Is the Battle for Guidant "Irrational"?

The bidding war between J&J and Boston Scientific has some Wall Street pros shaking their heads, but it shows how desperate both companies are

There are more questions than answers in the battle over Guidant (GDT ) following Boston Scientific's (BSX ) stunning $80-per-share offer on Jan. 17 for the device maker. Now that Guidant's board has declared the new Boston bid to be superior to Johnson & Johnson's (JNJ ) offer, will J&J hike its bid yet again (see BW Online, 1/12/06, "J&J-Guidant: A Deal at Last?")? And as Guidant shareholders have a chance to digest the latest offer, will Boston's shares fall enough to give investors pause about accepting the deal? �

Despite the many uncertainties surrounding this brawl, one thing is clear: Both J&J and Boston are desperate for growth (see BW Online, 11/16/05, "J&J-Guidant: Buyer Beware"). And both view Guidant's cardiac rhythm management business as the solution to that problem.

Take J&J. The health-care giant is certainly posting strong numbers. Earnings were up 12% in the third quarter, with sales climbing 6.6%. But the drug business, which accounts for 54% of operating profit, is struggling. Drug sales were actually down a bit in the third quarter, due to tough competition for key products like the anemia drug Procrit and new generic rivals. And like other drug companies, J&J's pipeline is weak, thanks to some new product flops, including the failure of a highly anticipated treatment for premature ejaculation.

STARVING FOR GROWTH. So J&J has been banking on the device business to generate more of its growth. And the Cypher drug-coated stent has certainly been a hot product (see BW Online, 8/17/05, "J&J: Opening Arteries, Narrowing a Lead"). But while J&J has been able to grab share from Boston's Taxus drug-coated stent, that market's growth has slowed. One reason: The devices are so effective at preventing arteries from reclogging that fewer patients are having repeat procedures. At the same time, analysts are projecting that prices on those devices will fall over the next few years.

All this adds up to a less-than-stellar outlook for the New Brunswick (N.J.)-based J&J. Michael Weinstein, an analyst at J.P. Morgan Securities, says Wall Street is expecting J&J's bottom line to grow about 8.5% a year over the next few years, down considerably from the 14% or so annual pace of the last decade. No surprise then that J&J is looking for some fast-growing businesses to juice that rate. That's why investors are already speculating that if J&J walks away from the bidding war over Guidant, it could make a move on rival device player St. Jude Medical (STJ ).

But if J&J is hungry for a deal, Boston appears to be near starvation. It's even more reliant on the slowing stent business, with Taxus generating 50% of earnings in 2005, according to Citigroup analyst Matthew Dodds. That's why Boston hopes to diversify its business by nabbing Guidant's fast-growing defibrillator operation.

NOT SO "COMFORTING." And while Boston had said its previous offer of $73 per share would dilute earnings through 2008, the new higher bid could dilute earnings even beyond that timeframe. Also, some analysts are warning about Guidant's increased debt load under the deal. While a source close to the bid says Boston would still maintain an investment-grade debt rating, Carol Levenson, director of research at Gimme Credit, argues that "isn't all that comforting, as it could still imply three- to four-notch downgrades from current ratings."

All this has left some Wall Street pros scratching their heads at the price now being offered for Guidant. "It's irrational, if you ask me," says Jon Fisher, portfolio manager at Fifth Third Asset Management. And if J&J tries to match that price he has one word for such a move: "Nuts".

READER COMMENTS

Barrett is BusinessWeek's Philadelphia bureau chief
Edited by Beth Belton

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