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J&J: Toughing Out The Drought


On many counts, 2003 was a fabulous year for health-care colossus Johnson & Johnson (JNJ). The company that makes everything from baby shampoo to artificial knees saw some very healthy results, with sales expected to rise an estimated 14%, to $41.5 billion, and profits pegged to climb 18%, to $8 billion. A lot of the credit goes to Cypher, J&J's new drug-coated coronary stent, a device to open clogged arteries, which has been embraced by surgeons. Launched in April, the tiny wire tube could rake in more than $1 billion in sales in its first year.

Yet J&J's share price tells a less sunny story. J&J has long been a Wall Street favorite. And its performance made it No. 4 on the BusinessWeek list of 50 best-performing large companies last year. In the five years through 2003 its shares climbed 23.2%, vs. a 9.5% drop in the Standard & Poor's 500-stock index. But the stock, recently priced around $52, fell 3.8% in 2003. Although it was a tough year for most drug companies, J&J's share performance trailed such rivals as GlaxoSmithKline PLC (GSK), Pfizer Inc., and Bristol-Myers Squibb Co. (BMY). And it was far below the S&P 500's 26% runup last year.

CHALLENGES AHEAD. Investors see a rough patch ahead for Johnson & Johnson. With no major new product due out before 2006 and its competitors gaining in some of its most profitable markets, J&J's next two years look to be relatively lean. In 2004, the consensus estimate among analysts is that revenue will grow only 8.5%, with some predicting a scant (for J&J) 5% rise in 2005. Likewise, earnings growth in 2004 may slow to only 11.7%. J&J does not dispute the challenges ahead. Says CFO Robert J. Darretta Jr.: "We've been going through a period well above historic averages. The next couple of years look tougher." But he believes that by investing heavily in new drugs, getting different parts of the company to cooperate on new products, and continuing to hunt out solid acquisitions, J&J can sustain its historical levels of 10% annual growth for revenue and 13% for earnings over the long haul.

No doubt J&J saw its current round of troubles coming. It began beefing up its drug-development operations in the late 1990s, an important move because drugs contribute 60% of operating profits. And in the past few years the company snapped up dozens of companies with promising compounds that it could transform into blockbusters. But a series of bad legal and regulatory breaks, manufacturing snafus, and drug failures have combined to leave J&J in a much tougher spot than it expected.

Cypher, for instance, stumbled out of the gate last year after the Food & Drug Administration mandated new production specs, temporarily leaving J&J with too few stents. The company had expected Cypher to grab 70% of the $3 billion market by now. Instead, it has about one-third. J&J hoped to discourage its stent competitors with patent lawsuits. Instead, rival Boston Scientific Corp. (BSX) has a stent some experts say is better and could garner 60% of the market after it arrives later this year.

Meanwhile, new drugs for diabetes, flu, and multiple sclerosis have failed clinical trials. And top-selling Procrit, a $4-billion-a year drug that J&J had expected to pick up some of the slack in these relatively lean years, has had problems too. The company canceled late-stage trials of Procrit among mildly anemic cancer patients last fall after doctors found higher rates of blood clots in those who used it. Potential lost sales: $1.25 billion. Meanwhile, Amgen Inc.'s (AMGN) longer-lasting anemia drug, Aranesp, is gaining. Says Jim Daly, general manager of Amgen's oncology business: "J&J is a very good marketing company. But they're in a tough spot now."

Despite these difficulties, the mood at the New Brunswick (N.J.)-based company is calm. The only sharp edges in evidence are those on the sides of its I.M. Pei-designed headquarters building. "We'll deal with these external challenges as we have always," says Christine A. Poon, worldwide chairman of J&J's pharmaceuticals group.

For one thing, that means more cost-cutting. J&J began one of the most sweeping efficiency efforts in its history last November, aiming to save $1 billion over the next two years for drug development. In a Nov. 17 internal memo to employees, two pharmaceutical-group executives wrote: "To secure our future, we must take steps now to ensure that our cost base is competitive and that we have adequate funding to invest in our most promising growth opportunities." J&J is centralizing back-office operations at its five largest drug companies and merging purchases to gain pricing power. J&J will also offer early retirement to about 1% of its 112,000 employees.

The money that's saved will largely go into a search for big new drugs. J&J today spends 50% of its drug-development funding on new compounds, vs. only 20% five years ago. (The rest goes toward finding new uses for existing drugs.) And advanced computer technology that analyzes genetic data, among other functions, has yielded several promising compounds. But the first new products likely to emerge will target small groups and fall far short of the $1 billion-a-year blockbuster threshold. One near-term possibility is Zarnestra, a drug to fight adult leukemia that is still in trials. Yet that market is fairly limited.

The company is also encouraging employees in its famously decentralized realm to cross company lines to spur product development. The aim is to replicate the success of Cypher, which drew on both device and pharmaceutical units within J&J. The company, for example, is working on combining slow-release technology from one unit, Alza Corp., with the antipsychotic drug Risperdal, acquired with Centocor Corp. in 1999. The new compound will ease side effects and encourage patients to take the drug. Other cross-divisional teams are tackling diabetes and stroke.

J&J's promising medical devices include a new, less invasive hip-replacement device, a synthetic spinal disk, and a stent that props open arteries in the neck to ward off strokes. If that carotid stent is approved in the first half of 2004, as expected, it'll be the first of its kind. Although the device is not likely to ramp up sales as quickly as the more widely used Cypher, J&J sees it eventually generating $1 billion in annual revenues. Of course, the competition is close behind: Nemesis Boston Scientific is also developing a carotid stent.

In the past, J&J would simply buy new products, but even that's becoming harder. Over the last five years, it spent $24 billion to acquire 34 companies, using its marketing muscle to turn their products into blockbusters as it did with arthritis drug Remicade from Centocor. But all of Big Pharma is now seeking new drugs, making acquisitions more costly. And with J&J's share price down, paying for companies becomes more expensive and runs the risk of diluting earnings. Finally, there are few acquisitions that can make a big difference in so large a company.

J&J says its growth this year will come from existing products, line extensions of drugs such as Topomax, developed for seizures and now used to treat migraines, and a newly acquired congestive-heart-failure drug, Natrecor. But analysts say that won't be enough to offset the expected decline in sales of top products. Until profits from new drugs and devices kick in, the health-care whizzes of New Brunswick might do well to keep the Tylenol handy.

Corrections and Clarifications

In "J&J: Toughing out the drought" (The Corporation, Jan. 26, 2004), Johnson & Johnson's drug-coated stent should have been described as being embraced by cardiologists rather than surgeons. The drug Risperdal was described as being developed by J&J's Centocor. It is actually a product of the Janssen Research Foundation, a different J&J unit. Also, it should be noted that final FDA approval of Topamax as a migraine treatment is still pending.

By Faith Arner in New Brunswick, N.J., with Arlene Weintraub in Los Angeles


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