Commentary: J&J: Don't Stop Dealmaking Now

Patent expirations and a thin pipeline mean the giant needs more than Guidant

It has been a long and tortured courtship. For years, health-care giant Johnson & Johnson (JNJ ) has held on-again, off-again acquisition talks with medical-device maker Guidant Corp. (GDT ). Now Wall Street sources say the companies are talking again. While a deal is far from assured, it appears J&J and Guidant are closer than they've ever been to linking up.

Even if J&J pulls off the Guidant deal, don't expect the company to put its checkbook away for long. Certainly, Guidant would be a good acquisition for the $47 billion J&J, giving it a big piece of the fast-growing market for implantable defibrillators, which correct overly rapid heartbeats and help stave off cardiac arrest. And the deal -- which analysts figure would be valued at about $25 billion -- could give a boost to slowing revenue growth over the next few years. But New Brunswick (N.J.)-based J&J could face a slowdown again later in the decade. The culprit: its large pharmaceutical business, which, like the rest of the drug industry, is facing patent expirations, intensifying competition, and a dearth of new products.

That's why Johnson & Johnson needs to continue hunting for deals -- and why Chairman and Chief Executive William C. Weldon wants to bulk up in the medical-device business, which has been on a tear of late. J&J already garners 36% of its sales from its devices and diagnostic testing business, a sector that enjoys healthy margins and the potential for lucrative new products in the years ahead. And few companies are stronger than Guidant. It's a major force in the fast-growing market for implantable defibrillators, which rack up sales of $4.7 billion a year. Credit Suisse First Boston (CSR ) analyst Adam K. Galeon figures that without tapping into that market, J&J earnings, excluding onetime items, would rise just 10% in 2005 and 2006, down from the mid-teens rate of the last few years.

What's more, the deal could improve J&J's prospects in the lucrative market for drug-coated stents, which help prevent arteries from reclogging after angioplasty. While Guidant does not have a drug-coated stent approved in the U.S. yet, it sells a noncoated stent that experts say is more flexible and easier to use than J&J's drug-coated Cypher stent. If regulators let J&J hold on to Guidant's stent operation, combining J&J expertise in drug coating with Guidant's popular stent could help J&J catch up to market leader Boston Scientific Corp. (BSX ). And a deal could also help J&J add some strong managers from the Guidant ranks -- a plus, considering some of the stumbles with the rollout of its Cypher product last year.

That all assumes, however, that the companies can reach a deal -- and that they aren't tripped up on antitrust issues. Only J&J and Boston Scientific make drug-coated stents. Guidant is developing its own drug-coated stent, and U.S. regulators may require some divestiture.

Other potential problems could surface as well. Guidant's entrepreneurial approach could clash with J&J's buttoned-down management style. "The question is whether J&J can maintain [Guidant's] aggressive, youthful culture," warns Sanford C. Bernstein & Co. (AC ) analyst Bruce M. Nudell.

If J&J can overcome those hurdles, access to Guidant technology could set the stage for promising new products. Guidant is in the early stages of studying ways to deliver drugs to plaques that have built up in the heart. It is also doing early research on how to adapt pacemaker-type devices to combat other diseases or disorders. For instance, they may be able to use electrical impulses to halt epileptic seizures. Linking up with J&J would give Guidant considerable financial resources to fund such projects as well as major marketing power to launch new products. No doubt Johnson & Johnson execs will use those selling points as they pursue Guidant -- and other potential partners -- in the days and months ahead.

By Amy Barrett With Michael Arndt in Chicago

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