It appears that the consolidation bug that has swept other areas of med-tech — most recently diagnostics — has now hit the spine sector with Medtronic’s (Minneapolis) disclosing Friday its plan to acquire Kyphon (Sunnyvale), the developer of the kyphoplasty balloon-based alternative to the vertebroplasty procedure, for about $3.9 billion.

The companies have signed a definitive merger agreement under which Medtronic will acquire all of the outstanding shares of Kyphon for $71 per share in cash, a 32% premium over Kyphon’s Thursday closing stock price of $53.68 and a 35% premium over Kyphon’s 30-day average trading price of $52.76 per share.

This price excludes $320 million in payments associated with Kyphon’s acquisitions of St. Francis Medical Technologies (Alameda, California) and Disc-O-Tech Medical Technologies (Herzliya, Israel). Medtronic said that Kyphon would have to pay a $95 million breakup fee if it decided to pursue another offer. The deal is expected to close in 1Q08

“We expect our combination with Kyphon to help accelerate the growth of Medtronic’s existing spinal business by extending our product offerings into some of the fastest growing product segments and enabling us to provide physicians with a broader range of therapies for use at all stages of the care continuum,” said Art Collins, CEO and chairman of Medtronic during a conference call on the merger. “Importantly, the combination will also enable more patients of all ages to receive the benefits of modern, minimally invasive spinal treatments earlier in their care, with life-style friendly options that are simpler, faster and less invasive than many traditional surgical treatments.

Collins indicated that the company is not done shopping just yet. He said that while the company will keep relying mostly on internal growth, it also will look to add two to three “additional growth platforms” over the next three to five years.

Medtronic said the two companies’ product lines and geographic presence are “highly complementary.” While both have expertise in minimally invasive treatments, Medtronic’s spinal surgery focus has been on providing treatment options for younger patients who are suffering from scoliosis and degenerative disc disease in the cervical and lumbar spine.

Kyphon’s focus has been on treating older patients suffering from vertebral compression fractures and spinal stenosis.

Medtronic primarily serves orthopedic and neurological surgeons who specialize in spinal surgery. Kyphon serves these same physicians and also has a significant customer base with interventional radiologists and interventional neuroradiologists.

“I believe this transaction will go a long way in enabling more patients to receive the benefits of modern minimally invasive spinal treatment,” said William Hawkins III, Medtronic’s president/COO, who will become president/CEO, effective next month.

“The purchase of Kyphon gives Medtronic opportunity to intervene earlier in the continuum of care with simpler and less invasive surgical procedures creates a new business opportunity for it by as it will give surgeons the tools to more effectively treat patients who may not be candidates for traditional fusion procedures,” Hawkins said during the conference call.

He said the acquisition would complement recent success the company has enjoyed in the spinal sector of orthopedics.

Earlier this month, the company garnered back-to-back wins with FDA approval of the Prestige artificial cervical disc and immediately after received an advisory panel recommendation for agency approval of its Bryan artificial cervical disc (Medical Device Daily, July 18, 19, 2007).

Kyphon had about 45.6 million shares outstanding as of April 30. In addition, Medtronic said the overall deal value includes $700 million it will spend to buy shares under stock options that have vested. It will also assume $350 million in debt.

Medtronic said it would pay for Kyphon with a combination of cash and debt. CFO Gary Ellis said the company has about $6 billion in cash and is still evaluating several financing options for the Kyphon acquisition.

”Suffice it to say, because of Medtronic’s financial strength and strong credit rating, we will have a number of very attractive financing options,” said Ellis.

Analysts were bullish about the deal.

Larry Biegelesn, a medical device analyst at Wachovia, wrote that the deal could boost Medtronic’s spine business to $3.3 billion, from $2.8 billion, increasing the medical device giant’s share of the spine surgery business to 48% from 40%.

Biegelsen noted that there are 150 different companies in the spine space, and that giants Medtronic and Johnson & Johnson (New Brunswick, New Jersey) have been losing market share to smaller players. Hence, mergers are “inevitable,” and Friday’s deal could be the “first significant move” toward a sustained wave of consolidations.

Rick Wise of Bear Stearns wrote in a research note that he expects the merger to drive accelerated top-line growth for Medtronic. In his current model, Wise said spine sales represent about 21% of projected FY08 Medtronic sales.

“Following the acquisition, spine would approximate roughly 25% of the total company. More important, Kyphon would drive accelerated top-line growth for Medtronic—-potentially layering on an additional 3% to annual sales growth.”

As part of the agreement, Medtronic halted legal proceedings in a lawsuit the company filed against Kyphon in April 2006 over four patents related to catheters and spinal treatments (MDD, April 17, 2006). The companies asked a judge not to continue with the case while the purchase is in progress and said the case will be dropped when the acquisition is completed.

Medtronic’s suit, filed in U.S. District Court in San Jose, California, said Kyphon infringed patents for balloon dilation catheters and spinal treatment. Medtronic also asked the court to rule that five Kyphon patents don’t prevent Medtronic from offering a spinal disorder treatment that doesn’t use a balloon.

Kyphon’s most recent financial numbers appear to support Medtronic’s premium price for the company.

It reported on Friday that its second-quarter profit rose 16% to $11 million, or 23 cents per share, compared with profit of $9.5 million, or 21 cents a share, during the same period a year prior. Revenue rose 43% to $144.3 million from $101.1 million.

The transaction is expected to be neutral to Medtronic earnings in the first full fiscal year after closing and accretive thereafter.

Cleary Gottlieb Steen & Hamilton is acting as legal advisor to Medtronic and Goldman, Sachs & Co. and Piper Jaffray are acting as financial advisors. Latham & Watkins is acting as legal advisor to Kyphon and JPMorgan is acting as financial advisor.