Wednesday, May 11, 2011

With CEO Out, Is Boston Scientific A Takeover Target?

Medical devices maker, Boston Scientific (NYSE: BSX), just announced that its CEO was leaving and its stock plunged 9%. This departure raises a question about whether this troubled company could be a takeover target. Should you invest?

Ray Elliot joined Boston Scientific, the second largest maker of implanted heart devices, such as stents and defibrillators, as CEO in July 2009 and he announced Tuesday that he was leaving at the end of 2011. Elliot had been known as "an industry tough guy" when he joined the company from orthopedics device maker Zimmer Holdings (NYSE: ZMH), according to Bloomberg.

But Elliot's bluster exceeded his performance. Under his tenure, sales fell -- 4.7% in 2010 to $7.8 billion and quarterly sales fell below the $2.1 billion level they reached the quarter before Elliot started there. In the most recent quarter, revenue declined 1.8% to $1.9 billion and Elliot was expecting a "difficult" 2011.

The sad thing is that Boston Scientific used to be a high flyer. It was one of the top performing stocks in my investment newsletter back in 2004. Between 2000 and 2004, its stock rose straight up from $6 to $45 as its Taxus dominated the market for drug-coated stents. But things went downhill and in 2006, Boston Scientific made what turned out to be a disastrous $27.3 billion acquisition of medical device maker, Guidant -- in a pyrrhic takeover battle victory over its stent rival, Johnson & Johnson (NYSE: JNJ).

What went wrong with this deal is an object lesson in what not to do in an acquisition. Boston Scientific overpaid, took on nearly $9 billion in debt, and in the process ignored technical problems with Guidant's defibrillators that led to costly lawsuits -- 4,000 of which were settled for $195 million. From its peak at $45, Boston Scientific stock is down 84%.

Is Boston Scientific stock a bargain at this price? At a P/E of 18.5, the company is expected to make $0.45 a share in 2012, up 15% from the $0.39 it's forecast to earn in 2011. If that 2012 forecast is accurate, the stock trades at a Price/Earnings to Growth (PEG) of 1.23, not overly expensive.

Unfortunately, Boston Scientific's short-term prospects are not as good. Its 2011 earnings are expected to be down 18% and the company is likely to suffer a talent exodus as its board spends the next few months trying to convince a new CEO to step in.

Meanwhile, Boston Scientific faces cash flow concerns. In 2011, the company is on the hook to repay $500 million in debt and in 2010, its cash balance plunged 75% to $213 million. How will it come up with the half a billion dollars? And in December 2010, the IRS charged Boston Scientific with underpayment of taxes to the tune of $525 million plus interest, according to its 2010 10K.

With all its problems, Boston Scientific is hardly the ideal takeover candidate. Yet its strong market position would make it a tempting target for J&J or market leader, Medtronic (NYSE: MDT) -- particularly if all its liabilities could be used to take a big bite out of the purchase price.

For investors with strong tickers and an iron-coated stomach, taking a bite of Boston Scientific at its current level, could be a profitable bet.

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