The aspiration for the biggest medical deal of the year is commendable — to transform cancer treatment so sufferers can live longer and better lives. In pursuit of this goal, German diagnostics group Siemens Healthineers has agreed to pay a high price to acquire US radiotherapy specialist Varian Medical Systems.

Covid-19 has displaced medical priorities this year. Cancer hasn’t gone away, but spending on the technology used to treat it has, at least temporarily. With elective procedures pushed out to make space for coronavirus patients, and hospitals spending heavily on safety measures, Varian’s underlying revenue fell 19% in its most recent quarter. A 14% decline in orders for its oncology systems division was a troubling indication of the future trajectory.

It’s the same challenge everywhere. Siemens Healthineers isn’t replacing its order backlog at the same rate it’s making shipments to customers. The company, whose controlling shareholder is industrial group Siemens, points to an “investment reluctance” caused by the pandemic. Rival General Electric recently warned of a challenging environment for its health-care business.

That backdrop may explain why Varian was willing to consider an all-cash takeover by Siemens Healthineers even though its stock had bounced from its March lows and was approaching pre-pandemic levels.

Strategically, the deal marks a new departure in marrying diagnostics with treatment. The thinking is that customers will benefit from a having a company that provides the kit for both, and that research & development will become more productive.

But financially, this is an expensive transaction despite a seemingly low 24% takeover premium. Strip out Varian’s small amount of net cash and the deal will cost about $16bn. Varian’s operating profit is forecast to be about $600m in its 2021 financial year when the deal is due to be completed. That would imply a paltry 3% post-tax return on investment initially. Siemens Healthineers investors will want returns to climb to double or high single digits.

Two leaps of faith are needed. One, that Varian’s performance is going to markedly recover from this depressed level. That could happen if a recent investment phase starts to bear fruit. And two, that Siemens Healthineers can deliver on a promised €300m profit boost from the deal. But this will take until 2025 to fully materialise. Only about one-third of it comes from cost savings. The bulk is revenue synergies — a challenge to achieve in any transaction.

While hospitals may see an initial spike in medical procedures from a loosening of lockdown restrictions, the longer-term trend is complicated by a potential resurgence in coronavirus cases. Patients could delay procedures due to changes in employment and insurance coverage, according to a report last month from Bloomberg Intelligence analyst Glen Losev. He expects it to take a year for demand for medical procedures to return to prior levels. Hospitals will struggle to make significant investments in the foreseeable future.

The acquisition cash is being provided by a cheap bridge loan from Siemens. That will eventually be refinanced by a share sale by Healthineers, in which Siemens will be diluted. The structure means the buyer can do this transaction without immediately relying on the debt or equity markets. That’s just as well. Investors will need to look beyond the current crisis to get behind this deal.


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