Should Johnson & Johnson Be Looking for a Cougar in Devices?

Several years ago, Johnson & Johnson (NYSE: JNJ  ) realized it had a problem with its drug business. This wasn't a particularly poignant revelation, as the struggles of the business from around 2004 to 2010 were pretty easy to see, but the company went and did something about it. Licensing agreements with Bayer and Mitsubishi Tanabe brought in drugs like Xarelto and Invokana, while the billion-dollar acquisition of Cougar Biotechnology ultimately turned into the blockbuster prostate cancer drug Zytiga.

I mention this because other parts of J&J could use some TLC. Not only is the consumer/over-the-counter business still on a slow path to recovery from repeated product quality and recall issues, but the device business has turned into a perpetual disappointment with low organic sales growth. While the large acquisition of Synthes (announced in 2011, completed in 2012) has spiffed up the orthopedics business, I think it's worth asking whether Johnson & Johnson should think about going Cougar-hunting in the device space.

First, a word (or a hundred) against...
Let me start off by saying that, although the growth hasn't been great lately, J&J still has a pretty good device business. There aren't many large med-tech companies showing all that much growth today, so it's not as though J&J is alone in reporting weak organic growth. What's more, between areas like orthopedics and minimally invasive surgery, the company does have some areas of real strength.

It's also worth noting that the device business isn't like the drug business. You just don't see multibillion-dollar "blockbuster" devices very often; even much-ballyhooed Intuitive Surgical (NASDAQ: ISRG  ) generates about half the revenue that Boehringer Ingelheim's Spiriva generated in 2012, and that was the No. 15 drug in 2012. Likewise, Medtronic's (NYSE: MDT  ) entire market-leading cardiac rhythm management franchise generates only about 6% more in revenue than Spiriva did in 2012.

Even so, where could J&J look for acquired growth in the med-tech world?

Surgical
With Johnson & Johnson's strong Ethicon Endo-Surgery business, acquisitions here could be highly leverageable. Intuitive Surgical has always been a popular rumored target, as its da Vinci surgical robot is seen as both a competitor to the minimally invasive surgery businesses of J&J and Covidien (NYSE: COV  ) , but also an avenue to converting more open surgeries to a minimally invasive approach. Unfortunately, while the growth is appealing, the price tag would be quite steep.

A smaller name, though, could make sense. Novadaq Technologies (NASDAQ: NVDQ  ) has developed some innovative imaging platforms that allow surgeons to better assess perfusion (blood flow) while they're performing surgeries, leading to fewer complications. Novadaq carries a steep multiple today, but is only just beginning to expand beyond the breast reconstruction market (also a strong market for J&J) where it has 15% share . With a potential addressable market of more than $1.5 billion, Novadaq could be a good thing in a small package for a surgery business like Ethicon.

Cardiovascular
Johnson & Johnson is also frequently tied to St. Jude Medical and Boston Scientific in M&A rumors. While there would certainly be some operating synergies here, I'm not sure the value prospects would be very appealing.

That's not to say that there aren't growth opportunities in cardiology, though. Transcatheter heart valve leader Edwards Lifesciences has lost some of its shine, but could still offer a meaningful boost to J&J's growth rate at a more affordable price today. The company could also turn to either Thoratec or Heartware in the ventricular assist space (a treatment for heart failure) -- I prefer Heartware, but even down 25% from its 52-week high, it's not exactly cheap or risk-free.

The bottom line
Johnson & Johnson is not without in-house opportunities to do better -- the ortho business has scale almost across the board, Ethicon is doing well, and emerging product opportunities like atrial ablation, renal denervation, and drug-coated balloons for the peripheral vasculature could all boost sales to a meaningful degree. What's more, it is hardly uncommon for M&A to destroy more value than it creates. Even so, it would seem that Johnson & Johnson does have some worthwhile options for M&A if it chooses to go that way -- none of these may be another Cougar in the making, but they're not house cats, either.

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