Johnson & Johnson (JNJ) Chief Executive William Weldon
has been yearning to get into the burgeoning market for devices that help defective hearts beat properly. In 2005, he was locked in a bidding war for Guidant, a struggling manufacturer of implantable cardiac devices (ICDs). Guidant, Weldon says, would have complemented J&J's own heart offerings, most notably stents—the tiny metal tubes that prop open blocked arteries. But when rival bidder Boston Scientific (BSX) raised the ante to $27 billion in January, 2006, just as Guidant was facing a massive product recall, Weldon backed out of the fight. "It was disappointing," he says. "I guess you have to be pretty cold about it and say that [ICDs] would be a nice space to be in, but it has to be at a price that's going to return value to shareholders."
Eighteen months later, Boston Scientific is struggling to turn around Guidant, raising an intriguing question: Could J&J swoop in and buy Boston Scientific? Stripping the math down to the simplest terms, it's not such an out-there idea. Boston Scientific's shares have lost 20% of their value in the last year, and the company now has a market cap of $24 billion—the highest J&J was willing to spend on Guidant. J&J ended up buying Pfizer's (PFE) consumer-health business for $16.6 billion shortly after Guidant fell through. But Weldon asserts he could have done both deals, and few analysts would disagree. With $11 billion in free cash flow—an historic high—and little debt, J&J could easily pull off more multibillion-dollar acquisitions.
MAKING UP FOR LOST STENTS A shopping spree may be the best remedy for J&J's growth challenges in its pharmaceutical and medical-devices divisions. A host of regulatory and marketing challenges could put pressure on J&J's stents and prescription drugs, which are far more lucrative than its over-the-counter pills and balms. "They have pressure on the franchises that are the most profitable and growth from the least profitable franchise," says Catherine Arnold, an analyst for Credit Suisse Group (CS).
Indeed, sales in the company's consumer division—home of iconic brands such as Johnson's Baby Powder, Band-Aid, and (thanks to the Pfizer deal) Listerine—grew 48%, to $3.5 billion, in the first quarter. The unit is expected to account for about a quarter of J&J's revenues this year, which are on track to hit $60 billion. But no matter how much Listerine J&J sells, it will need to shore up its drug and device units, which account for 75% of its total sales and 90% of its operating profit (see BusinessWeek, 4/23/07, "Under the Weather at J&J").
An acquisition could go a long way toward jump-starting J&J's medical-devices unit. Recent studies have sparked worries about "drug-eluting" stents that are coated with medicines designed to keep arteries clear. Some of the data suggests the stents may raise the risk of blood clots, and as a result, demand has flattened. Last year, J&J paid $1.4 billion for startup stent maker Conor MedSystems. Conor's next-generation stent promised to be a safe alternative to rival products, because it releases drugs in a precise, measured manner. But in May, a trial of Conor's most advanced stent failed and J&J pulled it from a handful of countries where it was already on the market. Some on Wall Street wonder if J&J blew a billion dollars. "J&J is becoming an afterthought in a market they were responsible for," snaps Frank Abella, CEO of Investment Partners Group
, a portfolio management firm in Metuchen, N.J., which hasn't been recommending J&J stock lately.
THE ACQUISITION STRATEGY J&J Chief Financial Officer Dominick Caruso
says the company takes a long-term view of acquisitions that the Street doesn't always appreciate. J&J is famously rigorous when it comes to acquisitions. They could have waited six months for Conor's trial results to come in, Caruso says, but if the trial worked, the price tag would have gone up, making it a less attractive target. Furthermore, Caruso says, "We didn't buy this asset for the results of that clinical trial. We bought it because we thought it provided a novel drug-delivery platform that has other potential uses at J&J."
Stent woes would argue against J&J buying Boston Scientific, which is the other major player in that market. J&J tends to stay away from troubled companies, choosing instead to swoop in when it's clear a company is firing on all cylinders. "J&J is comfortable paying a significant premium for businesses with a lot of certainty," notes Banc of America (BAC) analyst Glenn Novarro
. J&J's execs had no qualms placing a value on Pfizer's consumer business that was a staggering four times its annual sales.
Both Caruso and Weldon admit they're still pining for a way into the $5 billion market for devices that regulate the delicate rhythm of the heart. But they're put off by how long it's taking for doctors to regain confidence in ICDs. "The market is recovering, but not as fast as we would have liked," Caruso says.
OTHER CANDIDATES Consolidation in the devices space has left precious few acquisition candidates. Last year, there were rumblings that J&J might buy Medtronic (MDT), a Minneapolis-based maker of ICDs and other devices. But with a market cap of $60 billion, it could be too big of a bite, even for J&J. Medtronic's neighbor and rival ICD maker, St. Paul-based St. Jude Medical (STJ), has a market cap of $15 billion.
Still, antitrust concerns could make it challenging for J&J to pick up any of these players. Neither Weldon nor Caruso will speculate on potential targets. In general, Caruso says, "Cardiovascular is a strong, attractive space for us. We're still interested. But it has to be at the right price."
J&J's pharmaceutical division could use a growth infusion, too. Several of the company's top-selling drugs have suffered blows in recent months. The anemia drug Procrit brings in $3 billion in annual sales, but earlier this year the Food & Drug Administration added a warning to the labels of Procrit and competing drugs, indicating they might cause death if used at higher-than-recommended doses. The FDA is now weighing further restrictions on anemia drugs. What's worse, J&J is facing patent expirations on its schizophrenia drug Risperdal and its epilepsy treatment Topamax, which together account for $7 billion in annual sales. With few obvious blockbusters in the wings, J&J might need to acquire drugs that are close to hitting the market.
In the past, J&J's tendency has been to partner with other companies rather than to buy them. It has a deal with Bayer HealthCare
, for example, to co-develop an anti-clotting drug. But with free cash flow at an all-time high, analysts say they wouldn't be surprised if J&J goes shopping for small, innovative companies with promising drug candidates.
BIG IS POSSIBLE, SMALL IS BETTER Even a big acquisition wouldn't be out of the question. On Mar. 19, Credit Suisse's Arnold released a report suggesting J&J could buy Bristol-Myers (BMY), the New York drug giant that makes the anti-clotting drug Plavix. Bristol's strong pipeline, coupled with share weakness brought on by legal challenges, has turned the company into a hot acquisition target (see BusinessWeek, 2/26/07, "The Power of the Pipeline"). Antitrust concerns, however, could put a damper on a J&J/Bristol combination, she warns.
As for Weldon, he says he's more likely to think small. "We prefer to go after smaller companies, so we can take our science, our people, and complement what they have," he says. "We prefer companies that have a lot of runway ahead of them." He may need a few more of those to keep J&J from stalling. By Arlene Weintraub