Ending several weeks of speculation, Johnson & Johnson (NYSE: JNJ) announced that it would buy medical device maker Guidant Corporation (NYSE: GDT) for $25.4 billion. Coming just 10 days before Christmas, this is the largest domestic health care deal of 2004, and the second largest globally.
This transaction, which will give JNJ a large cardiovascular devices business, is a defensive move intended in large part to help keep earnings projections high.
Best known for its broad offering of consumer goods, ranging from Band-Aids to baby powder, Splenda sweetener to Neutrogena, Johnson & Johnson also manufactures and markets a broad range of products in the health care field, including medical devices and pharmaceuticals. In fact, 50% of the company’s revenue derives from its prescription drug sales. Operating through some 200 companies worldwide, JNJ divides its business into three segments: consumer, pharmaceuticals and medical devices, and diagnostics. On a trailing 12-month basis, JNJ generated revenue of $46 billion, EBITDA of $14.8 billion and net income of $9 billion.
Over the years, JNJ has grown through a series of acquisitions, the largest of which was its 2002 acquisition of the specialty pharmaceutical company Alza Corp. for $12.3 billion (see the chart below). Until now, that is.
Spun off from Eli Lilly (NYSE: LLY) in 1994, Guidant Corp. is a medical device company with four business units: cardiac rhythm management (CRM), vascular intervention, cardiac surgery and endovascular solutions. Under the CRM business are included pacemakers and implantable cardioverter defibrillators. Also important is GDT’s stent business, which manufactures devices to prop open arteries. The company is the current leader in bare metal stents, but that business is being challenged by the new drug-eluting, or drug-coated, stents. On a trailing 12-month basis, GDT generated revenue of $3.75 billion, EBITDA of $835 million and net income of $650 million. Guidant has also grown through acquisition, although its purchases have been more modest in size than JNJ’s. However, two of GDT’s larger competitors in the devices arena, in terms of revenue and market cap, Medtronic (NYSE: MDT) and Boston Scientific (NYSE: BSX), have been exerting pressure on Guidant, which may have made it receptive towards a deal.
Under terms of the transaction, each share of GDT stock is to be exchanged for $30.40 in cash and $45.60 in shares of JNJ common stock. Collars are provided for the stock portion of the deal: each GDT share is to be converted into JNJ common stock of not more than 0.8224 and not less than 0.6797 shares, plus the $30.40 in cash.
Based on this formula, the deal is worth $25.4 billion in fully diluted equity value. When the cash acquired from GDT is factored in, the net purchase price falls to $23.9 billion. Taking the higher of these two figures, the price to revenue multiple is 6.8x and the price to EBITDA multiple 30x. The deal offers GDT shareholders a 5.5% premium over the stock’s closing price the day before the announcement. However, ever since the deal was rumored in the press two weeks earlier, GDT’s stock had gained 12% in value in anticipation of this deal.
As envisaged in JNJ’s proposal, Guidant will join forces with JNJ’s Cordis Corp. The combined company, to be known as Guidant, will be a powerful cardiovascular device franchise. It will also have approximately 40% of the angioplasty balloon market and 50% of the guidewire market. This transaction would give JNJ a significant leg up in the stent business, allowing the company to take on market leader Boston Scientific Corp. and number two Medtronic. Creating a package that uses GDT’s catheters and guidewires to insert JNJ’s Cypher drug-eluting stent may put JNJ in a position to challenge BSX’s dominance in the market.
As noted above, JNJ is undertaking this deal partly for defensive reasons. The company seeks to prop up earnings as its painkiller Duragesic and ADD drug Concerta both face generic competition in the short term. From one angle, this is merely a stopgap measure to buy JNJ 18 to 24 months while they figure out how to boost sagging earnings from pharmaceuticals and otherwise lessen the volatility of the prescription drug market. Viewed more positively, this deal may give JNJ the heft it needs to further integrate its pharmaceutical and medical device units in such joint operations as drug-eluting stents. L
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