ArthroCare (Austin, Texas), a manufacturer of minimally invasive surgical products, continues to defend its recent purchase of DiscoCare (Margate, Florida), a third-party billing and reimbursement services company.

ArthroCare reported buying DiscoCare earlier this month for $25 million in cash, plus potential future milestones (Medical Device Daily, Jan. 7, 2008). At that time, Mike Baker, president/CEO of ArthroCare, confronted rumors about the acquisition during a company conference call, calling the information that had started to percolate “false and misleading.”

But the deal continues to be a concern for investors, prompting Bear Stearns (New York) to host a call Friday to question ArthroCare executives about some of the rumors plaguing the company for the past month.

Baker told call listeners that “this really is very much nothing” – referring to the rumors that led investors to question DiscoCare’s business practices and the relationship between the two companies prior to the acquisition. But he said, “If people are concerned about this kind of stuff, we’re happy to talk about it.”

Baker said ArthroCare not only did the standard due diligence as it would with any acquisition, but also took extra time to investigate the rumors.

“We’ve heard a number of stories that were just outright fabrications,” Baker said. “We’ve checked into all of them and there’s just not anything there.”

Baker said DiscoCare provided a lot of third-party billing services to ArthroCare on a contract-basis prior to the acquisition. Buying the company seemed like the easiest way to bring those services in-house, he said.

“All medical device companies face the same problem, and that’s getting adequate payment for new technology that’s introduced because most new technology tends to not be covered for the first three years of its introduction and that’s particularly a problem for us because most of what we do here is new,” Baker said.

Some people have suggested, he said, that the company should have just hired more people internally to provide those services and then fired DiscoCare. Had the company decided to go that route, Baker said, he believes ArthroCare would have ended up losing some business.

“It’s kind of the same reason why, when you go direct in an overseas country where you’ve been using a distributor, it often makes a lot more sense to buy out the distributor than it does to fire the distributor and hire your own people,” Baker said. “Because [if you do that] you get an inevitable disruption in the business and if the distributor is a good distributor these are good people you are acquiring and they have strong relationships and they provide a good service to your existing customers. So strategically this was a way to augment what we see as a key capability immediately and to do it in a way that prevented any potential disruption to the business.”

Baker said DiscoCare had about 20 full-time employees, and that “all the key people” would be relocating to ArthroCare’s headquarters in Austin. Those employees who will not be relocating will be bound by non-compete contracts, he said.

Financially, the deal is “mildly accretive,” Baker said, because ArthroCare will end up being more cost-effective by being able to provide these services internally instead of on a contract-basis.

Michael Gluk, SVP and CFO for ArthroCare, said that DiscoCare generated revenue in two ways. One, they had a “modest markup” and they also received a “small success fee” whenever they found a pre-approved patient, he said.

Raj Denhoy, orthopedic analyst for Bear Stearns, asked the ArthroCare executives about the “modest markup,” noting that some of the stories that have been published related to DiscoCare allege that the company may have been buying the device for as little as $1,500 to $1,700 and marking it up to $7,500.

Gluk and Baker quickly squashed that allegation, calling it “incorrect by many orders of magnitude.”

The company executives also assured investors that the “small success fee” was a fairly common practice among billing companies.

Baker also elaborated during the call on some of the additional due diligence ArthroCare conducted as a result of the allegations being published on various web postings and in some press reports about DiscoCare, prior to the acquisition.

“We did take the time to see what, if anything, there was about those stories that were true and what we found was that most of what was being said was garbage and the rest was kind of not relevant,” Baker said.

“I wanted to be in a position to tell my board what the facts were behind these allegations so that they could obviously have comfort in closing the acquisition,” Baker said.

He added that there was no dissent among the board to do the transaction.

Still, the stories that had surfaced while ArthroCare and DiscoCare were negotiating the deal did have the potential to stop the companies from going through with it, Baker said.

“If anything I think there was a significant risk that the intensity and the persistence of this basically negative PR campaign based on some information that was outright falsehood and other information that was very misleading and misleading in the way it was presented, could have ended up screwing up the deal.”