Smith & Nephew looks nice but unnecessary for J&J

January 10, 2011

The author is a Reuters Breakingviews columnist. The opinions expressed are his own.

NEW YORK — Smith & Nephew looks nice but not necessary for Johnson & Johnson. Buying the $10 billion British orthopedic company would give the U.S. conglomerate added scale and be an attractive use of cash stuck overseas. But J&J may heed potential antitrust concerns and its own history of financial discipline.

An acquisition of S&N could give a needed bump to J&J. Sales at the shampoo-to-arthritis-remedy giant are expected to grow less than 5 percent this year. Moreover, J&J’s consumer and pharmaceuticals divisions aren’t likely to do much acquiring any time soon. The company has said it prefers co-licensing agreements to grow its drugs business. And it’s still reeling from a series of embarrassing recalls of Tylenol, Benadryl and other products.

Buying S&N, on the other hand, would boost its already dominant position in orthopedics. Big U.S. hospital chains and governments globally are increasingly looking to restrain implant prices. The more concentrated the market of suppliers, the less likely they are to succeed.

Moreover, the price, for now, looks right. J&J was reported to have expressed interest in paying up to $11 billion for S&N. That would be three times trailing sales. The average multiple for similar deals is 3.7, according to Sanford Bernstein research. Furthermore, a large chunk of J&J’s $22 billion of cash and short-term investments is squirreled away overseas. Bringing it home would generate a tax hit. Buying an overseas rival is a relatively more attractive use of the assets.

Yet the orthopedic implant industry has run into problems with regulators concerned about practices within the concentrated industry. Limited competition already makes it such that surgeons grow accustomed to certain suppliers and tend not to switch. Greater consolidation might trigger antitrust objections.

Moreover, J&J has a history of walking away from deals over price. For example, it let Boston Scientific win Guidant in 2006 rather than outbid its rival. That was probably a smart idea, as the winner’s curse nearly pushed Boston Scientific into bankruptcy. So J&J may not be willing to put forward an attractive enough offer to woo S&N. That would leave J&J to retreat to the staid, low-growth company its investors have come to expect.

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