There is no question that healthcare and personal care giant Johnson & Johnson (NYSE: JNJ) has been an active acquirer over the years – doing over 20 deals worth more than $40 billion in the last ten years alone. With the company struggling through a dry spell in organic growth and embarrassing itself with a series of product defect (and recall) announcements, it would seem likely that the company will once again lean on M&A to recharge its growth prospects and divert investor attention away from management's own poor recent record.
With that in mind, it seems appropriate to take a look at JNJ's menu of options and its potential shopping list.
A Few General Thoughts
There is nothing wrong with small deals or the acquisition of pre-revenue companies with promising products in the pipeline, but for purposes of this analysis I am only considering major, multi-billion-dollar deals that could meaningfully impact short-term revenue and earnings performance.
Based on what the company has done in the past, it would seem improbable that the company would look too seriously at areas like life sciences (thus excluding names like Thermo Fisher (TMO), Life Technologies (LIFE), or Illumina (ILMN)). Likewise, services would be a big change in strategy, so names like Lab Corp (LH) or Davita (DVA) are likely out, as are imaging or “big iron” companies like Varian (VAR).
Generally speaking, it would also seem that JNJ should target businesses with good emerging market exposure – JNJ has good overall non-US revenue exposure, but not so much in the faster-growing emerging markets.
JNJ largely stayed on the sideline during the recent wave of big pharma mergers, and that makes sense. JNJ did not have large patent cliffs to manage and it did not really look like a prime candidate to reap great benefits from the brutal expense stripping and layoffs that major pharmas like Pfizer (PFE) have launched after big mergers. Still, drugs are a high-margin business with growth potential and JNJ could certainly find some opportunities in this sector.
Generics would seem to be an obvious target for JNJ, as the company currently has no real exposure to this class. Among listed companies in the United States, Mylan (MYL) and Waton Pharmaceuticals (WPI) would be logical candidates. Neither are shockingly cheap right now (excluding a takeover premium), but both would boost revenue and top-line growth at the expense of margins. Along similar lines, India's Sun Pharmaceutical could be a worthwhile candidate, but it's quite a bit smaller.
Looking among the biotechs, only a few names really jump out. Alexion (ALXN) is a great company, but it seems quite expensive relative to the growth boost it would give JNJ and its focus is too narrow. Likewise a company like Human Genome Sciences (HGSI) may not be so interesting given its revenue split with partner GlaxoSmithKline (GSK).
Vertex (VRTX), though, would make sense and fit with JNJ's existing antiviral efforts (whereas Gilead GILD) would produce antitrust issues). Dendreon (DNDN) fits in with the company's interest in oncology and JNJ could be in a position to really leverage the potential of Provenge. While earlier-stage companies like Seattle Genetics (SGEN) and Exelixis (EXEL) are in the right markets, the near-term revenue outlooks really would not be material to JNJ.
Among established pharmaceutical names, very few ideas really jump out. Japan's Astellas would give the company a top-flight drug sales force in the country, but not much of a growth boost. Novo Nordisk (NVO) would be a great addition in many respects, but its market cap is already almost half that of JNJ itself and likely far too large to seriously consider.
Like the drug sector, the device sector is one with a fairly modest number of really appealing candidates. Most of the companies with attractive growth are too small to really move the needle for JNJ and most of the larger companies do not have a lot to offer in terms of long-term organic growth potential.
Orthopedics is a big business for JNJ, but it is hard to see how they can do much in the way of meaningful M&A here. Companies like Stryker (SYK), Smith & Nephew (SNN), and Biomet would all have a lot to offer JNJ … including FTC antitrust hassles, not withstanding JNJ's rumored earlier interest in Smith & Nephew. The Swiss company Synthes could be a lot more interesting, though, as it would greatly boost JNJ's trauma business and the antitrust issues in spinal care could probably be manageable.
Cardiac rhythm management (CRM) is likely a more fertile field for JNJ. Boston Scientific (BSX) would give the company a presence in CRM, a big boost to drug-coated stents, and a bigger presence in markets like urology. Although current BSX management seems to have a solid plan for a long-awaited turnaround, the fact is that this is still a troubled business and JNJ's management may not survive another iffy deal or have the stomach to adopt a known problem child.
St. Jude (STJ), though, could be a much stronger candidate. St. Jude offers better products in the CRM space, as well as a growing neuromodulation business and a strong cardiology franchise. At the risk of burying the lede, St. Jude might be the single best acquisition candidate for JNJ today.
JNJ has long done well in the low-tech segments of medical devices and the acquisition of a company like Becton Dickinson (BSX), CR Bard (BCR), CareFusion (CFN), Getinge, or Alere (ALR) would all fit in quite nicely. If the company is really serious about building its emerging markets franchise, though, maybe the acquisition of a company like Shandong Weigao would fit the bill – the company would not necessarily add a lot in terms of exciting new products or technologies, but the marketing and manufacturing potential could be significant. That is, assuming the company could deal with Medtronic's (MDT) existing investment in Shandong Weigao.
JNJ has never shown much interest in imaging or “big iron”, and that would seem to leave ideas like Volcano (VOLC), Hologic (HOLX), and Mindray (MR) a little less likely. On the other hand, William Demant or Cochlear (OTCPK:CHEOY) could be very appealing ways to enter the hearing aid market.
Last and by no means least is Intuitive Surgical (ISRG). There is no question that the premium JNJ would have to pay for this surgical robotics specialist would give some shareholders fits. There is also no question that there could be powerful synergies with JNJ's Ethicon surgical tools business and JNJ could provide the boost Intuitive needs to see uptake in other surgical procedures outside of urology and women's health.
Consumer care has long been a great business for JNJ, but it is an open question as to whether this seemingly endless wave of recalls will harm the company's brand and image. Consumer care is also a great way for JNJ to leverage the rising standard of living in emerging markets.
Branded product companies like Kao, Shiseido, Beiersdorf, or Church & Dwight (CHD) would be pretty logical fold-in acquisitions. Add Estee Lauder (EL) or Natura Cosmeticos to that list if JNJ wants to expand into the cosmetics business.
Two of the best candidates might be names that are unfamiliar to most American investors. Brazil's Hypermarcas is in many ways the JNJ of Brazil, with popular brands in OTC medicine, home care, beauty, and personal care. Admittedly, home care and food are two current parts of Hypermarcas that don't necessarily fit in with JNJ, but those could likely be sold off pretty easily if JNJ wanted to go that route.
Looking at China, Hengan is hardly a household name in the U.S., but it happens to be a leader in tissues, diapers, and sanitary napkins. Hengan sports nearly $2 billion in revenue, growing over 20% a year, with excellent margins.
The Bottom Line
Intuitive Surgical and Dendreon are likely a little too exciting for today's JNJ. Nevertheless, the company certainly has more than a couple of appetizing selections on its menu. What's more, a deal for an overseas player like Hypermarcas or Hengan could not only give the company a solid foothold for future emerging market growth, but resolve some of the company's dilemma in how to repatriate its overseas cash.
Growth by acquisition is a dicey strategy; companies like Danaher (DHR) and Medtronic have done well with it, but many other companies have struggled. Unfortunately, Johnson & Johnson is a company whose M&A track record is less than perfect and the company has struggled to make “one plus one” equal two, let alone really build long-term value from deals.
Johnson & Johnson management is under a great deal of pressure right now, and pressure to perform often leads to attention-grabbing acquisitions. Shareholders can take heart that there are plenty of good companies to choose from, but they should likewise be wary of the price the company pays and whether management can deliver the growth and synergies that will no doubt be highlighted when a deal is announced.