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Johnson & Johnson: A Shopping Spree Waiting to Happen


There's no doubt that health-care colossus Johnson & Johnson (JNJ) has been in the pink lately. Net income climbed a healthy 18% last year, to $5.9 billion, excluding one-time charges, while revenues rose nearly 11%, to $33 billion, thanks to such successes as anemia drug Procrit. And the stock is up about 20% over the past year as investors anticipate the launch of a potential $1 billion-plus cardiac medical device in early 2003.

But J&J's performance is almost certain to taper off in a couple of years. Competition will heat up in some key markets, while the launch of J&J's own promising new drugs is at least several years off. It's increasingly clear that to keep profits rolling in, CEO William C. Weldon will have to break out the J&J checkbook and strike some deals--and do it before J&J's competitors snap up the best prospects or force it to pay more than it would like.

Weldon, the former head of J&J's drug business who took over the top spot this April, faces a tough balancing act. He has to generate long-term growth while making sure that he doesn't overpay to get it. "Nothing is cheap, that's for sure," says Weldon. But he adds, "If we have above-average earnings growth, it allows us to be more flexible, to look at more opportunities to enhance our growth." Competitors will be watching his strategy closely. Growth has come harder for the drug industry lately, with a rising share coming from extensions of existing drugs. If J&J can't make the acquisitions it needs to keep its momentum up, it is likely no one in the industry can.

Why the rush? This is, after all, the same company whose performance easily outpaced industry averages, while finishing first among BusinessWeek's 50 top-performing companies. And Weldon disputes the notion that the company will face a gap in its new-drug pipeline in the next couple of years. Still, J&J has no imminent blockbuster drugs of its own, and some top sellers will likely soon face intense competition. With $3.4 billion in yearly sales, Procrit (sold abroad as Eprex), could take a hit from Amgen Inc.'s (AMGN) anemia drug Aranesp, which may be approved for use by cancer patients this year. And J&J's new drug-coated stent, which seems to sharply cut the risk that arteries will become clogged again after angioplasty, may face rival products from companies like Guidant Corp. (GDT) by late 2003.

The result: After torrid growth this year and next, Merrill Lynch & Co. analyst Daniel T. Lemaitre sees J&J's earnings growth falling to 13% by 2005. Says Jon M. Fisher, head of equity research at Fifth Third Bank, a large J&J shareholder: "They have to do some deals."

Finding the right deals won't be easy. A number of big drugmakers, such as Merck & Co. (MRK) and Bristol-Myers Squibb Co. (BMY), face an earnings slump as they grapple with generic competition and a dearth of big new drugs. So J&J will be competing with increasingly hungry competitors eager to buy or license promising new products. And that could push the price of the best companies up substantially. "It is so competitive out there," says one investment banker. "The hardest part will be [striking deals] at a reasonable price."

Still, J&J has a strong track record as an acquirer. Weldon's predecessor, Ralph S. Larsen, purchased 55 companies over the past 10 years--usually with solid results. Take the 1999 acquisition of biotech player Centocor Inc. That allowed J&J to get its hands on promising rheumatoid arthritis drug Remicade. J&J's marketing might helped boost Remicade sales from $116 million to $721 million last year. And J&J has learned from its periodic stumbles. After the company's 1994 hostile purchase of medical-device manufacturer Cordis Corp. led to an exodus of talent, J&J created a merger-integration team to avoid such problems in the future.

So what might Weldon buy? Analysts and bankers figure J&J will probably strike a series of deals in the $10 billion range over the next two years for companies with new drugs that are already on the market or close to regulatory approval. One possible target is Gilead Sciences Inc. (GILD), which recently won Food & Drug Administration approval for a new HIV drug. Lloyd S. Kurtz, senior vice-president for San Francisco money manager Harris Bretall Sullivan & Smith LLC, says that drug could hit $1 billion in sales. Cephalon Inc.'s Provigil--approved for narcolepsy--could fit in with J&J's fast-growing psychiatric franchise and fetch $700 million a year in sales. And other investors point to Scios Inc., whose new drug to treat congestive heart failure could bring in $500 million a year in revenues, and CV Therapeutics Inc. (CVTX), which is working on a treatment for angina. Jonas V. Alsenas, a portfolio manager at ING Furman Selz Asset Management LLC, believes that CV's drug could exceed $500 million in annual sales. All the companies cited as possible acquisitions declined to comment, as did J&J.

J&J is likely to be highly discriminating. While there has been speculation that it might be interested in buying troubled Bristol-Myers Squibb, investment bankers say that's unlikely because Bristol's top-line growth is weak. Industry sources say that earlier this year, J&J looked at St. Paul (Minn.)-based St. Jude Medical Inc. (STJ), a medical-device maker with $1.4 billion in sales. But J&J is said to have passed on a deal because rapidly changing technologies would make an acquisition too risky. St. Jude and J&J declined to comment.

In the race to make the best acquisitions first, J&J has a trump card to play against the Mercks and Bristols of the world: Its strong earnings have led to a high-priced stock. J&J's price-earnings ratio based on projected 2003 earnings is 22, vs. Merck's 16.7 and Bristol's 17.6. J&J can easily afford to ante up in any high-stakes acquisition game. The only question is how it will play its hand. By Amy Barrett in Philadelphia


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