problems and was spending too much time on low-margin business.

Bowman has made big changes. The firm no longer makes diabetes pumps, for example, having accepted that Medtronic and Johnson & Johnson had already cornered the market. This decision, and others like it, allowed it to concentrate on more profitable work. Margins at the medical business now stand at around 22 per cent – a decade-long high.

As a private equity firm, Apax needs to squeeze more value from the business before selling to an end buyer. But with the turnaround plan in full swing, it is unclear how it would do so. There are no similar medical businesses in the Apax stable that would allow it to make significant synergies, for instance. That suggests it would pursue an injudicious round of cost cutting followed by a quick sale.

Management can get more for shareholders by completing the turnaround plan and eventually selling to a medical consumables manufacturer like Baxter, Becton Dickinson or Covidien. Investors can make more in the long run by cutting out the middle man.