J&J Ready To Re-Balance? Guidant Deal Would Decrease Dependence On Rx

Johnson & Johnson's proposed acquisition of Guidant will help the company restore the balance in its health care portfolio.

By adding Guidant's approximately $3.75 bil. in medical device revenues to its base of business, J&J would reduce its growing dependence on the pharmaceutical side of its operations.

J&J is said to be close to a $24 bil. agreement to acquire Guidant, with an announcement expected as early as Dec. 13.

The acquisition would be the largest in J&J's history, at about twice the size of the 2001 Alza deal. The company's willingness to make such a large move in the device sector reflects J&J's historical commitment to maintaining a diversified product line in health care.

Over the past 15 years, J&J's prescription drug business has grown more quickly than its consumer and medical device segments, and is now approaching 50% of the company's overall revenue line.

Through the first nine months of 2004, J&J's pharma business generated 47% of total revenues, while medical devices represented 35% and consumer products 18%. Pharma is also by far J&J's fastest growing business segment, with operational growth of 11%, compared to 7% for consumer and 4% for devices.

By comparison, consumer products was J&J's largest business line in 1991, representing 37% of sales, with devices at 33% and pharma at 30%.

J&J's growth in pharma reflects the underlying dynamics of the health care business in the last two decades, but it has also been helped by several mid-sized acquisitions, including Alza, Centocor and most recently Scios (¹ (Also see "J&J Buys Scios: Will Natrecor Make Another Centocor?" - Pink Sheet, 17 Feb, 2003.), p. 4).

The company's last significant device acquisition was DePuy in 1998.

The Guidant deal will help restore the medical device business to near-parity with pharma. Based on 2004 sales through nine months (and assuming no divestitures related to the Guidant business), J&J's revenues after the merger would be approximately 44% pharma, 40% devices and 16% consumer.

Guidant would also help accelerate the growth rate in the device business. The company's revenue forecasts suggest growth of approximately 7% in 2005 (from a projected $3.75 bil. in full year 2004 sales to $4 bil. in 2005).

When asked about the possibility of pharma representing the majority of its business, J&J tells investors that its commitment to a diversified portfolio does not mean it will set any arbitrary limits on the size of the components.

However, J&J is facing several near term challenges in the pharma sector that make it a good time to reduce its dependence on that market.

The company's largest product, Procrit , has been struggling in the face of head-to-head competition from Amgen's Aranesp . In addition, J&J is facing a cluster of significant patent expirations, with relatively few new products ready to enter the market in the near term (² , p. 27).

In addition, the company is trying to redefine its business model to take more advantage of its diversified product line by offering "product solutions" for diseases like diabetes (³ (Also see "J&J Focusing On “Product Solutions”; Diabetes Care May Be Early Model" - Pink Sheet, 1 Mar, 2004.), p. 16).

The Guidant deal also confirms the impression that J&J is becoming more aggressive on the mergers & acquisitions front under CEO William Weldon. The company has always used small and mid-sized deals, but Weldon appears more comfortable with larger deals.

Weldon was named CEO in 2002 in part because he was credited with the Centocor and Alza transactions (⁴ (Also see "J&J Says “Well Done:” Centocor, Alza Dealmaker Weldon Climbs To CEO" - Pink Sheet, 28 Jan, 2002.), p. 20). At the start of 2004, he indicated that J&J is open to larger deals than it has pursued in the past (⁵ (Also see "J&J Open To Large-Scale Mergers; Still Prefers Centocor, Alza-Sized Deals" - Pink Sheet, 26 Jan, 2004.), p. 29).

The logic behind the Guidant deal could also be an indicator that J&J will look for a major move on the consumer products side to help restore that business to parity with pharma and devices. J&J has not made a significant acquisition on the consumer side since Neutrogena in 1994.