Johnson & Johnson's stumble in the purchase of the Guidant Corporation, the medical device maker, illustrates the perils of designing a corporate strategy around acquisitions.
Until recently, Johnson & Johnson served as the rare example of a company that could execute such a strategy successfully. From 1995 to the end of last year, Johnson & Johnson bought 51 companies.
Most of the acquisitions have been regarded as smart and successful, in part because the company prides itself on a slow, deliberative vetting process before making purchases. But like a new homeowner who has discovered a leak in the basement, Johnson & Johnson is experiencing buyer's remorse this time, particularly because Guidant is Johnson & Johnson's largest acquisition ever.
After the Federal Trade Commission approved the Guidant deal yesterday, Johnson & Johnson said it would not complete the $25.4 billion acquisition unless Guidant agreed to renegotiate the terms. In a statement, Johnson & Johnson cited product recalls of some Guidant heart devices and federal investigations of the company.
The deal had been viewed as important to Johnson & Johnson's long-term strategy. It gave the company a chance to build a cardiac rhythm business, a fast-growing area.
If Johnson & Johnson cannot persuade Guidant to agree on a lower price, some analysts expect Johnson & Johnson to look elsewhere to complete its strategy. The problem is other heart device makers may not want to do business with a company that just walked away from a deal.
Johnson & Johnson's problems with the Guidant deal are not unique. Even before the deal began to unravel, questions had been raised about the wisdom of several other Johnson & Johnson purchases, as well as the way some companies have been integrated into the corporate family.
Notably, some financial analysts say that the company paid too much for its largest completed acquisition, the $12.3 billion purchase of Alza in 2001.
"Alza initially started out well, but more recently the price has started to look rich," said Matthew J. Dodds III, who monitors Johnson & Johnson for Citigroup Investment Research.
Just four years after the purchase, two of Alza's big products, the attention-deficit treatment Concerta and the urinary incontinence drug Ditropan XL, are already facing generic threats. Alza suffered another setback last month when the Food and Drug Administration declined to approve its new drug for premature ejaculation.
Another product, a battery-operated painkilling patch, which Alza has promoted since 1995, has yet to obtain F.D.A. approval.
But the main reason Johnson & Johnson said that it purchased Alza was for the company's technology, which includes innovative ways of delivering drugs to the body. Questions have been raised about how quickly that technology is being used by the parent company. Even the chief executive of Johnson & Johnson, William C. Weldon, said last year that Alza "is not evolving as quickly as I would like it to."
This year, the Scios division of Johnson & Johnson, acquired in 2003 for $2.4 billion, has run into bid problems with its main product, the heart-failure infusion therapy, Natrecor.
Some cardiologists have wondered whether Natrecor's risks outweigh its benefits. And like Guidant, which is being investigated by the Justice Department, Scios is the target of a federal investigation. Justice is looking into whether Scios inappropriately marketed Natrecor for outpatient use, a use not approved by the F.D.A.
Natrecor had been predicted to reach blockbuster status, but sales of the product are down this year after reaching $400 million last year.
The deals illustrate the risk of aggressive buying. A medical product that looks promising on the surface can face regulatory problems or quickly turn into a lemon. And the seller always knows more than the buyer. While Johnson & Johnson has generally done a good job of taming the octopus - a far-flung collection of more than 200 operating companies with more than 115,000 employees - it has not always capitalized on the innovative abilities of the companies it acquires, according to Sydney Finkelstein, a management professor at the Tuck School of Business at Dartmouth.
As an example, Mr. Finkelstein points to Johnson & Johnson's 1996 takeover of Cordis for $1.8 billion. While the acquisition was a chance for Johnson & Johnson to cement its early lead in the stent business, crucial Cordis talent, accustomed to an entrepreneurial approach, clashed with Johnson & Johnson's more top-down structure, he said. Some decided to leave the company.
"They tend not to be able to retain the innovative capability," Mr. Finkelstein said. "That resides in people."
Because of the resulting delays in stent innovation, Johnson & Johnson left the door wide open for competitors, including Guidant, allowing other companies to capture the bulk of the stent market by 1998, according to Mr. Finkelstein. It took Johnson & Johnson several years to recover.
Since then, the medical devices business has become the company's main growth area. While pharmaceutical sales are stagnant, revenue from medical devices grew 14.5 percent in the most recent quarter, driven by drug-eluting coronary stents, orthopedic joint reconstruction and spinal products, and disposable contact lenses.
Retaining talent will be a major issue as Johnson & Johnson tries to renegotiate with Guidant. With many Guidant employees holding large amounts of stock, Johnson & Johnson runs the risk of angering vital Guidant employees if it pushes too hard, according to Jan David Wald, a financial analyst for A. G. Edwards & Sons who formerly worked for Guidant.
"I think what people forget in this is that a lot of the net worth of Guidant employees is tied up with Guidant," said Mr. Wald, who still holds about 3,000 shares of Guidant in a retirement account. "So playing around with the Guidant stock price, the takeout price, affects these individuals a lot more dramatically than anybody realizes. If you upset them, Medtronic, St. Jude and Boston Scientific are just down the street."
Johnson & Johnson could also look at other device companies as potential takeover targets, if the Guidant deal is not completed, with St. Jude Medical the most likely takeover target. St. Jude shares were up $2.10 yesterday on such speculation.
But if the Guidant acquisition is not completed, it could poison the well with other companies, Mr. Wald said.
"If J.& J. walks away from this, they will have trouble making other deals," he said.