Healthcare conglomerate Johnson & Johnson (NYSE:JNJ) is a trend setter in the sector. Anytime it makes a move, its drug and device peers and Wall Street monitor closely.
Though Johnson & Johnson has a cadre of organically developed pharmaceutical products, medical devices, and consumer healthcare products, it's also used M&A throughout its history to expand its product line, further its global reach, and boost its growth prospects.
Go big, or go home
Yet J&J has always been a bit reluctant when it comes to pulling the trigger on a large deal. CEO Alex Gorsky and his management team have reiterated many times recently that J&J is on the hunt for acquisitions that could complement and further its business, but he's frequently suggested that J&J would prefer to stay small, since it hasn't had the best of luck integrating larger transactions (ahem! -- Synthes). Johnson & Johnson is best known for the fact that its business is made up of more than 250 subsidiaries, many of which were bolted on over the years in relatively small or midsized transactions. So it's a bit of a surprise that J&J has thrown its name in the ring as a possible suitor for Swiss-based drugmaker Actelion (NASDAQOTH: ALIOF).
Last week, Johnson & Johnson and Actelion confirmed that they were in negotiations for a possible deal. According to reports, J&J approached Actelion with a $26 billion bid (it closed on Tuesday with a valuation of nearly $22 billion), which the Swiss drugmaker rejected as being too low. J&J reportedly has significantly increased its offer, according to Bloomberg, although the value of the new price couldn't be confirmed by people familiar with the matter.
J&J certainly has the capacity to make such a deal happen. It ended the third quarter with nearly $41 billion in cash on its balance sheet, and it also sports a pristine "AAA" credit rating. J&J is one of only two publicly traded companies to bear Standard & Poor's highest credit rating.
Actelion is a powerhouse in the pulmonary arterial hypertension (PAH) drug space. PAH drugs treat chronic high blood pressure in the arteries between the heart and lungs, and Actelion has therapies designed to treat all stages of the disease.
In particular, Actelion has two relatively newer PAH drugs it's introduced that are expected to grow into blockbusters. Opsumit, which was introduced in the U.S. in November 2013, had net sales of $373.6 million through the first half of 2016, a 76% year-over-year improvement on a constant currency basis. The other potential blockbuster, Uptravi, was introduced in the U.S. markets this past January and has thus far totaled $89 million in first-half 2016 sales. Both drugs, according to Wall Street pundits, have been launched successfully and are on track to eventually reach approximately $2 billion each in peak annual sales.
These two drugs would be perfect for J&J, which does have a respectably large portfolio but is also facing biosimilar competition for its best-selling drug, anti-inflammatory Remicade. Johnson & Johnson has previously aimed to file 10 new drug applications for potential novel blockbuster drugs between 2015 and 2019. Adding Actelion to the mix would immediately add revenue and profitability that should more than offset lost Remicade sales.
Furthermore, Actelion has a pretty impressive pipeline for a company its size. It has four late-stage studies ongoing or initiating, two of which involve label expansion opportunities for Opsumit to pediatric PAH via the TOMORROW trial, and Eisenmenger syndrome via the MAESTRO study. Additional late-stage products could include cadazolid for clostridium difficile-associated diarrhea, and ponesimod for relapsing multiple sclerosis.
A potentially big risk for Johnson & Johnson
However, betting upwards of $26 billion on Actelion could be a big risk for J&J.
For starters, there's no certainty that cadazolid or ponesimod will perform well in their ongoing phase 3 studies. Yet paying such a large premium for Actelion would make the assumption that they're going to succeed, which isn't always the case for phase 3 drugs. As FierceBiotech pointed out recently, ponesimod will especially have to shine in the OPTIMUM trial, considering that Novartis' (NYSE:NVS) Gilenya is the dominant drug in relapsing MS. If ponesimod is just par for the course in meeting its primary endpoint, it may struggle to carve out market share.
A potentially bigger worry for J&J is that Actelion's leading mature product, Tracleer, which was introduced in the U.S. in 2001, is expected to begin facing generic competition in 2017. Sales of the drug have decreased by 18% on a constant currency basis to $539 million in the first half of 2016. Though it still puts Tracleer on track for about $1 billion in annual sales, generic drugs have a history of devouring around 80% of branded-drug sales within the first two years of introduction. That's worrisome when Tracleer made up 46% of Actelion's total sales in the first half of 2016.
There are also suitors waiting in the shadows that could coerce J&J into a bad bid. Various reports have suggested that Novartis and Sanofi have expressed interest in Actelion, and it's always possible that J&J ups its offer for Actelion to the stratosphere to ensure that its peers don't get it. However, doing so would nullify the benefits of acquiring two potential PAH blockbusters.
Finally, Actelion's own CEO, Jean-Paul Clozel, has regularly spoken of his interest in keeping Actelion as an independent company. Clozel successfully fought off an activist investor in 2011 and has seemed unwilling to budge on his thesis that Actelion remain independent. It's possible J&J may work out a separately structured deal that keeps Actelion independent, such as taking a minority equity investment in the company, but it nonetheless casts uncertainty over any negotiations between the two companies.
A deal to pass on
As an investing enthusiast who's followed J&J for a long time, I'd like to see it pass on Actelion. Its offer at $26 billion was already a large premium that I don't believe Actelion deserved, let alone the upped offer since then. Even if Opsumit and Uptravi are generating a combined $4 billion annually, and let's say for the sake of it that Actelion's remaining therapies contribute $1 billion annually, J&J could be paying five to six times the peak sales of Actelion's product portfolio. Comparatively, we've seen deals go down in biotech for anywhere from three to four times peak sales of a product portfolio in recent years. Actelion has the drug specialization that J&J can appreciate, but it seems unreasonable to command a $26 billion-plus valuation.
The good news here is J&J's diverse business model and organic-drug pipeline will keep churning out profits and opportunity regardless of whether J&J buys Actelion. But in my opinion, it could take an exceptionally long time for J&J to get its money's worth out of Actelion's drug portfolio and pipeline based on a $26 billion-plus offer price.
As investors, we can only wait and see what happens, but if J&J is wise, it'd wait until after generic Tracleer has hit the market and ponesimod data is available before seriously pursuing Actelion. My suspicion is it may be able to get a far better deal on the company a year or two from now, if it's even willing to sell.