Prognosis looks good for J&J

J&J's consumer healthcare products division generates 18% of its revenues.

More from Fortune

The superheroes, the geeks and the studios Fannie's new watchdog: All bark? Why we tolerate bailouts

FORTUNE 500 Current Issue Subscribe to Fortune

NEW YORK (Fortune) -- Johnson & Johnson's reorganization might seem like nothing more than a Band-Aid. But even in the face of looming drug patent expirations and slowing sales for some of its key medical devices, the company is a more solid bet than ever.

J&J announced Thursday, as part of a series of broad changes at the $53 billion healthcare company, that it will create three new business units. The new divisions include an office of "strategy and growth" to identify new sales opportunities outside the company's existing markets; a surgical care unit to promote technologies, services and devices for surgery settings; and a comprehensive care group for products and services that address chronic conditions.

Think of J&J's changes as a holistic health solution aimed at transforming the company's biggest managerial headache - its vast array of healthcare businesses - into a source of strength.

"The very solutions that the health care system most needs - those coming from the convergence of science, technology and services - are the ones we are most capable of providing," said J&J CEO William Weldon in a statement.

"We have the know-how across our pharmaceutical, biologics, devices, diagnostics and consumer businesses to bring completely new solutions to market. And we believe we can accelerate growth through a dedicated focus on the intersection of our existing capabilities, customer needs and emerging trends," Weldon said.

J&J's reshuffle couldn't come at a better time. The company's sales slowed to 5.5% in 2006, after several years of double-digit growth.

J&J (Charts, Fortune 500) has endured a slew of bad news too. In September, the company's orthopedics unit agreed to pay $85 million to settle charges that it paid kickbacks to doctors who recommended its hip and knee replacement devices.

And the FDA recently slapped a new safety warning label on the entire class of blood-thinning treatments that includes one of J&J's biggest selling drugs, Procrit (which had $3.1 billion in sales during 2006).

The next year will be a tough one, as it marks the beginning of patent loses for several of the company's key drugs. Among the J&J drugs facing competition from cheaper generic medicines in 2008 will be antipsychotic, Risperdal (which garnered sales of more than $4 billion in 2006), and Alzheimer's medication, Reminyl. In 2009, the company's $2.1 billion-a-year epilepsy and migraine treatment, Topamax will lose its patent protection.

Of course, J&J isn't the only healthcare giant reshaping itself in the midst of slower growth. The moves come as part of a broader trend, especially among drug companies. Bristol-Myers Squibb (Charts, Fortune 500), GlaxoSmithKline (Charts), Merck (Charts, Fortune 500), and Pfizer (Charts, Fortune 500) are all in the midst of rethinking their business structures.

Many companies are also cutting their expensive and increasingly less effective salesforces. J&J previously said it would cut 4% of its 120,000 worldwide workforce. Many of those cuts will occur in the company's U.S. pharmaceutical sales division. The company is also closing several production sites. All told, Weldon hopes to achieve savings of up to $1.6 billion.

J&J's divisional tweak also comes just days after Warren Buffet's Berkshire Hathaway (Charts, Fortune 500) revealed that it recently upped its stake in the company. It boosted its J&J holdings by 16% (to 61.6 million shares) between June 30 and the end of September, according to an SEC filing. Berkshire has increased its stake in other healthecare related companies as well.

Buffet's endorsement makes sense. Unlike its so-called "peers" like Pfizer and GlaxoSmithKline, Johnson & Johnson is a diversified healthcare company, with some 44% of revenues coming from pharmaceuticals, 37% derived from medical devices, and roughly 18% from consumer healthcare products such as Band-Aids, Tylenol, and Listerine.

In other words, J&J can weather the drug industry's current spate of patent expirations and declining lab discoveries by relying on growth in other areas of the health sector.

Moreover, J&J's pipeline of future medicines doesn't look as bad as some of its peers. In spite of the patent expirations, says Tao Levy, an analyst with Deutsche Bank: "following a thorough analysis of the company's pipeline, we believe enough emerging products exist which can offset this headwind and allow sales in the division to remain flat, rather than significantly decline." Levy rates J&J a "buy" with a price target of $71. J&J shares are currently trading at around $67.

Indeed, J&J's strength lies in its diversity. The company's reorganization should help it better integrate ideas for future offerings, products that combine areas of J&J's expertise in the way that, say, drug-eluding stents have done.

"Going forward, potential products include a contact lens combined with a pharmaceutical," notes Bear Stearns analyst Rick Wise. "There are currently 80 'combination' product projects under way," observes Wise in a note to investors this week, though he cautioned that "these are more end-of-decade realities."

That's probably a fine timeframe for Warren Buffet - or any savvy healthcare investor.