Smiths Medical, Inc. (SMIN) Earnings Call Transcript & Summary

Good day, and thank you for standing by. Welcome to the Smiths Group plc call. [Operator Instructions] I would now like to hand the conference over to your speaker today, Paul Keel. Please go ahead.

Good morning, everyone, and thank you for joining us today. For those of you, who I've not yet met, my name is Paul Keel, and I had the honor of joining this great company as CEO in May. I am joined today by our CFO, John Shipsey. We are pleased to announce that we have entered into a definitive agreement to sell Smiths Medical for a price of USD 2.3 billion plus an additional $0.2 billion contingent on future performance of Smiths Medical. This delivers on the commitment we made to separate this business and focuses our attention, resources and capital on the many exciting opportunities available to us in Smiths' attractive industrial technology core. Let me walk you through the details of today's announcement, beginning on Slide 3. We took the decision to separate Medical in order to simplify and position Smiths for more focused and accelerated growth. After evaluating multiple options available to us, including demerger as well as bids from both financial and strategic acquirers, we've chosen to sell Smiths Medical to TA Associates for $2.3 billion plus an additional $200 million earn-out. Smiths will invest around $0.2 billion of the sale consideration for 30% ownership of the newly separated business. We negotiated this as part of the deal because we strongly believe in the future value creation of the transaction. After reinvestment, deal adjustments and transaction costs, net proceeds will be about $1.8 billion. A significant portion of this will be returned to shareholders with the remainder being invested in Smiths' high-margin, high-return core portfolio. This transaction is conditional upon approval by Smiths' shareholders as well as typical regulatory clearances. Please turn to Slide #4, for details on transaction value and future upside. This transaction strikes a strong balance between immediate value captured through the sale and meaningful participation in future upside through both the earn-out and our retained equity stake. In terms of immediate value, our strategy from the outset was to pursue a dual path in order to maximize value across 3 variables: price, timing and certainty. Through a thorough separation process, that included full demerger preparation, a very public sale process and multiple bids, this is exactly what we did. We were in a position to choose from multiple options. And TA's offer was the highest and best in terms of all 3 variables I just mentioned: price, timing and certainty. In terms of upside potential, we participate in several ways. First, through the earn-out. Smiths Group will receive an additional $200 million in cash should certain performance objectives, which we view as reasonable, be achieved. Second, we enjoy upside through our retained equity stake. Smiths Medical is a good business in a good market. In recognition of this, Smiths Group has made sizable investments in medical over the years. This structure allows us to participate in the returns from those investments. In addition to immediate value from the sale and upside from both earn-out and equity, by far the biggest value creator is positioning Smiths as a more focused industrial technology company, I'll say more about this in just a moment. Please turn to Slide 5, for more detail on timing and proceeds. As mentioned, in addition to regulatory clearance, this deal requires approval by Smiths' shareholders. In support of this, the circular will be distributed as soon as practicable and well in advance of the general meeting, which we expect to hold in September. We will consult with our largest shareholders on the return of proceeds in the coming weeks, and we expect the deal to close by the end of this calendar year. Please turn to Slide 6, for more on the positive impact this transaction has on Smiths Group. In today's announcement, we also reiterate that our fiscal '21 performance continues in line with our expectations. And we foresee no change to our progressive dividend policy as a result of this transaction. Let me wrap up by noting that today marks an important milestone for Smiths Group. We have delivered on our commitment to separate medical in a way that captures immediate value for shareholders and allows for further value creation moving forward. Smiths is now a more focused industrial technology company with compelling opportunities for growth. I've been with this company for just over 2 months now and really like what I see. We have an attractive portfolio of well-positioned businesses, a common operating model and a shared purpose. I'm looking forward to sharing our full year results with you in September and outlining our strategic direction at our Capital Markets Day in November. With that, I'll pass it back to the operator for any questions that you might have. Thank you.

[Operator Instructions] Your first question is from the line of Mark Davies Jones.

Could you give us a bit more color on why you think this outcome is preferable to a demerger? If you're so convinced there's a lot more value to come out of medical why give 70% of that upside away to a partner, effectively, particularly if it's staying under the same management? And then more broadly, if you can just discuss what the considerations are in reaching the valuation because I appreciate it's the best available offer, but certainly relative to a lot of healthcare stocks and transactions, it looks like a very modest multiple. So what are the key considerations in the outlook that have been behind those kind of valuation levels?

Thanks for the questions, Mark, and good morning. Let me take them in the order you asked them, starting with sale versus demerger and then coming on to price. With respect to the sale, this transaction, again, strikes a very attractive balance, we believe, between immediate value capture through the sale and meaningful participation through both the earn-out and a retained equity stake. An even bigger driver of the value, though, is the positive impact that the separation has on Smiths Group. We now have a more focused portfolio of industrial technology businesses. Our strategy from the outset was to pursue a dual path in order to optimize across the 3 variables I talked about in my comments: value, timing and certainty. And this is exactly what we did, Mark. When we signed with TA, our demerger preparations were essentially complete. And on the sales side, we had multiple offers from both strategic and financial bidders. So TA's bid was the highest invest of all available options, both in terms of the purchase offers from strategic and financial bidders and relative to the demerger option that we were prepared to take. Let me say a few things now about price. Now I mentioned that Smiths Medical is a good business and a good market, which is true. But the fact is also true that it has underperformed its med tech peers. Against a peer group of mid- to high single-digit growers with strong operating leverage, this business has posted flat to negative top line growth and has seen operating margins contract about 6 points now in 3 years. And I think today's sale reflects that performance, which, of course, also contributed to our decision to separate. So why don't I pause there and see if this addresses your questions.

Well, it sort of starts. But obviously, the guidance from Smiths on the outlook for medical has been that after investment, we should see a return to growth and margins turning back to 20%, and if one believes that outcome, then 9x EBITDA seems like a very modest exit price. So clearly, there was some skepticism on the part of the potential buyers around that kind of outlook.

Well, first off, we would call it 10x EBITDA by our math. And I think I would just underline that the price has been fully market tested. The business has been very publicly for sale now for about 3 years. Dozens of parties participated in the auction, several conducted due diligence, and we received multiple bids. And then as I just mentioned, on top of all that, we completed all necessary steps to demerge. So Smiths is committed to separating this business, and we conducted a full and complete process to surface all available options to do that. And this clearly was the best option available.

Okay. Can I ask one slightly more detailed follow-up. There's some mention of the pensions in the statement. Maybe John could run us through what the issues there are because clearly, you're in substantial surplus, but this is a big asset to depart from the group. So what do you think the considerations are there? Is there any risk that, that consumes some of the proceeds?

Mark, so as you are aware, both our main schemes SIPS and TIGPS are both in a very strong funding position. They're both in technical provision surplus, not just accounting provision surplus at the last valuation. And indeed, we announced on TI that we -- with the agreement of the trustee, we would be pausing contributions as they progress quite close towards full solvency. We have a really good relationship with the trustees. It's important that I respect that relationship and don't prejudge the consultation that we will have with them. We have a really strong dialogue, and that's what got us over many years to this incredibly strong and enviable position. So I don't want to prejudge that. We will consult with them first. But as I say, I do draw your attention, and you know this, the strength of the existing position in terms of the covenants and the funding position of both schemes.

The next question is from the line of Andre Kukhnin.

Could I ask on the use of proceeds? Could you outline what your priorities are for that? And on the return part of it, do you, at this stage, have any preference of a buyback or a special dividend or any other structure? And the second question is on the 30% equity stake that you will hold in a new entity, is there going to be any put or cold structure around it? And lastly, just a much broader question, please. In terms of what the new ownership structure will bring to Smiths Medical that will yield better results. What is it that will be different there compared to how Smiths Medical was run within Smiths Group, given obviously your expectations for improved performance given the earn-outs, et cetera, if I could go over these, please, that would be great.

Sure. Thanks for the question, Andre. Let's start with proceeds. Proceeds will be balanced between investments in growth and return of capital to shareholders. We'll begin our discussions with our largest investors on the details of this balance as soon as possible, and then we'll provide further details in the circular, which we'll release well in advance of the shareholder vote. Respect -- with respect to the 30%, first, I would say that buying 30% of the separated entity was our decision. We negotiated it because we have invested heavily in medical over the years and strongly believe in the future returns available from those investments. I'd also say that while we'll sit on the board of the newly separated company, Smiths Medical is no longer an operating division of Smiths Group. Our time and attention will be squarely focused on building our industrial technology core. It goes back to the whole reason for separating this business. With respect to ownership under private equity as opposed to medical -- rather than Smiths, we announced our intention to separate the business back in 2018 in order to create 2 more focused companies with quite distinct strategies, and in doing so, to maximize value for all stakeholders. So we accessed some of that value today through the transaction, and we access future value through the 2 participation elements that I mentioned, the earn-out and our equity stake. As an independent company, Smiths Medical can now pursue the opportunities they have available to them and that, frankly, weren't priorities for the broader Smiths Group, again, the reason for the separation in the first place. And since we're retaining 30% ownership in the separated business, we'll participate in that upside.

The next question is from the line of Edward Maravanyika.

Just a question on any potential dissynergies here, maybe in the way of a shared R&D platform that you might lease or might get diluted with medical exiting. And with the disposal, how practically does this enhance growth at remain core?

Can you repeat the second question again, Edward, I didn't quite understand it.

Yes. Just with the -- so having done the medical exit, how does that practically enhance the growth opportunity set at the remaining industrial technology business?

Yes. Okay. So first question, potential dissynergies, no, nothing worth noting. It's a very separate business. It's a separate business in terms of its business model. It's a separate business in terms of its assets. It's a separate business in terms of its location. We don't see any entanglements here in terms of the separation. There will, of course, be a transition services agreement, principally related to IT, but I think that's the extent of it relative to your question. Your second question, how does the medical exit lead to acceleration of the core? It comes down to priorities. Smiths Medical has a very distinct strategy focused on different end users, has a different business model and has a different risk return profile for capital allocated to it. For the broader core of Smiths Group, the industrial technology core, those 4 businesses are all well positioned in very attractive markets. And just in my first 60 days here, have a very long list of opportunities available to them. But to translate that potential into financial results, we're going to need to allocate attention, resources and capital to them, and that is harder to do when you're in 2 very different businesses. So I'm quite confident that this move will result in improved performance for the core. And again, I'm excited to talk about that both when we announce results in September and then our Capital Markets Day in November.

No further questions at this time. So I'll hand back to the speakers.

Okay. So today is an exciting milestone for Smiths Group. We committed to separating this business in a way that would both access immediate value through shareholders and allow us to participate in future value creation moving forward. We believe this transaction does exactly that. So we're excited to engage now in discussions with our largest shareholders on the use of proceeds. And then again, speak with all of you in September and later in November, where we expect to have further good news in terms of moving forward with this great business. Thanks for your time.

We do have a couple of late questions that come through, if you'd like to take them.

Sure.

The next is from the line of Robert [ Davies ].

I'm Robert from Morgan Stanley. I guess my question was the original sort of genesis for selling the medical business was to plug a gap in the pension, which went away. I guess once the ball started rolling a couple of years ago, was there any opportunity to sort of put the hand break on and just wait for sort of 2, 3, 4 years of the benefits of the investment cycle you put through started to serve more fruit and potentially get more valuation out of that business? Or once its -- once the process started, was that -- effectively, [ do you ] kind of [ have taken the early ] decision? Just wanted to get a feel for how that thought process went?

So, Robert, I'm not familiar with the original genesis for the separation. I can't say that when I was in the process of joining the company and the 2 months that I've been here, I was given complete freehand by the Board to make a decision on what was in the best interest of Smiths Group and our shareholders. I have spent about a decade of my career working in med tech. I have worked in other multi-segment industrial companies, both of which have healthcare businesses. And I have sold healthcare businesses out of those similar entities before. So I think I have a pretty good feel for when a healthcare business fits inside an industrial parent and when there's greater value to be created through separation. And I wholeheartedly endorse the decision that was made 3 years ago to separate medical in order to focus on the many opportunities in the core.

Understood. And then my follow-up question was just the comment you made around medical effectively being a very different sort of separate entity within the overall group structure. Of the remaining 4 divisions, are there any that already have gone through the process of sort of legal separation or carve out in terms of operating as a stand-alone entity within the broader group? Or is everything -- or all the remaining assets sort of fairly embedded?

I would say the 4 remaining businesses share common operating models and a shared purpose. They are very similar businesses, asset light. They have both OE and aftermarket elements to them. So they have a lot of operating commonality. They are, though, distinct businesses. And while I'm quite happy with the portfolio we have today, just as we did with medical, we're in dynamic markets, and we're constantly evaluating our portfolio, and we'll take decisions dispassionately and objectively to maximize value to shareholders.

And then my final one is just really around, I guess, the challenges of getting sustainable growth at Smiths. In terms of your forward-looking expectations for the group from here, are you seeing the sort of remaining 4 divisions as the best structure for the business? Would it be better to focus in and around specific end markets so people get a greater clarity around the different drivers of the businesses? Or are you happy with the sort of the current sort of divisional structure? I guess my question is even if you didn't change the overall group assets, is there a potential to move things around or change the way that those assets are presented to the market? That was my final question.

Yes, it's a good question. So I would say that you all have seen our first half results that were quite encouraging. On this call, we reconfirm that we're tracking to our expectations for the full year, and we'll share those in September. We see a lot of opportunities in our core industrial technology businesses that we'll share in -- at the Capital Markets Day in November. With respect to specific structural changes, I don't anticipate any here. But certainly, that would be something that would underlie the strategy we discussed in the fall.

The next question is from the line of Bruno Gjani.

I just had one on the cost base. We're in the middle of a quite a significant restructuring plan. Beyond this plan, and I appreciate it's quite early, that do you see any further opportunities to cut costs or, perhaps, reduce complexity? Or are opportunities around the cost base, say, more limited given the scale of what the current cost savings plan?

Yes. Let me John fill that one.

Yes, Bruno. Yes, we have now completed that restructuring that we began just over a year ago. That is now -- that completed at the end of our fiscal year. We will continue to focus on speed and execution, and I think reducing complexity and simplifying is going to be fundamental to that. But we are not -- we are complete on the restructuring that we just carried out.

Okay. And just a quick follow-up. So in regards to the current plan, can you, perhaps, relate how much of the expected benefits are expected to be captured by the continuing group? And how much relates to medical [indiscernible]?

Yes, that's a good question. So we will -- so we did actually -- in our half year results, we did -- we -- right through January, we have always separated out what was medical and what was continuing operations. We will update that in September. I don't think I can speak to that today, but we will update you fully on that at the September results.

Understood. And I just had a final one, just quickly on net proceeds. But some of the net proceeds, it seems, will be used to delever. Up until what point do you aim to delever to? And how much of these medical net proceeds will be used to that? Are you able to shed any color on this at all?

Not at this stage, no, Bruno. We want to have an open dialogue with the largest shareholders and get the benefit of their input into it. Might be helpful for me just to -- for clarity to just walk through the march from the $2.3 billion enterprise value to $1.8 billion in net proceeds. Again, enterprise value is $2.3 billion, plus there's an incremental $200 million earn-out if certain performance criteria are met. Below that then, there's about $300 million of adjustments related to lease treatment, deferred tax and other future commitments we've made to commercial and other operating partnerships. That brings you to the equity value of $2 billion. And then below the $2 billion is the $0.2 billion for the 30% stake in the separated business. That gets you to $1.8 billion of net proceeds.

The next question is from the line of Mark Fielding.

Actually, the first question is a bit of a follow-on to that last question. Obviously, not precisely outlining where you want to delever to at this point. But more on an ongoing basis, how do you think about the sort of target net debt-to-EBITDA range that the industrial business might operate in? Obviously, the medical business was pretty consistently cash generative. So I suppose, how do you think about a target range? And just willingness to flex that target range as well for the right M&A? And then maybe related to that, when you're thinking about the use of process, just maybe a little comment on how attractive the M&A pipeline is looking for the industrial businesses right now?

Thanks, Mark. Appreciate the question. So a couple of thoughts in response. The first is, you're familiar with our peer group. So you'll know that, on average, their debt-to-EBITDA is below 1. We're closer to 1.8. So if we wanted to come in line with peers that would be notionally the area we would head to. Second comment I would make is that this is a very cash-generative business. We -- in the past, every acquisition we've done, in the near term, let me say, has not required outside financing that the cash generation of the business covers it. We have a healthy pipeline of interesting bolt-on targets for the 4 core industrial technology businesses, and we're constantly evaluating those. And if a larger transaction that fit with our strategy came together, certainly, we would look at whether we needed to secure additional financing to do it. But right now, that is not the plan.

And we have a question from the line of Andre Kukhnin.

It was more related to the core of the business. And may I ask -- do you see clear synergies across the 4 divisions and businesses within those being part of the same organization, same group?

Yes. So as I mentioned, Andre, I worked at 2 previous companies similar in structure to Smiths, larger in different end verticals, but similar. And from those experiences, synergies across portfolios like this can come in a couple of different ways. People often think of the hard synergies from shared infrastructure, plants that make products across multiple businesses. That does not exist here. These are discrete businesses with discrete supply chains. The second group of synergies comes from shared technologies that is available here. We have technologies, for instance, that we use in our detection business that can be applied to our Flex-Tek business. We have insights from our John Crane business that can be shared in other parts of the portfolio. So those are available to us. But thirdly, in my experience at least, the most valuable synergy that comes from these multisegment players like us in the U.K., like 3M, GE, Danaher, Honeywell in the States is from a common operating model. So a consistent belief in terms of delivery, a consistent belief in terms of shareholder value, consistent belief in terms of leadership development, operating rhythm, lean six sigma, et cetera. And I think that is the piece that will create the greatest value for Smiths moving forward. And again, now with a more focused portfolio, it's much easier to access those synergies because you have a more similar group of businesses, and you're able to focus your energy, your capital, your resources on those highest priorities.

And I guess on that common operating model, if I could dwell into it a bit more. From the peers that you mentioned, and you obviously have been inside them as well, my understanding is that it also comes with quite sort of ruthless implementation of portfolio strategy that's kind of weeding out of underperformers as well. Is that something that you'll be fully committed to at Smiths Group?

Absolutely, sure. I mean 60 days here, I have met, I think, now almost our entire senior leadership team, the top 200-or-so leaders and I would say I'm quite impressed with the Group. There's great capabilities, deep industry expertise. I don't think the gap here is in terms of capability. I think the opportunity for us is strengthening a culture where there's good routing around consistent delivery of results and a focus on continuous day-over-day improvement. And again, I've just seen that implemented in other companies and believe strongly it can be done here.

Very helpful. If I may just wrap up with kind of thinking about the Capital Markets Day in November. And what can we expect from that day? To me, it feels like we will not have any sort of earthshattering structural announcements as you said earlier, but there will be more about demonstrating how you can achieve this consistent delivery of results, as you just said, of kind of day-to-day basis. Is that kind of the right way to think about it? Or is there anything else we should expect from the Capital Markets Day?

Well, Andre, the nature of earthshattering announcements is that if you tell them several months in advance, they're no longer earthshattering. No, if we had something material to share with you, we would share it today like the announcement about the separation. We think it's going to be -- we have a great story to tell here. These are really good businesses and the length of really tangible opportunities in front of the 4 core businesses is significant. So I'm anxious to focus on those and tell you guys more about them, in particular, Flex-Tek and Interconnect. We do spend a fair amount of time on detection in John Crane because they're larger, but there's really good stories to tell across all 4. And it will be good to have some focused time with all of you to get under the hood there.

And there are no further questions. So I'll hand back to the speakers for closing. Thank you.

Okay. Thanks, everyone. You already heard my closing comments. So I'll just, again, thank you for your time this morning and looking forward to talking more in the weeks and months to come.

Thank you. And that does conclude the conference for today. Thank you for participating, and you may now disconnect.