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Johnson & Johnson: A deal well lost
Boston Scientific beat J&J in the contest to acquire Guidant. But J&J shares may end up being the real winner.
By Michael Sivy, MONEY Magazine editor-at-large

NEW YORK (MONEY) - For six weeks, Boston Scientific and Johnson & Johnson were locked in a bitter struggle to acquire Guidant, a maker of pacemakers, defibrillators, stents and other devices for treating heart problems. Then last week, Boston Scientific outbid J&J and seems to have cinched the deal.

The loss was unquestionably a blow to J&J, which is having trouble finding new growth opportunities. And J&J's stock has since fallen to a 15-month low. There's an argument, however, that J&J is fortunate not to have succeeded in acquiring Guidant.

Whatever advantages the acquisition might have created, Guidant would have come with a lot of problems. Now, the investment case for J&J has become a whole lot simpler.

To understand why losing the deal may be a win for J&J shareholders, it's worth looking back at the twisted history of the proposed Guidant acquisition.

J&J first agreed to acquire the heart-care company in December 2004 at a price of $76 a share.

The following year, however, the Food and Drug Administration prompted Guidant to announce several product recalls. Occasional problems with the FDA are not all that unusual for companies that produce high-tech medical devices. But they are costly and can damage business franchises if they occur repeatedly.

In response to Guidant's problems, J&J lowered its bid to around $63 a share in November.

Three weeks later, Boston Scientific (Research) jumped in with its own higher offer, and a bidding war followed.

Now Boston Scientific has won, but it sure has paid a high price for Guidant. In addition, both businesses continue to have problems with the FDA about manufacturing standards.

Boston Scientific's share price is down nearly 20 percent since the company first bid for Guidant. Analysts are divided about the stock's near-term prospects, although several think the company has probably hit bottom. But even Boston Scientific acknowledges that earnings may not benefit from the acquisition until 2009.

By contrast, J&J has been cut loose from the complexities surrounding Guidant. J&J still has the problem of finding growth opportunities, particularly as some of its existing blockbuster drugs come off patent. But the company also has a fairly strong pipeline of drugs under development.

J&J is already among the best-diversified health-care companies, and most analysts think it will continue looking for acquisitions. The most frequently mentioned possibility is St. Jude Medical, which is undeniably attractive but would be expensive to acquire.

Another alternative would be the purchase of a series of smaller medical-device companies, such as Edwards Lifesciences. It's even conceivable, although not likely, that the deal between Boston Scientific and Guidant could fall apart and that J&J might get a second shot at Guidant at a more attractive price.

In any event, any of those deals would still lie in the future. Right now, J&J (Research) is simply a very high-quality blue chip with moderate growth prospects, little debt and at least $12.5 billion in cash over and above its liabilities.

The total return potential may not be spectacular, but it's certainly attractive. Earnings growth could be as low as 5 percent this year, but it should average more than 10 percent annually over the next five years. And the stock yields 2.2 percent.

At the current share price of $58.40, J&J is trading at only 16 times earnings for the current year. That's a very reasonable price/earnings ratio for a stock that is slightly above average in growth potential and way above average in quality.

Sivy on Stocks resources:

Sivy 70: America's best stocks

Guide to Growth


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