In buying an asset, such as a house or stock in a company, the Foolish investor will weigh the risks and costs of owning the asset against the expected returns. If the risks and costs, both monetary and otherwise, outweigh the expected returns, a Fool will probably avoid the purchase. But if an honest assessment of returns outweigh the risks and costs, then the Fool will be likely to go for it. To be conservative, though, one should overestimate the costs and keep one's expectations for returns low. That way, if the costs are lower or the returns higher than anticipated, the surprise is pleasant. One should also try to pay as little as possible, to minimize the pain if things do not go as planned.
By the same token, companies also should strive to be Foolish investors when buying other companies. And in reviewing the history of Boston Scientific's
Tale of the tape
In December 2004, Johnson & Johnson
Three weeks later, in early December 2005, Boston Scientific unexpectedly entered the picture and offered $72 per share for Guidant, almost equal to Johnson & Johnson's original offer. After some consideration, J&J upped its bid to $68 per share in early January 2006 -- still less than Boston Scientific's offer, but higher than J&J's own November bid. Then a bidding war ensued. Boston Scientific increased its bid the very next day to $73. J&J increased to $71, and Boston Scientific followed up with $80, for a total of $27 billion, less than a week later, with help from Abbott Laboratories
That was the bid that Guidant finally accepted. And why not? That bid was 12.7% higher than Johnson & Johnson's last offer and 5.3% higher than the original offer, and it came after the recall news. The deal finally closed this past April 21.
Was this price reasonable?
Management at Boston Scientific believes the company will benefit from the addition of Guidant and its products. Guidant's drug-coated-stent technology will be strengthened and new technologies made available, thereby opening up new markets. Scalable costs and operations will improve margins. Even given the sale of Guidant's vascular line to Abbott -- part of the price for getting Abbott to help on the winning bid -- the potential product spread and improved business efficiency looks promising.
On the other hand, Johnson & Johnson stated that it considered "the proposal from Boston Scientific to be a highly dilutive and leveraged transaction based on extremely aggressive business projections and, as such, one that will not provide $80 per share in value to Guidant shareholders."
Not all that glitters is gold
Let's examine that criticism more closely. When Guidant accepted Boston Scientific's offer, it increased Boston Scientific's debt load substantially -- from $2 billion to almost $10 billion. As a result, Moody's downgraded the company's rating to Baa1. On the day the deal closed, Moody's further downgraded the company to Baa3, the absolute lowest investment-grade rating and just one step above junk status. Such downgrades mean more expensive borrowing, which cuts into that potentially improved business efficiency.
Further, Boston Scientific has been in repeated trouble with the Food and Drug Administration. Since August 2003, the company has been issued five warning letters, which the FDA issues over problems in production or distribution of a medical product. Its most recent warning was issued this past January. For the sake of comparison, Guidant has received one letter, last December; Abbott got four in 2002 and one in 2004; a Medtronic
Meanwhile, before the deal closed, Guidant called back the release of its latest drug-coated stent, citing manufacturing control problems. Barely three weeks after the close date, more defibrillators that Guidant manufactured were pronounced defective.
Given the quality-control trouble at the two manufacturers, one wonders why Boston Scientific believed the companies would do better together. It also raises the question of how long the looked-for manufacturing efficiencies will take to materialize, particularly because Boston Scientific is now turning out more product than either did alone before. Management must address this issue, and soon, if it wishes to realize benefit from Guidant.
Finally, Boston Scientific's management has shown that it was overly optimistic in at least two instances. First, management originally stated that the acquisition would be accretive to earnings in 2008, but it then postponed that to 2009.
Second, management included in its offer a clause stating that if the deal had not closed by the end of March, which it didn't, Boston Scientific would pay Guidant's shareholders $4.47 million per day missed. By the time it closed, the total outlay was almost $95 million -- money that could have been better spent for other projects, such as overcoming the manufacturing problems. I'm not blaming management for missing the hoped-for closing date. These things happen. But being so sure as to stake money on it? That is a serious case of excessive optimism.
Foolish final thought
In letting the Guidant acquisition pass, Johnson & Johnson -- which has acquired companies very successfully in the past, has good quality control, and is quite efficient at manufacturing -- showed that it believed the risks outweighed the potential benefits at the higher price. By the definition given at the start, I'd call J&J a verily Foolish bunch of investors.
Granted, J&J is a much larger company, so the acquisition would not have had as big an impact as it did for Boston Scientific. The latter's calculus is, therefore, necessarily different. But with the potential problems outlined above, management must believe that the potential gains are worth it.
For the sake of investors in Boston Scientific, I hope management is right.
Recent related Foolishness:
- Goodbye, Guidant
- Boston Scientific's Big Task
- High-Stakes Medical Device Chicken
- Once More With Guidant
Johnson & Johnson is a Motley Fool Income Investor recommendation. If you like getting paid to invest, you'll love Income Investor, which recommends the market's best dividend payers. Try it out free for 30 days.