For quite a number of investors, Johnson & Johnson (NYSE:JNJ) is a staple, long-term holding in their investing, retirement, and/or income portfolios -- and with good reason. Johnson & Johnson is one of around 50 Dividend Aristocrats to have raised its annual payout for at least 25 years running (2017 will presumably be J&J's 55th consecutive dividend increase), and it's also one of two remaining publicly traded companies that bears Standard & Poor's highest credit rating, "AAA."
Furthermore, most of J&J's pharmaceutical, device, and even healthcare products, are inelastic, meaning consumers need them regardless of how well or poorly the U.S. economy is performing. Because of this, J&J can accurately be called a "go-to healthcare stock" for long-term investors.
But, one thing even Johnson & Johnson isn't immune to is making a mistake and looking foolish (with a small "f"'). Earlier this week, J&J's foolishness, which we'll get to in a moment, was on full display for Wall Street and investors.
Johnson & Johnson blindly chases Actelion
For those who may not recall, Johnson & Johnson has been in ongoing discussions with Swiss-based drugmaker Actelion (NASDAQOTH: ALIOF) on two separate occasions since November. It was initially reported that J&J was willing to pay around $26 billion to acquire Actelion, which makes drugs designed to treat pulmonary arterial hypertension (PAH), a disease characterized by high blood pressure in the arteries between the heart and lungs. After unsuccessful negotiations, J&J backed away for a short time. However, as announced on Thursday morning, the second time was the charm, with J&J agreeing to acquire Actelion for $30 billion.
Why was Johnson & Johnson so eager to make a move? The impetus is the launch of Inflectra, a biosimilar medicine that's being targeted at J&J's top-selling drug, Remicade. Developed by Celltrion, but licensed to Pfizer, Inflectra, which was launched in November, is priced at a 15% discount to Remicade. Long story short, J&J's top drug could be facing an intermediate-term sales decline, and the company is looking for ways to quickly fill the revenue gap. Actelion's niche drugs, which include Opsumit and Uptravi, both of which have blockbuster potential, would do the bulk of the work.
It's no secret, either, that J&J has been on the hunt for inorganic growth opportunities. It had more than $40 billion in cash and cash equivalents on its balance sheet at the end of last quarter. However, it's far more common for J&J to acquire smaller companies than a business the size of Actelion given J&J's desire to control the development of drugs and devices from an early stage.
This could be a foolish move
However, it's been this Fool's contention for months that Johnson & Johnson could be making a foolish move by potentially overpaying for Actelion. In particular, chasing Actelion right now may be a poor idea considering just how many unknown variables are lurking within its product portfolio and pipeline. J&J's foolhardy pursuit of Actelion could bite it in the behind, as we witnessed this Monday.
Before the opening bell this past Monday, Actelion announced that a 226-patient phase 3 trial involving Opsumit as a treatment for Eisenmenger syndrome failed to reach its primary endpoint of a statistically significant improvement in exercise capacity as measured by the six-minute walk test. Though success in the study would merely have expanded Opsumit's label and added somewhere in the neighborhood of $100 million to $200 million in peak annual sales, it nonetheless represents a reduction in peak annual projections for Opsumit's annual sales of between 5% and 10%. Considering the premium J&J has been offering Actelion, we're talking about perhaps $1 billion in lost valuation on this deal (assuming a multiple of five times peak sales), if not a hair more.
But, this is far from the only question mark in J&J's pursuit of Actelion.
For example, Tracleer, which was approved in 2001 and is Actelion's best-selling PAH drug, has lost its patent protection and is about to face generic competition. Generally, generic drugs can wipe out around half, if not more, of branded drug sales within a year since they're considerably cheaper than branded therapies. This would mean Tracleer's more than $1 billion in annual sales could dwindle to less than $500 million relatively quickly. Considering that Tracleer's sales in the first-half of the fiscal year comprised close to half of Actelion's total revenue, J&J could be in for an unpleasant surprise.
There's also an ongoing phase 3 study examining ponesimod as a treatment for relapsing multiple sclerosis. Not only is it unknown if ponesimod will meet its primary endpoint in pivotal late-stage trials, but even if it does, will it offer any differentiation from current market share leader Gilenya? If ponesimod just winds up being par for the course, it may not move the needle much at all.
Here's the thing about Actelion: if J&J had waited 12 months, we'd have had a much clearer picture of what Actelion's pipeline and product portfolio are worth. Executing a transaction now, though, risks overpaying for Actelion and essentially wasting much of J&J's $40 billion-plus in cash on hand.
It's rare that J&J's often top-notch management team is directed criticism, but its blind pursuit of Actelion without understanding the variables that could be at work here isn't of any benefit to its shareholders.