Johnson & Johnson’s Orthopedics Expands Through M&A

by Tony D'Altorio

Johnson & Johnson's Orthopedics Expansion Through M&A

by Tony D'Altorio, Investment U Research

Wednesday, May 4, 2011

Johnson & Johnson (NYSE: JNJ) has its hands everywhere in the healthcare business, from drugs to medical devices. Yet its unit volume and sales have remained flat over the last three years...

  • 2010 was especially bad, due to product issues and bribery allegations. The company saw after-tax charges of $992 million due to lawsuits over its recalled DePuy ASR hip replacements, and other liabilities and litigation.
  • The list of recalls especially affected its fourth quarter in 2010, setting sales back 30 percent.
  • Then last month, J&J paid $70 million to U.S. regulators after admitting to "improper payments" to healthcare employees in Poland, Greece and Romania over the sales of medical devices.
  • The company even had to admit to doling out kickbacks to Saddam Hussein's former regime in Iraq.

Those are hardly the kinds of headlines a company wants to generate, to say the least. They probably contributed notably to J&J's stock falling in the past year, despite an overall strong market.

Johnson & Johnson Gets a Leg Up on Orthopedics

Johnson & Johnson looks like it's turning around - generating better headlines as it does so. Its new focus involves expanding its orthopedic business through acquisitions.

And the company has good reason to do just that...

  • Demand in the $37-billion-per-year orthopedic market should grow strongly going forward. Rising life expectancy and an aging global population practically guarantee more broken bones and the need for more artificial hips and knees.
  • Even here in the United States, the number of people aged 65 and older is growing quickly.
  • The older population represented 8.1 percent of the total population in 1950. By 2009, it increased to 12.8 percent, and by 2050, one in five will be 65 or older.

With statistics like these it's not surprising that Johnson & Johnson made a recent bid for the U.K.'s Smith & Nephew (NYSE: SNN).

The attempt for the hip and knee replacement supplier ultimately fell through. But just last week, it clinched a $21.3-billion takeover offer for Switzerland's Synthes.

  • The deal combines its existing DePuy business with Synthes' dominant position in trauma surgery, to create one large orthopedics player.
  • Sales at Synthes reached $3.7 billion last year, based on growing demand for its products. That includes high-tech precision screws, plates, saws and drills for orthopedic surgery.
  • The company controls about half of the $5-billion trauma market and about a fifth of the total orthopedics market. Specifically, the $6-billion market for trauma-related products grew an annual average of 10 percent over the past five years.

So it's no wonder so many pharmaceutical companies see medical devices as a way to blunt losses from upcoming patent expirations.

Analysts estimate that Johnson & Johnson's share of the orthopedic market will grow to 28 percent after the deal closes. And medical devices will account for 46 percent of its overall sales, up from 40 percent.

Johnson & Johnson's Solidifies Dominance in Othropedics

Michael Mahoney, Johnson & Johnson's Chairman of Medical Devices and Diagnostics, recently underlined the importance of the device business to his company.

He expects the healthcare reform law to provide a boost, as more insured patients seek treatment. But, he notes, device prices do remain under pressure, while the looming medical device tax poses a further challenge.

Despite that, the takeover solidifies Johnson & Johnson's dominance in orthopedics. And it allows the company to gain increasing power when dealing with hospitals.

The deal also gives J&J a better position to address the market trends of an aging customer base. That includes "patient desire to remain active" and growing affluence in the emerging markets.

Synthes marks the company's biggest takeover yet in the wake of rapid acquisitions in recent years. It's now spent a decent chunk of its $28-billion gross cash position.

But with orthopedics' compelling growth story, this seems like a good buy all the same.

Good investing,

Tony D'Altorio

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