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The Not-So-Hip Trend at Johnson & Johnson

By Dan Carroll - Feb 21, 2013 at 2:29PM

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Health care's biggest player is taking heat for hip implant recalls

If there's one company that nearly every investor knows in the health care arena, it's Johnson & Johnson (JNJ 1.13%). The medical colossus reaches across virtually every industry in the sector, from pharmaceuticals to medical devices and more. Unfortunately for J&J, however, it's picked up a new honor, courtesy of several ugly recalls: leader in public relations nightmares.

Hip device recalls, among other things, have hit the company's publicity hard. J&J's latest fiasco? The company warned physicians outside the U.S. last week of its Adept hip implant's high failure rate that exceeded expectations; J&J told doctors to stop using the Adept and recalled all of the devices distributed abroad  between 2004 and September 2011. So is that it for J&J's most recent round of PR disaster -- or should this mess make you think twice about this health care giant?

What's the deal?
J&J first acquired the Adept hip implant, which uses a metal-on-metal surface, from British firm Finsbury Orthopaedics in 2009. Though J&J halted sales in 2011, 7,500 implants eventually spread abroad in 21 different countries, although none were sold in the U.S. A British database later found that 12% of implanted patients later needed follow-up procedures to repair the devices.

While the recall only involves the top part of the devices – J&J pointed out that a similarly named product called the Adept Hip Resurfacing Femoral Components was not recalled -- the company doesn't know just how many patients were fitted with the device.

What makes this situation so much worse than a simple recall is J&J's recent track record of recalls and mishaps. The company's ASR hip implants are perhaps its most infamous recalled product now, with 10,000 lawsuits revolving around the products. J&J subsidiary DePuy recalled 93,000 ASR implants back in 2010, and after an internal study in 2011 showed that up to 37% of the products failed within five years, things haven't been going the company's way.

Complicating things even more, the company's faced suits over DePuy's Pinnacle metal-on-metal hip implant that's still on the market. Orthopedics just isn't J&J's cup of tea recently, and the shaky history won't help in whatever develops from the Adept's recall.

But just how much could this latest problem hurt Johnson & Johnson?

What it means to the company
On a purely legal standpoint, the settlements and cost of fighting potential suits may not be all that bad in context. Because the Adept's recall affects overseas products rather than those sold on U.S. soil, it's doubtful J&J will have to repeat shelling out the more than the $900 million it's already spent fighting and settling suits over the ASR implant. With Adepts in question totaling less than a tenth the number of ASRs recalled, don't expect the court ramifications to be anywhere near as bad with this development.

The real question is whether J&J will take a hit on its orthopedics revenue. Orthopedics sales made up more than 28.4% of the company's total medical device and diagnostics revenue in 2012. Out of total company revenue, orthopedics made up more than 11.6%. That's a sizable share for such a massive company (J&J's 2012 sales of more than $67 billion underscores that fact), and any serious hit here could send investors into a panic.

The ASR recall mess' hit on revenue has largely been covered up by J&J's acquisition of Synthes, a move that boosted operational orthopedics sales growth to an astounding 36.2% last year. The Synthes purchase was good timing by J&J, but if further scrutiny over the company's hip implants ends up in more recalls -- particularly if they involve products already on the market, such as the aforementioned Pinnacle -- watch out.

While the Pinnacle line of products covers a range of products, the metal-on-metal implants in that family will be under the gun in the near future. Even without a massive blow from recalls and litigation -- J&J has been tougher in fighting claims  for the Pinnacle as compared to its settlements with many ASR suits -- expect doctors to continue to back away from metal-on-metal products. As of mid-2012, more than 150,000 patients had received a Pinnacle metal-on-metal implant, according to a report from Reuters.

All of this is a boon to J&J's competition in the hip implant industry. Granted, some rival companies have had recall problems, too: Smith & Nephew (SNN 0.18%) launched a voluntary recall of an all-metal hip implant product, a component of its R3 Acetabular System, last year. Still, competitors don't face nearly the scale of lawsuits and publicity damage that J&J is squaring off with.

What to watch for
Expect orthopedics players such as Zimmer Holdings (NYSE: ZMH) -- which pulled its own metal-on-metal hip component, the Durom Acetabular, from Australia last year, although its troubles aren't even in the same universe as J&J's -- and Stryker (SYK 2.48%) to look to take advantage of J&J's PR struggles. I wouldn't be surprised to see the competition claw back market share in the orthopedics industry as J&J gets a handle on the scope of its problem-particularly if more problems crop up. Even an upstart company such as MAKO Surgical (MAKO.DL), which could use some good news with its stock in the dumps, could turn J&J's misfortune into an opportunity to sell its MAKOplasty hip replacement as an alternative to the declining metal-on-metal implant trend.

Is Johnson & Johnson's orthopedics division doomed? Of course not: This is still the biggest player in the health care industry, and regardless of these troubling concerns, J&J won't be toppled that easily. The company will face its hurdles, and less-than-expected growth in orthopedics despite the synergies of the Synthes addition wouldn't surprise me. For long-term investors, however, J&J is still a company worth your investment. You should keep an eye on how the hip recall saga plays out, but at the end of the day, Johnson & Johnson will come back swinging.

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