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Johnson & Johnson CFO on Synthes Deal

May 04, 2011 | About:
Alex Morris

Alex Morris

36 followers
Dominic Caruso, the chief financial officer of Johnson & Johnson (JNJ), spoke to analysts at the Deutsche Bank Health Care Conference on Tuesday. After a brief recap of the Synthes acquisition (which I wrote about here), Mr. Caruso took questions from analysts; I would like to highlight some of the key questions that have material importance to long term shareholders.

The first question raised by analysts is why orthopedics (via Synthes) as opposed to an acquisition in another area, like consumer? First off, orthopedics is a huge market ($37 billion), which the company believes has good growth prospects looking forward due to an aging population and increased demand in emerging markets. As Mr. Caruso notes, this is an area where Johnson & Johnson was not so strong before; now, they have a leadership position in a category with sizable and growing demand.

As noted previously, the use of stock (65% of transaction) was a big issue with many shareholders. On the original call, the company said that the deal would be structured this way regardless of efficient use of cash from outside of the United States. Now, it appears that might be up for further discussion: “We are evaluating various alternatives to finance the transaction in the most efficient way possible. So, I’ll just leave it at that. We have plenty of opportunities to do that. It will depend on how we integrate the businesses going forward. So, it’s a little too early to comment any further on that.” One can only hope that this means more cash and less equity as the structure of the deal is finalized (even though paying with Johnson & Johnson stock at $65 is a lot different than $58-59 where we were a few weeks ago).

As noted last week when the deal was announced, the reasoning for using so much equity was to maintain the financial flexibility and the AAA credit rating at Johnson & Johnson. As one analyst notes, does this mean that the company will be put off from doing some larger deals in the near future? Mr. Caruso’s answer suggests that while maintaining their AAA credit rating is important, it isn’t a deal breaker: “Although we’ve just done or are in the midst of doing a pretty significant deal, it doesn’t really preclude us from doing anything else. Our AAA credit rating is important to us, but I don’t think it’s limiting in terms of how we proceed to generate significant shareholder value.”

As I stated in my value submission for April, the price for Johnson & Johnson (this was in the high 50s) suggested 3.5% growth per annum over the next decade. Mr. Caruso believes that healthcare “looks like it’s a 5% grower for the next four or five years,” and that their other interests, such as MD&D, is in “markets that grow a couple of points above 5%.” If this comes to fruition, Johnson & Johnson still looks like a steal in the low-mid 60s.

At the end of the day, I think Synthes is a good acquisition for Johnson & Johnson. As noted on the call, 70% of their [Synthes] sales last year came from new products, a focus on R&D and innovation that will be continued under the Johnson & Johnson umbrella. Here is the link for the presentation:

http://files.shareholder.com/downloads/JNJ/1143167308x6147253xS950157-11-285/200406/950157-11-285.pdf

About the author:

Alex Morris
I am a recent graduate from the University of Florida; I received a finance degree as well as a real estate minor during my time at UF. I will be sitting for Level 1 of the CFA Exam in December 2011, as well as for my series 65 exam. I am a value investor, plain and simple.

Rating: 3.9/5 (11 votes)

Comments

rgosalia
Rgosalia - 3 years ago
Alex,

In your write-up the reverse DCF calculation suggested a 3.5% growth in earnings. But is Mr. Caruso here talking about 5% growth in revenue or earnings?

Thanks

Rishi
Alex Morris
Alex Morris - 3 years ago
Rishi,

Good point; Mr. Caruso was talking about revenue growth. However, as long as the growth is comparable (and the revenue mix remains comparable to today), there is no indication/reason to believe that margins will be adversely affected by the addition of Synthes.

To put it in numbers, JNJ's 2010 profit margin (company wide) was 21.65%; for Synthes, it was quite a bit higher (24.6%). Thanks for the comment Rishi.

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