The respective shareholder bases struggled to understand the strategic rationale for the deal (i.e., Why do the companies need to combine as a single entity?) and worried that the deal was more defensive than offensive in nature (i.e., Did the merger signal an upcoming slowdown in core growth trends for either or both companies?). Sirona investors were also disappointed in the lack of a takeout premium in the deal, although we'd argue that in a merger, there rarely is (and by definition shouldn't be) a sizeable premium paid for the acquired company.
Despite the lack of enthusiasm for this deal, we actually upgraded our rating of Dentsply to outperform from neutral the morning after the merger was announced. We already had an outperform rating on Sirona at that point and left that rating unchanged. We believe there are a number of positives with this deal:
1. Dentsply not only gains entry into the rapidly evolving (by dental standards, anyway) digital dentistry market, but does so with a partner that many consider to be the leader in digital dentistry.
2. Sirona gains access to a recurring revenue stream (i.e., Dentsply's consumables dental supply business), which should help smooth some of the volatility seen in Sirona's performance over the years. From a high level, investors tend to worry less about recurring revenue stream businesses such as Dentsply and more about capital equipment companies like Sirona.
3. We also foresee a number of product development synergies. The line between dental equipment and consumables is blurring and equipment increasingly is being used to optimize the functionality of consumables. Because of this, there are opportunities in dental implants, orthodontics, endodontics, and even general dentistry, where product development from a combined Dentsply Sirona could be more robust and more innovative than what we might have seen from either company individually over the coming decade.
4. We also believe a combined Dentsply Sirona will be able to more actively pursue additional deals over coming years. Many dental manufacturers have a mix of equipment and consumables-which doesn't make perfect sense strategically for a consumables-only company (e.g., Dentsply) or an equipment-only company (e.g., Sirona).
Beyond the potential product integration benefits, there will undoubtedly be cost synergies generated by the combined entity, a point that is admittedly more compelling for Wall Street investors than for employees of either firm. For dentists, however, we see very little risk that day-to-day experiences or interactions with either company will change. Management from each company is adamantly discussing the need to keep, if not expand, the size of the combined sales force and host more, not less, continuing education and doctor training courses.
One final positive we've stressed is the sizeable cash flow that will be generated postmerger and the combined company's improved ability to access Sirona's growing cash hoard that's been somewhat trapped outside the United States in recent years. With greater access to the $500 million in cash currently sitting on Sirona's balance sheet and an annual free cash flow that should easily top $500 million, we expect shareholders to benefit from a greater ability of management to fund both internal and external product development efforts and potentially return some of this cash to investors in the form of share repurchases or an increased dividend over time.
Five key dental themes thus far in 2015 (from a Wall Street perspective)
1. Dentsply-Sirona merger: Easily the top story of 2015, as the planned merger brings together the world's largest dental consumables and equipment players and reflects a continued blurring of the lines between dental consumables and equipment.
2. Steady improvement of the US dental market: Based on our monthly dental surveys and reported results from the publicly traded dental manufacturers and distributors, it appears domestic dental end markets are back to growing 3-4%, levels we've not seen since prerecession days in 2007 and early 2008.
3. Shuffling of dental chairs: A-dec opened distribution to Henry Schein in May of this year, a move we never thought we'd see. Danaher then opened its Pelton & Crane and other basic equipment lines to Patterson for the first time in years. Patterson further expanded its basic equipment offerings this year by adding Belmont. Overall, our sense is interest in exclusive distribution agreements is waning throughout the industry, a trend that we believe is good for dentists.
4. Sirona giving the United States another go with its treatment centers: Sirona has attempted to enter the US market with its treatment centers in the past, but with the recent introduction of its Intego system, the company believes it now has an option that strikes the right balance between features, capabilities, esthetics, and price (modestly priced by European standards, but still expensive in the United States). Patterson began selling Sirona's treatment centers in mid-September.
5. Still waiting on tax incentives: We still don't have a final decision on section 179 tax incentive limits for 2015. As it currently stands, dentists will be able to write off only $25,000 worth of equipment purchases this year, but the hope is that Congress will still act to raise section 179 limits back to something much higher. Earlier this year, the House passed a bill to make section 179 permanent at $500,000 with bonus depreciation, while the Senate Finance Committee recently approved a bill containing a two-year extension of section 179 at the 2013 $500,000 level. The full Senate has yet to vote on this issue, however, and the number of official working days left on Congress' 2015 calendar continues to shrink, so stay tuned.
Bottom line: The Dentsply-Sirona merger brings together two powerhouses in dentistry and, in our opinion, is a deal that should benefit both investors and dentists over the coming decade.
Jeffrey D. Johnson, OD, MBA, CFA, is Baird's senior analyst covering medical technology. Prior to joining Baird full-time in 2003, he was an optometrist, an instructor of ophthalmology at Harvard Medical School, and an equity research intern at Baird. Jeff received his MBA from Northwestern University.