In order to strengthen its medical device portfolio, Johnson & Johnson (JNJ) recently announced its intention to acquire Synthes, Inc. for $21.3 billion. The companies entered into a definitive agreement under which Johnson & Johnson will acquire Synthes for CHF159 per share.
Terms of the Agreement
Per the terms of the agreement, which has been approved by the Boards of both companies, each Synthes share will be exchanged for a combination of cash (CHF55.65) and stock (CHF103.35 in Johnson & Johnson common stock). The net acquisition cost is approximately $19.3 billion.
Johnson & Johnson expects to pay the cash component of the deal through a combination of cash and the issuance of new debt. The company will not be using ex-US cash for the deal, which is scheduled to close in the first half of 2012.
With shares being issued, there could be concerns regarding the dilutive impact of the deal to the shareholder base. It is possible that Johnson & Johnson may resort to share buybacks later to drive the bottom-line.
Deal to Strengthen J&J’s Orthopedics Portfolio
Once the transaction is completed, Johnson & Johnson intends to combine its DePuy segment with Synthes’ business. While the DePuy segment has products targeting the orthopedics, spinal care, sports medicine and neuroscience markets, Synthes is a global developer and manufacturer of orthopedic devices.
The products of both companies should complement each other. While DePuy is a leader in joint replacement, the largest segment of the orthopedics business, and sports medicine, Synthes is a leader in several important market segments where DePuy has little or no presence at all.
Segments at Johnson & Johnson which should benefit from the acquisition include trauma, cranio-maxillofacial and power tools. The company expects the $5 billion trauma market to grow at about 7% going forward.
Synthes has a strong global footprint with manufacturing facilities in the US, Europe and China and a solid pipeline of new products and technologies. Besides being a market leader in trauma and cranio-maxillofacial, Synthes enjoys a strong position in spine and power tools.
The $37 billion global orthopedics market represents huge commercial potential and should be a major growth driver for Johnson & Johnson. Factors like an aging population, expansion in emerging markets and availability of healthcare should lead to continued market growth.
Financial Impact
Based on current analyst estimates, Johnson & Johnson expects the deal to increase both the revenue and operating profit growth rate by at least 0.5%. While the deal will not impact Johnson & Johnson’s 2011 guidance, it is expected to be 1-2% dilutive to earnings in 2012 and modestly dilutive thereafter. The Zacks Consensus Estimate for 2011 and 2012 is currently $4.95 and $5.23, respectively.
Johnson & Johnson expects to record after-tax special charges of $500 – $600 million and $1 – $1.2 billion in 2011 and 2012, respectively. Management laid emphasis on the deal being more of a growth opportunity.
Neutral on Johnson & Johnson
We currently have a Neutral recommendation on Johnson & Johnson. This is supported by the Zacks #3 Rank (short-term “Hold” rating). Even though Johnson & Johnson has been facing challenges in the form of OTC product recalls, pricing austerity in the EU and generic competition, we believe that the company’s diversified business model, lack of cyclicality and strong financial position will help it in tough situations.
Other catalysts could be regulatory approval for a couple of important pipeline candidates. Johnson & Johnson is currently seeking FDA approval for abiraterone acetate plus prednisone for the treatment of metastatic, advanced prostate cancer in patients who have received prior chemotherapy containing a taxane.
Another important pipeline candidate, telaprevir, is currently under regulatory review. Telaprevir has been developed in collaboration with Vertex Pharmaceuticals, Inc. (VRTX) for the treatment of hepatitis C virus.
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