Assignment #1
Johnson & Johnson and Guidant

FIN 648
February 13, 2006
Shreyasee Kothari
Shalini Ramchandren
Mattia Valdisolo
William Smith

Guidant, a company in the surgical & medical instruments & apparatus, is in the process of being acquired by Johnson & Johnson (J&J), a company that engages in the manufacturing and selling of various products in the health care field. By evaluating each company’s current strategy, it can help to decipher if J&J is undertaking a company that can add value to its business. Using several strategy models, such as Porter, Kauppi, the BCG Growth Matrix, and a Strength, Weakness, Opportunities, and Threats (SWOT) analysis for each company, we can identify how these companies operate in their own industries, as well as compare each to assess compatibility.

Porter’s Model: 1. Barriers to Entry a. Regulatory restrictions: Guidant has extreme federal restrictions, as mandated by the industry it is in. By operating in the United States (US), Guidant must comply with the laws of the Federal Drug Agency (FDA). Operations in other countries (over 100) must comply with FDA equivalents in their respective countries. (Guidant 10-K 2004) Primary operations are in the US, Asia, and Europe. “The regulations also hold true for J&J due to the Medicare Prescription Drug, Improvement, and Modernization Act of 2003 (MMA) that took effect on January 1, 2006. It will have a major impact on how drug companies negotiate prices and, subsequently, demand for drugs.” (S&P Industry survey report) b. Patents: Patents are the most important issue when it comes to drug manufacturing industry. Every drug that a company manufactures needs to be patented. This acts as an entry barrier as it is not an easy process to get a drug patent. Moreover, this prevents others from using the expertise thereby making it difficult for new entrants. This pertains particularly to J&J. c. Capital requirements: The drug manufacturing industry is a capital intensive industry. It requires huge capital to establish manufacturing plants which acts as a barrier to entry to companies. For Guidant, the stringent law compliances needed to operate in various countries requires capital. Prior to selling its devices in the US, mandates in foreign countries must first be addressed. The industries that both companies operate necessitate severe resources due to the large quantities of products that are in the research and development (R&D) stage. Many of the products are ‘in the pipeline’, awaiting either government approval or market demand. 2. Customer Power: a. Buyer Concentration: In these industries that Guidant and J&J operate in, the buyers are concentrated (i.e. the major market share is distributed among a few buyers) thereby giving them more power. b. Threat of Backward Integration: In the drug manufacturing industry, customers possess a significant backward integration threat to its suppliers. Many companies like Johnson & Johnson, Merck, etc have acquired its supplier. Guidant supplies many of its products to healthcare systems. 3. Supplier Power a. Supplier concentration: In this industry, the suppliers are weak because of presence of many competitive suppliers. The number of suppliers is more as compared to buyers (because of huge players in the industry) which results in the dilution of suppliers’ power. Due to its products, which are lives saving for patients with cardiovascular diseases, the leading cause of death among men and women; Guidant is able to compete quite nicely in this area of demanding and getting competitive prices from its customers. b. Standardized inputs: Because the inputs to the drug manufacturing companies are standardized, the supplier position is weakened. 4. Threat of Substitutes a. Switching Costs: In drug manufacturing industry, the switching cost for customers is not great, which acts as a threat to any company working in this industry. For Guidant, it is especially difficult to lessen the threat of substitutes. Other methods of alleviating cardiovascular disease symptoms can be produced prior to Guidant getting its product to market. b. Product Differentiation: In this industry the, products are not highly differentiated from one another, which acts as a threat to the existing company. For Guidant, product differentiations are not protected by patents, enabling other companies to make similar products that may bypass some of the regulations. 5. Rivalry Conduct a. Barriers to Exit: The drug manufacturing industry is a capital intensive industry which implies that there are high barriers to exit for companies in this industry. One of the barriers is specialized plants and equipments. The plants and equipments used in this industry can not be easily absorbed into manufacturing of other products. Thus, this acts as a barrier to exit. b. High fixed costs: Due to asset specificity, the fixed costs are high in this industry. This leads to economy of scale effect thereby increasing rivalry amongst the players in the industry. c. Low level of Products Differentiation: Due to low level of differentiation in the products, the rivalry amongst the players increases. d. Both Guidant and J&J operate in many geographic areas which can be considered market cannibalism.

From Porter’s model, it seems that an acquisition of Guidant by J&J will benefit J&J. Although they are not in the exact same industries, the industries are very similar. Acquiring Guidant would enhance J&J’s position as well as benefit Guidant’s price by having a household name such as Johnson & Johnson, which has entities related to Guidant’s products affiliated with it.
Kauppi’s List-Categories of Strategic Acquisition: Johnson & Johnson’s primary interest in acquiring Guidant relates to their defibrillator technology. Guidant’s main business is in the surgical & medical instruments & apparatus. In this proposed acquisition, Johnson & Johnson’s strategic reasoning suffices a few, but not all of the 12 strategies that Kauppi outlines. Below is a list of these strategies, along with a description of the condition that adds supports: 1. Acquire Customers: Acquiring of Guidant would provide Johnson & Johnson a broader array of solutions for cardiac treatments. A combination of a superior stent and defibrillator technology will create a bundled solution from one manufacturer. (WSJ 10/2004) This provides a selling advantage for J&J. This also allows for Guidant to be able to have a higher asking price for the acquisition 2. Capitalize on a company’s strength: One of Johnson & Johnson’s strength is that they are a broadly based manufacturer. Acquiring Guidant will create a broader portfolio for J&J with relation to the cardiac equipment and minimal invasive surgical offerings. Guidant’s primary products are in the cardiovascular sector, which is an emerging sector at J&J. (J&J 10-K 2004) By adding Guidant to its portfolio, J&J chose one of the leading makers of defibrillators, which would give it an edge to its competitors in that market. 3. Cover a weakness: J &J, through its collaboration with Guidant, seeks to improve its Cypher stent by improving its delivery system. (WSJ 10/2004) These improvements will come from the delivery system that would employ catheter technology. A stent with the drug coated characteristic of the Cordis and the delivery system of such as this would lead the market. 4. Improving or completing a product line: Guidant’s cardiac devices and heart disease therapies will accompany J&J’s line of cardiac diagnosis equipment and their minimal invasive surgical devices. The defibrillator will also complete their stents market to provide a broader range to assist in cardiovascular solutions for people. 5. Technology-build or buy?: J&J’s primary reason for acquiring Guidant is to buy the defibrillator technology. (WSJ 08/2004) The barriers to entry associated with this industry, such as FDA approval and extensive R&D that needs to be performed before a product hits the market, makes it a more viable purchase of the technology that is already in the market rather than attempt to pioneer it. 6. Protect and expand mature product lines: The product line from acquiring Guidant would level the diversity in Johnson & Johnson’s portfolio. (J&J 10K 2004) This would result in a more balanced distribution of 42% in pharmaceuticals, 41% in medical devices, and 17% in consumer versus their original 46% in pharmaceuticals, 36% in medical devices and 8% in consumer. Acquisition of Guidant will put J&J ahead of some of its major competitors, such as Boston Scientific, Abbott Laboratories, and St. Jude’s Medical, in the cardiovascular disease sector. With those being the largest Guidant competitors, the merger would benefit Guidant in placing its already established products in a broader market spectrum.
Guidant’s SWOT Analysis: Guidant, with its 12,000 employees, is a complete firm that designs, manufactures, and markets products and services that treat cardiac and vascular diseases. It makes implantable devices that monitors the heart and treat coronary abnormalities. In addition makes cardiac surgery systems that treat coronary artery disease.

Strengths: 1. Global market presence in more than 100 countries. 2. Specialize in several medical fields due to its major subsidiaries, such as: • AFx Inc. • Advanced Cardiovascular System Inc. • Bio-absorbable Vascular Solution • Cardiac Intelligence Corp. • Cardiac Pacemakers Inc. • Endovascular Technologies Inc. • Guidant Norden AB • Incontrol Inc. 3. The continued investment in strategic developments: drug-eluting stent, implantable defibrillator development, increased distribution capabilities, and management sales force. (Baseline). 4. Bullish sentiments on the Guidant’s Xience drug (but this product appears headed to Abbott Labs) (Matthew Dodds Analyst, Citigroup, January 30 2006).

Weaknesses: 1. Decline of the sales in 2005 of 14% versus the prior year, due to product recall (Baseline). 2. Particular focus on the sharp decline in pacemakers (-24%). 3. January 23, 2006 Guidant informed that a hermetic sealing component utilized in 78,000 devices ( PULSAR, DISCOVERY, MERIDIAN, INTEILS II, CONTAK TR, VIRTUS PLUS) may experience a gradual degradation, resulting in serious health consequences (a total of 145 incidents were reported) (Baseline) 4. Lawsuits resulting in the voluntary recall of 109,000 defibrillators due to malfunctions in some of the models. Share prices dropped 1.5% after a class action suit was filed, claiming Guidant liable to patients implanted with faulty defibrillators (Matthew Dodds Analyst, Citigroup, January 30 2006). 5. Insurance and product liability increased due to the fact that products are implanted inside the human body for a long or indeterminable amount of time.

Opportunities: 1. New competitive products: Developed “Xience V”, an expandable mesh tube used to prop open clogged blood vessels. Xience was approved in January by the European regulators, and it will be launched during the second quarter 2006. As a result, it is prospected an increase of revenue. ( Bloomberg) 2. Announced merger with J&J increased share prices up $3.60 from its previous price.

Threats: 1. Guidant must pay $800 million dollar if it decide to walk away from the deal with Boston Scientific, and it decide to accept a takeover offer from another company (yahoo news web-site). 2. Citigroup does not suggest Guidant will see much of a rebound in 2006. (Matthew Dodds Analyst, Citigroup, January 30 2006) 3. Potential for other product recalls 4. Strong competition, especially from Boston Scientific 5. Expenses for R&D (20.7% of sales) and SG&A (42.9% of sales) were well ahead of Citigroup expectation: Guidant can no longer afford to starve its CRM business and the Xience V stent program is ramping up the R&D costs. FDA has issues a warning letter over Guidant’s CRM manufacturing process (Matthew Dodds Analyst, Citigroup, January 30 2006). 6. All of Guidant’s three major product lines- ICD, pacemakers, and stents- are under pressure due to a slowing market growth (Matthew Dodds Analyst, Citigroup, January 30 2006).

J&J’s SWOT Analysis:
Strengths:
1. Recognized as the worlds most comprehensive and broadly based manufacturer of health care products and provider of related services. While other companies in the pharmaceutical industry have experienced negative effects to profits from a diverse portfolio and structure, J&J has experienced synergies that contribute well to the bottom line. (Datamonitor J&J Profile 2005) 2. Remicade dominates the anti-arthritics market. This drug treats the effects of rheumatoid arthritis, which affects more than 21M Americans. (S&P Healthcare Industry Survey 2005) 3. Splenda: It is ranked the number one sweetener, even over the sugar brands. It has been permitted to be sold in 20 additional countries, increasing the total to 79. (J&J 10K 2004) 4. Brand name equity: The Johnson & Johnson name is easily recognized in the consumer market. It addition, from the many acquisitions made by J&J, the acquired organizations experience a boost in sales from being affiliated with the Johnson & Johnson label. (Datamonitor J&J Profile 2005)

Weaknesses: 1. No blockbuster drugs or any major products coming out of R&D in its pipeline. J&J had halted development of Topamax. This is a long-acting version of an epilepsy treatment and serves as a weight loss aid. (S&P Healthcare Industry Survey 2005) 2. Lacking a source for growth. J&J has grown inorganically over the past 10 years through a series of 58 acquisitions. Without having a foothold on the merger with Guidant, another growth engine will have to be sought out for. (WSJ 12/2004)

Opportunities: 1. Increases in the levels of health care spending each year. This could signify increase earnings from an upwards trend in demand for pharmaceuticals. (S&P Healthcare Industry Survey 2005) 2. Johnson & Johnson currently has the lowest exposure to senior citizens. 16% of J&J’s products are relevant to the Medicare population. 40% of Merck’s portfolio of products is relevant. With the growing rate of senior citizens, this presents an opportunity for J&J to increase their portfolio of products relevant to the medical needs of senior citizens, as the baby boomers are a growing sector of the population. (S&P Healthcare Industry Survey 2005)

Threats: 1. Risperdal goes off patent in 2007: In the anti-psychotics market, generics will be entering into the mix when their formulation patents expire. (S&P Healthcare Industry Survey 2005) 2. Pfizer’s Geodon has a clean side-effect profile: At the same time, Risperdal ($3.1B for 2004 global sales) is declining slowly due to concerns of its side effects, Geodon has entered the market with a clean side-effect profile. (S&P Healthcare Industry Survey 2005) 3. Generics: ANDAs filed for Tri-Cyclen Lo, Risperdal, and Topamax, each of which generates the higher revenues when compared to other pharmaceuticals in Johnson & Johnson’s profile. (S&P Healthcare Industry Survey 2005) 4. Changes to healthcare systems: With the global changes in healthcare systems, Johnson & Johnson will experience pricing pressures that include government legislation relating to sales and promotions. (S&P Healthcare Industry Survey 2005) 5. Guidant’s Taxus Stent and Medtronics Endeavor stent enters the market: The Taxus stent is viewed as superior to the J&J’s Cordis stent because it is considered by cardiologists to be easier to put into place. Medtronics offering a drug coated stent similar to Cordis’. (WSJ 02/2005) 6. Boston Scientific makes investment in defibrillator. They have invested in Cameron Health that is developing the newer type implantable defibrillator. (WSJ 08/2004)

BCG Growth-Share Business Portfolio Matrix for Johnson & Johnson:

Relative Market Share Position High Low
|STARS |QUESTION MARKS |
| | |
|J&J | |
|CASH COWS |DOGS |

High

Industry
Growth
Rate Low

The current position of Johnson & Johnson places it as “Star” cell in the Growth-Share matrix which is the combination of high industry growth rate and high relative market share position. The US leads the world in drug manufacturing, claiming both the largest market share and five of the ten largest drug manufacturing companies namely Pfizer, Bristol-Myers Squibb, Johnson & Johnson, Abbott Laboratories, and Merck & Co. “In real world demand directs drug development. Due to rising R&D costs the manufacturers now tend to focus on products for chronic diseases rather than acute diseases with large patient populations (such as cancer, arthritis, cardiovascular conditions)”. (Yahoo! Finance) “Another factor driving the industry is the world's increasing elderly population. The total portion of over-65 people consumes three times as many drugs as younger populations are expected to reach 690 million by 2025, and people are living longer because of the drugs.”
(Yahoo! Finance) Also the market cap of Johnson & Johnson is 173.71 billion (Yahoo! Finance) where as market cap of its main competitors are: (From Yahoo! Finance)

Pfizer Inc. 189.30B
GlaxoSmithKline plc 145.62B
Novartis AG 126.33B
Merck & Co. Inc. 75.02B
AstraZeneca plc 73.62B

Johnson & Johnson has strong competitive position in the rapid growing industry. At this position the growth opportunities and profit opportunities are more. All the company needs to do is to tap the right opportunity and earn profits.

BCG Growth-Share Business Portfolio Matrix for Guidant:

Relative Market Share Position High Low
|STARS |QUESTION MARKS |
| | |
|GDT | |
|CASH COWS |DOGS |

High

Industry
Growth
Rate Low

Guidant was spun out of Eli Lilly in 1994 and has become one of the largest players in the medical supplies. It is the #2 player in the world market of cardiology devices (sales of $3.8 billion in 2004, market of $21 billion) and implantable cardiovascular defibrillator (ICD). Sales are $4.7 billion. It is the #3 player in the world market of pacemaker and coronary stent. Guidant’s P/E ratio is 60.32, has a 5 year historic growth rate 7%, long-term future growth rate is 12%, price momentum value is better than 8% of S&P500 stocks, and a market cap ($ billions) of 24.9. Its principal competitors are as follows, detailing the competitors’ data: 1. Abbott Vascular Devices • P/E Ratio 19.70 • 5 year historic growth rate 7% • Long term Future growth rate 10% • Price momentum value: better than 22% of S&P500 stocks • Market Cap ($ billions) 65.9 2. Boston Scientific • P/E Ratio 12.1, • 5 year historic growth rate 53%. • Long term Future growth rate 12% • Price momentum value: better than 1% of S&P500 stocks • Market Cap ($ billions) 17.84 3. Novartis AG: • 5 year historic growth rate 11%, • Long term Future growth rate 11% • P/E Ratio is 20.6 • Price momentum value: better than 56% of S&P500 stocks • Market Cap ($ billions) 142.3 4. Medtronic Corporation: • average # of shares 1,209.000 MLN • P/E Ratio 36.32 • 5 year historic growth rate 15% • Long term Future growth rate 15 % • Price momentum value: better than 48% of S&P500 stocks • Market Cap ($ billions) 67.5 5. Johnson & Johnson: • Market Cap ($ billions) 173.7 • P/E Ratio 16.9 • 5 year historic growth rate 17% • Long term Future growth rate 10% • Price momentum value: better than 46% of S&P500 stocks 6. St. Jude Medical: • average # of shares 379.106 MLN • P/E Ratio 31.1 • 5 year historic growth rate 24% • Long term Future growth rate 17% • Price momentum value: better than 74% of S&P500 stocks • Market Cap ($ billions) 18
(All the above information are from Bloomberg)