Sometimes a bird in the hand is worth an unknown number in the bush, but this is one expensive bird for Boston Scientific (NYSE:BSX). Rather than roll the dice with a jury trial to determine patent-violation damages for the company's drug-eluting stents, Boston Scientific settled its dispute with Johnson & Johnson (NYSE:JNJ) for $1.725 billion.

That's on top of the $716 million that Boston Scientific agreed to pay Johnson & Johnson last year to settle other patent issues. I understand the allure of negotiating damages rather than leaving it up to a jury, but so far it's been very expensive for Boston Scientific. Shareholders will determine whether or not this payment, as explained by CEO Ray Elliott's comments, "We have recently made a concerted effort to mitigate risk throughout the Company, including litigation risk. ... We believe today's settlement -- while substantial -- is in the best interest of the Company and its shareholders," really is in their best interest. So far, the vote is against the company.

Part of that might be the fact that, as of September, Boston Scientific didn't have the whole $1.7 billion in cash. So, Johnson & Johnson is putting Boston Scientific on an installment plan. Boston Scientific will pay $1 billion today -- $800 million from cash on hand and $200 million from its credit facilities -- and the balance, including $20 million in interest, by the first week in January 2011.

No matter when the payments are made, it's still going to do a number on Boston Scientific's balance sheet. The company had been doing well paying down the debt from its acquisition of Guidant, but this large settlement will have it headed in the wrong direction.

 

Dec 2006 (in billions)

Dec 2007

Dec 2008

Sept 2009

Today*

Cash and Short-Term Investments

$1.7

$1.5

$1.6

$1.4

$0.6

Total Debt

$8.9

$8.2

$6.7

$6.1

$7.0

Net Cash

($7.2)

($6.7)

($5.1)

($4.7)

($6.4)

Source: Capital IQ, a division of Standard & Poor's.
*Ignores significant changes in cash or debt positions between 9/09 and today's announcement.

Boston Scientific says the settlement won't have an impact on its debt covenants and it'll be able to refinance debt that's due next year, but that may be the least of Boston Scientific's worries. Any cash flow used to settle patent litigation isn't available to make strategic purchases. While Boston Scientific is paying down debt, Johnson & Johnson, Medtronic (NYSE:MDT), St. Jude Medical (NYSE:STJ), and the like will be adding new externally developed technology to their pipelines.

Worse yet, the patent infringement settlements may not be over. The settlement covers violations for Boston Scientific's Taxus brands of drug-eluding stents, but Johnson & Johnson still has a lawsuit pending that claims Boston Scientific's new stent, Promus, violates Johnson & Johnson's patents. Abbott Labs (NYSE:ABT) markets the same stent under a different name, Xience, and is also being sued by Johnson & Johnson.

Investors can only hope that any future risk-mitigation strategy isn't as costly.

Motley Fool Rule Breakers is always on the hunt for hot drug stocks and other cutting-edge picks. Click here to see all of our latest discoveries with a free 30-day trial subscription.

Fool contributor Brian Orelli, Ph.D., doesn't own shares of any company mentioned in this article. Johnson & Johnson is an Income Investor recommendation. The Fool owns shares of and has written puts on Medtronic and has a disclosure policy.