Motley Fool healthcare contributor Todd Campbell shares with analyst Kristine Harjes why he thinks that Johnson & Johnson (NYSE:JNJ) is one stock-to-watch coming out of the annual J.P. Morgan Healthcare Conference earlier this month.

At the conference, J&J's management discussed how it goes about finding and developing new drugs both internally and externally. CEO Alex Gorsky's comments offered up important insight into how J&J's deal-making may shape up this year. Should investors expect a big M&A splash out of J&J in 2016? Find out in this clip of Industry Focus: Healthcare. 

A full transcript follows the video.


This podcast was recorded on Jan. 20, 2016.

Kristine Harjes: Let's talk a little bit about Johnson & Johnson. I found their call really interesting.

Todd Campbell: Yeah, that was a really interesting J. P. Morgan presentation, too. One of the reasons is because J&J took the typical script of, "Here's my PowerPoint presentation, I'm going to put it up and walk you through it," and kind of threw it in the garbage and said, "Let's do a fireside chat instead. Let's just talk about healthcare, let's talk about what we're doing to improve healthcare."

And during that conversation, their CEO basically ... I don't want to say tipped his hand, because it's not like he said they would buy X/Y/Z company. But he did say, "Hey, we're still on the hunt, and we're looking for small companies that we can tuck in as part of our goal for research and development, bring in some companies that are maybe in phase two, and see if we can get some new drugs on the market that way."

Harjes: And this is a company that ended last quarter with $37 billion in cash and short-term investments. And they kick off some $11 billion a year in free cash. So they have the money to do it. And to me, it just looks like it's a matter of time before they pull the trigger.

Campbell: Yeah. I think one of the things CEO Gorsky said in the conversation was, they went back and looked at the 10-20 years in the past and said how have they gotten their drugs on the market. 30% of their free cash flow goes toward R&D and M&A. And it's split, roughly, I think 55% goes to internal R&D, 45% goes to external deals, collaborations, acquisitions, and the like. It doesn't seem like that's going to change anytime soon.

Harjes: Yeah. Gorsky weighed in on that split, the 55-45, saying that's a good balance, that's where they want to be.

Campbell: That means, probably, that investors who are trying to figure out, what does that mean for J&J, what targets might they be going after, in the past, $2 billion or less. It doesn't seem like they like to do you much larger than that. Hey, they could surprise us. But in the past, things like Cougar Biotech, which they bought to get ZYTIGA, a multibillion-dollar prostate cancer drug. Recent deals have all been in that $2 billion or less area.

Harjes: Yeah. The Cougar acquisition was $1 billion, if I recall. One that stands out to me that was a lot bigger than that was Synthes. I'm not sure if I'm saying that right. But in 2012, their biggest buyout up to that date. This was a $21 billion acquisition. And it didn't seem like it really went very well. So I'm wondering if this is Gorsky and Johnson & Johnson acknowledging that, "Hey, we have done bigger deals, and they haven't been great. So we're going to stick with the small deal route."

Campbell: Big deals are hard. You look at a big deal and say, "Okay, well, maybe I can capture some synergy." Obviously, Pfizer's trying to do that, and other companies are trying to do that, merge larger companies together, remove a lot of the costs and drop more money to the bottom line. But they're also very complex.

They're hard, there's a lot of moving pieces. It's not as simple as being able to say, "Hey, look, we found this really interesting small molecule or biologic drug, we just need some help getting it to the finish line." Yeah, I think, to your point, they're looking at it and saying, "You know what? Small deals may be more profitable for us over time, if we leverage all of our knowledge and experience for that benefit."