Abbott Lab’s market value plunged more than \($5\) billion or 6% in a single day following the announcement of the firm’s acquisition of St. Jude Medical (St. Jude) on April 26, 2016, as investors expressed their disapproval. Their concern was that Abbot was overpaying and would be unable to earn financial returns demanded by investors. The \($25-billion\) deal included a \($6.5-billion\) premium, 37% above St. Jude’s closing price on April 25, 2016. St. Jude’s shares soared by more than 27% boosting the firm’s market capitalization to \($24.1\) billion from its level of \($17.59\) billion the prior day.

In announcing the transaction, Abbott said the primary motive for the takeover was to expand its heart device business. Abbott, the industry leader in manufacturing coronary stents and heart valves, wanted to combine with St. Jude, a maker of pacemakers and other devices for failing hearts. The aging population makes the “failing heart” market likely to show considerable growth in the coming years.

Medical equipment makers are under pressure to offer a wider portfolio of products to their hospital customers, which have been through a wave of mergers that have increased their power to negotiate pricing. With combined revenue of \($8.7\) billion, Abbott said its deal would help it compete more effectively against larger rivals Medtronic Plc, Boston Scientific Corp., and Edward Life Sciences.

The combination of Abbott and St. Jude creates a medical device manufacturer with leading positions in high-growth cardiovascular markets, including atrial fibrillation, structural heart, and heart failure, as well as a leading position in the high-growth neuromodulation market. The new firm also will have the largest pipeline (products in development) to deliver a steady stream of new medical devices to these high-growth markets....

Discussion Questions:

1. Based on the information provided in Table 8.5, what do you believe is a reasonable standalone value for St. Jude Medical? (Hint: Use the comparable company valuation method to derive a single point estimate of stand-alone value.) Show your work.
2. D oes your answer to question (1) include a purchase price premium? Explain your answer.
3. What are the key limitations of the comparable companies valuation methodology? Be specific.
4. In estimating the value of anticipated cost savings, should an analyst use St. Jude’s marginal tax rate of 40% or its effective tax rate of 22%? Explain your answer.
5. What is the PV of the \($500-million\) pretax annual cost savings expected to start in 2020? Assume the appropriate cost of capital is 10% and that the savings will continue in perpetuity. Show your work.
6. What are the key valuation assumptions underlying the valuation of St. Jude Medical? Include both the valuation of St. Jude as a stand-alone business and synergy value. Be specific.
7. What is the maximum amount Abbott Labs could have paid for St. Jude Medical and still earned its cost of capital? Did Abbott overpay for St. Jude based on the information given in the case? Explain your answer.