Smiths Group plc (SMIN) Earnings Call Transcript & Summary

Good morning, everyone, and thank you for joining us today on such short notice. With me in London this morning is John Shipsey, our CFO; and Jemma Spalton, who leads Investor Relations for Smiths. We're pleased to announce that we have received a higher value offer for Smiths Medical from ICU Medical, a U.S.-based leader in Medtech. After thorough consideration, we've agreed to sell the business to ICU on terms that are superior to the deal we announced last month with TA Associates. Today's transaction values our medical business at an enterprise value of USD 2.7 billion, which is about USD 0.4 billion higher than the TA proposal. On this morning's call, I'll walk you through details of the transaction, how it compares to the previously announced deal, the proposed use of proceeds and the timeline moving forward. Let's begin with the details of this morning's announcement on Slide 3. The headline here is that the ICU transaction is superior to the previously announced agreement with PA in several respects. First, both the enterprise and equity values are about USD 0.4 billion higher than the TA deal. Second, you'll recall that we renegotiated a retained equity interest in the TA agreement in order to participate in expected future value creation. We work a similar, but we believe even more attractive structure into the ICU transaction. As part of purchase consideration, we'll receive 2.5 million newly issued ICU shares valued at just over USD 500 million based on yesterday's closing price. These shares represent just over 10% of ICU. A number of growth cost and capability synergies are made possible by this combination, and we, of course, want to share in those as ICU was publicly traded on the NASDAQ that participation will now come in a more transparent and liquid way. The third incremental benefit of this deal concerns cash proceeds, which are just about $50 million higher. We engaged an extensive shareholder consultation following the TA announcement, which resulted in our proposal to return 55% of upfront cash to shareholders via buybacks. We will replicate that approach here, albeit with a somewhat higher return amount. And fourth, while completion of this transaction is only contingent upon approval by our shareholders and clearance by regulators, time to completion will likely be longer. As such, we negotiated a $300 million one-way break fee in recognition of this. In light of these benefits, which we view as significant, our Board of Directors has withdrawn its support of the TA transaction. Slide 4 gives a side-by-side comparison of the 2 deals and a bit more detail on the points I just covered. I'll highlight 2 things here by way of completeness. First, the shares we receive in ICU are subject to a 6-month lockup. While we have no further sale restrictions thereafter, we would need to hold at least half our initial stake in order to qualify for the earn-out, which is triggered when ICU stock averages $300 per share for any 30-day period in the first 3 years or 45-day period in year 4. $300 per share represents an increase of around 50% from today's levels. Second, upon completion, we will take a seat on the ICU Board. In the case of the TA transaction, where we would have owned 30% of the business, we would have had 2 of 6 seats. Here, we'll own about 10% of ICU and hold 1 of 9 seats. Please turn to Slide 5 for more on the expected approval timeline and proposed use of proceeds. As was the case with the TA deal, we are required to carry out a nonbinding consultation with our French Works Council. With TA, we did this prior to signing. Circumstances didn't allow for that here, so we'll start that process shortly. For clarity, while Smiths will ensure the views of the works council are properly considered the council's opinion on the ICU offer is purely consultative and not binding. Once complete, we expect our Board to unanimously recommend the ICU transaction. The remaining steps to completion include obtaining the customary regulatory clearances, and we expect to close during the first half of 2022. As mentioned, the quantum of returned proceeds will be a bit higher here although the proportion in mechanics will mirror the TA transaction. Also in parallel, retained proceeds will be used to further strengthen our balance sheet in support of value-accretive growth opportunities. I'll wrap up on Slide 6 by noting that in early August, we delivered on our commitment to separate medical on the timetable promise. At that time, TA's offer was the highest and best available and provided both immediate value as well as upside potential. Today's announcement preserves that balance and does so with increased value and greater flexibility. The medical separation position Smith as a more focused group with compelling opportunities for growth. In the short time since the August announcement, we've already felt the impact of this, as our energy and attention has tangibly shifted to our higher-performing industrial technology core. I'm looking forward to sharing our full year results with you in just a few weeks and then going more deeply into our strategy and priorities at our Capital Markets event on November 17 and 18. I'd like to take this opportunity to thank all Smith's employees for the hard work and dedication that makes this performance possible. In the same way, we're grateful for the strong support we enjoy from our customers and shareholders. With that, I'll pass it back to the operator for any questions that we might have. Thank you.

[Operator Instructions] Our first question from the line of Andre Kukhnin from Crédit Suisse.

I've got 2 areas I want to touch on. Firstly, the stake you have in ICU, would you view it as strategic -- I realize as you've just said, you've got lockup and there are conditions for the earnout to be met, but just thinking about the kind of the broader context here.

No. We view it as consideration for the sale of Medical we separated Medical to focus our energy, our resources and our capital on our industrial technology for, and that is what we'll do.

That's very clear. And -- regarding the potential antitrust or regulatory risk to this deal, could you talk through the main potential risks here? And are there any key milestones that we should be looking out for in the course of the next 6 to 9 months to track the progress of that?

Yes, these 2 businesses are highly complementary, both from a geographic and a product portfolio perspective. We believe that the merger will benefit patients and customers by combining these complementary strengths. As such, we expect the deal will be approved and have built in a time line to achieve that.

And in terms of anything we can follow in the public domain to track the progress of that? Or is that just subject to your announcement?

No, there wouldn't be anything in the public domain as far as I'm aware in terms of how the regulators process their work.

We will now take our next question from the line of Mark Davies Jones from Stifel.

Can I just follow up on that last one. You sounded confident on that regulatory point of view. And I understand there's not a huge amount of direct overlap between the product suites. But in the release today, you say that there are some circumstances in which closing could be extended out to March 2023, which seems a very long way distance. So what conceivably could cause that sort of scale of delay in this moving ahead, do you think?

As I mentioned, there's good geographic complementarity here. And so that could lead to more filings across countries relative to TA for instance, which is a financial buyer that wasn't that complementary overlap. I guess we were just being cautious in what could happen.

Okay. Understood. And perhaps I can ask one to John. The adjustments between enterprise value and equity value are the same as you suggested in sort of the round, but it's still a big number. Can you give us any more color on how that breaks down? I understand some of it relates to future liabilities for the medical business, but some of it is balance sheet adjustment. So how much of that $400 million actually impacts the kind of opening balance sheet of the continuing operations. If you could split the bits of that out for us a bit, that would be helpful.

Thanks, Mark. Yes. So the difference between equity and enterprise is exactly the same as under the [ Truly ] transaction. So you're right, it's about $0.3 billion. And as we said before, there is about -- $0.1 billion relates to future obligations in regard to regulatory and a commercial partnership within medical and the rest are normal balance sheet. So lease liabilities and tax, for example, is the remaining $0.2 billion. So that's the amount that will affect going forward the opening balance sheet.

We will now take our next question from the line of Bruno Gjani from Exane BNP.

It's Bruno Gjani from Exane BNP. Just a quick question in relation to the ICU stake. You do not consider the stake strategic? Just keen to understand how you think about your ultimate exit in the likely time frame. So is it your intention to sell down that half of your stake, not so long after that 6-month period elapses? So you can truly focus on that industrial business or should we instead expect slower gradual exit?

Yes. Bruno, thanks for the question. We consider the ICU shares at purchase consideration. One of the features of this transaction that I mentioned in my presentation that we view as more attractive than the TA proposal is that ICU is publicly traded. There is a 6-month lockup on our shares. And after that, we're free to do as we deem appropriate with those shares. Two other things I should note in that regard, there is a $100 million cash earn-out as part of this deal, and eligibility for that earnout requires that we hold 50% of our initial stake. So we will have an incentive, but not a requirement

Understood.

Bruno, it's John. Just 1 further element that's relevant. -- from a tax perspective, there is an incentive for us to hold on to a 4, 12 months minimum. We do that holding 10%, we would have a substantial shareholding redemption. There would be no tax on sales.

Understood. I just was wondering if you could provide any comments around what you intend to do with the cash when you ultimately exit that ICU stake? I guess should we expect a similar proportion of cash to return to shareholders are around that 55% level? Or is your thinking somewhat different? Any color here would be super helpful and appreciated.

Yes. Bruno, your thought on it. We consulted to shareholders, and we think the same methodology and quantum, so 55% share buyback would apply in this transaction as well.

We will now take our next question from Edward Maravanyika from Citigroup.

I've just got 2 questions. The first one, after receiving the ICU offer or proposal. Did you go back to TA and give them a chance to respond to that? Have they had any communication with you soon? And just secondly, could you please just remind us of the -- kind of the opportunities of the ICU Medical with Smiths Medical attached to it? So where do you see the upside?

First, thanks for the question. With respect to -- going back to TA -- when the announcement was made this morning, we did reach out to TA but we didn't feel it would have been appropriate to negotiate their already accepted offer while we were negotiating another one. Second, your question in terms of the synergies here, they come in 3 ways. The primary benefit here is to patients and customers. There is terrific complementary in terms of both geography and portfolio, as I mentioned. So for example, ICU has large volume pumps while Smiths has ambulatory and syringe pumps. They make a nice combination together. As another example, ICU is strong in something called CSTD closed system transfer devices. These prevent contaminants from entering a vascular access system. We offer something called PIBCs, Peripheral Intravenous Catheters, which sit downstream from the CSTDs. So there's a very natural combination there. Then as a third example that comes to mind, ICU offers IV sets that are used in pediatrics. Smiths is a leader in pediatric airway management. These are sold at the exact same clinical call point. So very nice complementarity here. There's also infrastructure synergies, for example, in IT, procurement and supply chain. Both of the businesses run Oracle, for example. And then there's other strategic synergies that come from increased scale and scope.

[Operator Instructions] And we will now take our next question from the line of Denise Molina from Morningstar.

Just going back to capital allocation and the use of proceeds but maybe also broadly on where you think you might be reinvesting in the future? And specifically, with John Crane probably, interested to know what you think about the long-term positioning away from OMV, understanding that's not going to drop away overnight. But if you think that there might be other verticals you might be investing in either organically or through strategic acquisitions with ease of proceeds or maybe other cash flows down the road?

It's a good question, Denise. Thanks for offering it. Yes, there's a big opportunity across the core industrial technology portfolio. Specific to your question about John Crane, there's both a near-term growth benefit that I'll describe. And then a medium or longer term, that touches on, I think, the nature of your question. So in the near term, the energy sector broadly is recovering from the lockdowns. And as Crane is a very well-positioned participant in that space as that end-user market recovers we're seeing strengthening of the order book and expect that to benefit Crane here in the coming months. In the medium to long term, of course, there's a huge opportunity as the energy sector transitions from fossil fuels to other energy type. One of the really nice things about our John Crane business is that its technology applies to any rotating equipment. So any compressor or a pump doesn't need to be a fossil fuel. It can be water. It can be chemicals, it can be pharmaceuticals, and the second benefit is that Crane has a very substantial and well-placed service network around the world. And again, those service centers and the people and capabilities they're in can apply those skills to things beyond just servicing John Crane seals. So as that sector transitions here to alternative energy sources, Crane is ideally participated to help our customers navigate that.

I guess if I could just follow up on just thinking about how OMV has a lot of -- high temperatures, say, the margins on that business might be higher than, say, water because it's more highly engineered and more demanding. So I mean if you're thinking about replacement demand longer term from another vertical, what would be most attractive to you in terms of where you want to pivot kind of the product and the portfolio and service going forward?

I mean the benefit is in oil and gas, these are large, well-capitalized customers, and we have enviable positions with many of them. The big win for Crane is helping our customers solve their biggest problems. So as they go through in the oil and gas sector, the transition I talked about, or as pharmaceutical customers go through transition from traditional small molecule drugs to macro molecules or increasingly now vaccines or as the water market transitions, all of those are problems that Crane can be very helpful in helping to navigate. So there's many ways we can play here. And again, it comes down to these 2 sort of intrinsically and secularly strong capabilities that Crane has in terms of its technology is applicable to multiple applications and its service network is ideally placed to serve customers.

As there are currently no further questions, I would now like to hand the call back to the Chief Executive Officer Paul Keel. Please go ahead.

Again, I thank everyone for coming out this morning on such short notice. We're excited by the news. We think that this combination, first and foremost, is really good for patients and customers. And because of that, that will translate to benefit for both our stakeholders as well as ICUs. I would tell you while this news came as a surprise following the TA announcement. Our conversations and the work with ICU was quite constructive, and we think that bodes well for our partnership moving forward. With that, we'll wrap up, and thank you again for your interest and support.