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Morningstar | Conmed's Acquisition of Buffalo Filter Makes Strategic Sense but Valuation Looks Stretched

After market close on Dec. 13, no-moat Conmed announced its intent to purchase privately held Buffalo Filter for $365 million. Preliminary adjustments to our model suggest the transaction is roughly neutral to our existing $55 per share fair value estimate. We've been expecting management to pursue another deal as the firm reduced its leverage profile following the 2016 acquisition of SurgiQuest. However, while we think the strategic rationale for the deal is sound, the price management is paying for the asset precludes much value creation for Conmed shareholders, in our view.

Buffalo is a leader in the approximately $100 million market for surgical smoke evacuation and filtration technologies and is expected to generate roughly $48 million in sales during 2019. Management suggests this market grows roughly 20% annually, driven by strengthening regulatory standards surrounding the hazards of inhaling surgical smoke. The company's economics are attractive, in our view, as the bulk of sales are generated through consumable products and carry an EBITDA margin of 25% before anticipated synergies. Incorporating this business should be accretive to Conmed's consolidated growth and operating margin, but the lofty valuation paid leaves us neutral on the deal. With a headline multiple of 7.5 times expected 2019 sales, or nearly 23 times 2019 EBITDA (including proposed synergies), we have a hard time seeing obvious value in the transaction. While Conmed won't be taking on any existing debt or cash from Buffalo, management intends to finance the acquisition through an extension of its existing credit facility and newly issued convertible notes. This should put the firm's pro-forma leverage profile near 4.8 times 2019 EBITDA after the deal's expected first quarter close--at the high end of the firm's historical range but a manageable temporary level, in our view. Management's goal to reduce leverage below 3 turns by end of 2021 seems achievable.

Aside from benefiting from Buffalo's strong economics and exposure to a high growth market, we think Conmed can improve the business through the utilization of its broader footprint. Buffalo's product portfolio fits squarely within Conmed's existing sales competencies in its general surgery business, which should allow for an efficient transition. Additionally, Conmed generates roughly one third of its surgical sales from international markets, which should create natural revenue synergies as the company brings Buffalo's U.S. focused operations to the global marketplace.