Will J&J sing "Hey, St. Jude"?
Boston Scientific the victor in Guidant bid, J&J must look elsewhere to secure growth
NEW YORK (CNNMoney.com) - Johnson & Johnson was going to buy Guidant to grow its strongest line of business. But J&J lost. So it needs to buy something else to keep its most promising business rolling.
"To get outperformance from the stock, they're going to have to acquire smartly," said Bruce Nudell, analyst for Sanford Bernstein, who rates J&J a "buy."
St. Jude, which trails Guidant in market share as a maker of implantable pacemakers and defibrillators, is that smart target.
"St. Jude is clearly small enough for them to absorb," said Phillip Nalbone, analyst for RBC Capital Markets. "I think it's a good target. I don't think they're going to have trouble raising money for it."
But St. Jude is more expensive than Guidant, which seemed like the ideal growth play for J&J. But after a two year struggle, Boston Scientific (down $0.36 to $23.64, Research) won the growth prize. Guidant (down $1.48 to $75.30, Research) announced a merger agreement Wednesday, accepting Boston Scientific's $27 billion offer in a cash and stock deal worth $80 a share.
"There's a lot of fundamental buyers who believe that this acquisition solves Boston Scientific's growth problems," said Nancy Havens, president of Havens Advisors, who counts Guidant stock as one of her three largest holdings. Havens said that Boston Scientific will flourish in the long run, even though it assumes responsibility for whatever lawsuits result from Guidant's product recalls.
And so Boston Scientific will control the second-biggest slot in the $10 billion industry for implantable defibrillators and pacemakers, behind industry leader Medtronic (down $1.83 to $57.40, Research) and ahead of St. Jude (down $3.31 to $49.99, Research).
"We believe the loss of Guidant is disappointing, given the challenges that J&J will face in the coming years with its soft pharmaceutical business (owing to generics, few potential drugs in pipeline) and a medical device business that will face greater competition (especially in stents) in the next couple years," said Bruce Cranna, analyst for Leerink Swann, in a report published Wednesday.
Unless J&J (Research) can secure another promising acquisition, the giant will have to rely on its three lines of existing business – consumer goods, pharmaceuticals and medical devices and diagnostics - which totaled $50.5 billion in 2005 sales. Of these areas, drugs is the largest and the most sluggish, declining 1 percent in 2005 sales to total $22 billion. Furthermore, the company's drug business ended the year on a particularly weak note, with a 6 percent sales slump in the fourth quarter.
J&J had better luck with its vast array of consumer goods, with sales in that area jumping 9 percent in 2005 to $9 billion. But analysts do not see consumer goods as a strong area for growth. Medical devices and diagnostics, an area that would have included Guidant if the deal had gone through, was J&J's strongest area in 2005, with sales jumping 13 percent to $19 billion.
The revenue growth in medical devices explains J&J's fascination with acquiring Guidant. Without the defibrillator maker under its wing, J&J's prospects for growth are significantly slimmer.
So what are the options?
Hey, St. Jude
Medtronic, the largest player in the area of implantable defibrillators and pacemakers with a market capitalization of $70 billion, is probably too big of acquisition target even for J&J, with its market cap of $186 billion. Boston Scientific, now the second-largest player with Guidant under its wing, is also prohibitively large for a J&J takeover. Anti-trust laws would prevent J&J from merging with either of these companies, even if the company could swing it financially, analysts say.
"I think right now it's on the crazy end of the spectrum," said Robert Faulkner, analyst for JMP Securities, referring to the possibility of a J&J merger with Medtronic or Boston Scientific.
"They might have passed the acid test of being too big," said Jan Wald, analyst for A.G. Edwards.
This brings us to St. Jude, the most obvious choice as a take-over target with a market cap of $19 billion. However, St. Jude's valuation makes it pricier than Guidant, even though it has less market share, because St. Jude isn't hampered by the product recalls that have marred Guidant's name in the business world.
Will J&J pay more for less?
"There's a lot of people who think [a J&J takeover of St. Jude] is perfectly obvious and it's going to happen," said Faulkner of JMP. "But St. Jude is more expensive than Guidant, so if [J&J] didn't like Guidant economics, they're not going to like St. Jude's economics, either."
Wald of A.G. Edwards said that St. Jude "is kind of an obvious candidate, but it's rich. [J&J] would end up paying as much as they would have paid for Guidant, even though it would lose about 9 points of market share."
So who else is out there? Anti-trust laws would also prevent a take-over of Stryker Corp. (down $0.11 to $44.01, Research), a Michigan-based maker of spine implants and devices for hip and knee replacement, Faulkner said. But he said that J&J might take a closer look at Synthes, a Swiss maker of plates and screws for trauma surgery. Synthes also specializes in spinal devices, an area where J&J is already a player, under its subsidiary DePuy Spine.
To read about J&J's fourth quarter earnings, click here.