Are the Samsung M&A Rumors True?

As the American economy seems to be slowly turning around, mergers and acquisitions are heating up. Approximately a month ago, SonoSite SONO was rumored to be pursuing a sale to Samsung. Rumors stated that SonoSite had already hired JP Morgan JPM to broker the sale, and the stock skyrocketed by almost 25%.

However, many investors questioned the validity of the rumors. Typically, rumors are not extremely specific, stating all the sell-side and buy-side parties involved. However, some pundits seem to be convinced that the SonoSite and Samsung deal is bound to happen, including analysts at Little Bear Research.

Before understanding their reasoning, it help to understand why Samsung would want to purchase SonoSite. SonoSite produces portable ultrasound machines, and has been trying to expand its presence in the medical devices industry. Insiders claim that Samsung is trying to be like General Electric GE, in the sense that it wants to expand itself into all facets of technology. Considering the background, Samsung may actually have the motivation to purchase SonoSite.

The next question is if SonoSite is a good acquisition target? SonoSite's growth over the last several years seems to be a bit volatile. The overall trend is upwards, but the company's revenues suddenly dropped in 2009. While this could simply be a happenstance, it is something that should be considered. At the same time, costs of goods sold and certain operating expenses have reacted along with revenues. Research and development has been consistent year over year, meaning that it is committed to increasing its IP assets.

One of the ways that SonoSite could benefit from an acquisition is that its interest and tax expenses would be absorbed by the parent company. As such, accounting regimes would be modified and net income figures as well as EPS estimate could end up being better than normal in the long run.

One thing that investors need to look out for, in terms of mergers and acquisitions, is the capital structures of target companies. Over the last four years, SonoSite has been issuing significant amounts of debt. Depending on the particular types of debt, this may or may not be the hugest deal. For example, if SonoSite entered several revolving credit facilities and issued various types of high yield debt, acquirers may be wary of acquiring them.

A combination of all of SonoSite's activities ultimately points to a lack of cash flow growth. Apart from fluctuating income numbers, SonoSite's cash flow has been stagnant due to large capital expenditures and investment vehicle purchases and variable financing strategies year-over-year.

While there may be some imperfections in SonoSite's business, Samsung may be itching to purchase the company for strategic purposes. This is the thinking behind Little Bear Research's report on SonoSite, which is convinced that the acquisition will take place. According to the analyst, Zack Prensky, Samsung has wanted to invest in medical technologies in emerging markets, which may make SonoSite the perfect acquisition target. Prensky states that the first case in point is Samsung's non-controlling interest in Medison, a large ultrasound manufacturer. In fact, Samsung has acquired various other medical technology companies since then.

Little Bear Research has also investigated further, talking to insiders who believe that Samsung may be in the running for SonoSite. The analyst's connections identified Morgan Stanley as Samsung's investment bank, and have mentioned that bidding has already started for SonoSite. Moreover, Prensky points to Jay Caplan's article, which mentions that Samsung has clear motives to build on its existing medical technologies to include medical devices like those offered by SonoSite.

Investors can look at the chatter and determine for themselves if SonoSite is a legitimate acquisition target for Samsung. While there are quantitative and qualitative evidence on both sides, SonoSite is running a good business that can be successful by itself or complement Samsung's existing med-tech business well. Investors should learn more about SonoSite's actual products and more about Samsung's growing medical technology practice as well.

SonoSite is currently trading at about $41.40, up over 30% for the year.

Traders who believe that SonoSite will be acquired by Samsung might want to consider the following trades:

• When acquisitions are announced, the target's stock goes up while the acquirer's stock goes down. Shorting Samsung may be a good idea if the acquisition goes through. Samsung, however, is traded on international exchanges.

• There has been speculation regarding the price at which SonoSite might be bought for. Some claim that it could be bought at $50 per share, meaning that there is a potential 25% upside in a long SonoSite trade.

• The health care ETF, Health Care SPDR XLV, may be a good play if the acquisition goes through, as it would represent a major milestone in the medical technology industry.

Bearish:
Traders who believe that the acquisition will not occur may consider the following positions:

• If the acquisition falls through or if it turns out that the rumors are false, short SonoSite. It went from $30 to $40 when the rumors came out, so there could be up to 25% downside if the rumors are disproven.

• Some investors could consider a failure to be detrimental to Samsung's medical technology portfolio, which means that Samsung's stock could be driven down.

• Since there are other companies in the running for SonoSite, companies like Johnson & Johnson JNJ or Merck MRK may decline if SonoSite remains in solidarity.

Neither Benzinga nor its staff recommend that you buy, sell, or hold any security. We do not offer investment advice, personalized or otherwise. Benzinga recommends that you conduct your own due diligence and consult a certified financial professional for personalized advice about your financial situation. Follow me on Twitter at @makinmarkets