CDU Associate

In an 11th-hour deal, Boston Scientific (Natick, Massachusetts) proposed in early December to acquire all the outstanding shares of Guidant (Indianapolis) for a combination of cash and stock worth $72 per Guidant share, nearly a $3 billion increase, or 14% over the $63.43 per share that was offered by Johnson & Johnson (J&J; New Brunswick, New Jersey) in a revised deal outlined in mid-November.

The $25 billion offer is much closer to what J&J had initially proposed to pay for Guidant prior to that company’s well-documented problems with its cardiac rhythm management business

In December 2004, J&J had proposed to buy Guidant for $25.4 billion or about $76 a share. That deal appeared to be in jeopardy due to Guidant’s continued problems over this past summer with the recall of thousands of pacemakers and implantable cardioverter defibrillators (ICDs).

After the problems began to surface, J&J showed signs of wanting to back away from the original deal, claiming that product recalls and related regulatory investigations, claims and other developments had “a material adverse effect” on Guidant’s value. Instead of the deal breaking down, as some industry watchers had forecast, the two companies finally agreed to a $3.9 billion reduction in the merger’s valuation

A day after the Boston Scientific proposal was made known, J&J indicated that its offer for Guidant “represents full and fair value” for the company. J&J said it remained committed to acquiring the medical device maker, but declined to immediately raise the bid price it had already negotiated with the firm.

The company disclosed its intention via an S-4 registration statement it filed with the Securities and Exchange Commission a day after Boston Scientific made its J&J-topping offer. Interestingly, while analysts viewed the latest offer as a surprise attack by Boston Scientific, J&J’s filing with the SEC revealed that the company was aware that Guidant had been approached by Boston Scientific about a potential buyout on Nov. 1, an event Guidant reported to J&J on Nov. 2.

“On Nov. 1, 2005, [Guidant Chairman James] Cornelius received an unsolicited call from a representative of Boston Scientific . . . inquiring as to his availability for a meeting to discuss a possible business combination transaction involving the two companies,” the J&J filing said. Cornelius declined to meet with Boston Sci at that time, informing them it would be in violation of his company’s agreement with J&J, the filing added.

A day after the J&J response, Guidant said its board of directors had agreed to discuss the latest offer with Boston Scientific.

Under the Boston Scientific proposal, each share of Guidant common stock would be exchanged for $36 in cash and a fixed number of shares of Boston Scientific common stock having a value of $36 on or about the date that a definitive merger agreement is reached.

Boston Scientific maintains that it can close the deal quickly, sometime in 1Q06. “Combining our two organizations will create the world’s leading device company,” said President and CEO Jim Tobin during a conference call on the proposed deal. He noted that the company has been interested in the cardiac rhythm management (CRM) sector for years, an area in which it, like J&J, has not been a player.

He added that the revised J&J offer “gave us a reason to take an even closer look at Guidant.”

While Tobin stressed that the merger was about growth, it is no secret that his company and J&J are fierce competitors, and it appears that Boston Sci decided it could not sit idly by and let J&J acquire a well-established CRM program at such a significantly reduced price without putting up a fight.

It would undoubtedly be a bitter pill for J&J to swallow if it has to offer more money for Guidant after already indicating that its original offer substantially overvalued the company. If J&J ultimately elects not to make a counter-offer, it could potentially look to acquire another company with a CRM business, St. Jude Medical (St. Paul, Minnesota), whose market capitalization wouldn’t break the bank.

Aside from the obvious financial upside, Tobin also stressed the benefits of the combination from a cultural perspective, calling the potential merger “a natural fit,” a not-so-subtle jab at the significantly larger corporate entity that J&J represents.

“Boston Scientific offers Guidant employees an environment and culture that will allow them to continue to make a difference,” he said, noting that while Boston Sci has grown considerably over the years, “in many ways we have retained the spirit of a small company, one that values initiative and creativity and that recognizes each person’s talents and contributions.”

He also indicated that the new proposal would not lead to massive layoffs at Guidant and is not premised on cost cutting.

“We plan to retain Guidant’s talented employee base, especially its dedicated sales and product development teams,” Tobin said.

Boston Scientific said that if Guidant agrees to the merger plan, it is prepared to divest that company’s vascular intervention and endovascular businesses, while retaining shared rights to Guidant’s drug-eluting stent program in order to assuage any antitrust concerns.

Paul LaViolette, chief operating officer of Boston Sci, offered further rationale for the merger, noting that it would combine the No. 1 interventional cardiology platform and the No. 2 CRM platform, making the combined entity the third-largest medical device company in the world.

He also said that from his company’s perspective, it would serve to greatly diversify the BSX product portfolio, whose blockbuster Taxus drug-eluting stent (DES) currently accounts for more than 40% of total product sales.

In the combined company, he said that drug-eluting stents would account for only a quarter of annual revenues, even given the strength of two DES programs instead of just one. And the CRM business will account for roughly 28% of the revenues for the combined business, Tobin said.

Perhaps of greatest interest to analysts was his prediction of an average 12% annual compound growth for the combined firm by 2008.

LaViolette also expressed confidence that Guidant would be able to work through its current CRM recall issues “and over the medium and long term, maintain its traditionally strong position in this business.”

Boston Scientific Chief Financial Officer Larry Best said that the company already has the financing in place to conclude the transaction and that the company expects “near zero net debt by 2009.” It expects that the deal would be accretive to cash earnings in 2008

Not surprisingly, analysts had very different takes on how Boston Sci’s latest bid will ultimately play out.

Expressing surprise at this latest turn of events was Harris Nesbitt (New York) analyst Joanne Wuensch. “Given BSX’s market capitalization of $22 billion, this appears to be a big nut to crack,” she wrote in a research note.

She did note, however, that “strategically, it does make sense, combining Guidant’s cardiac rhythm management franchise with BSX’s market-leading cardiovascular stent franchise, as well as its endoscopy, urology and neuromodulation platforms.”

JP Morgan (New York) analyst Michael Weinstein expanded on Wuensch’s concerns, writing in a research note that Boston Scientific would have to raise about $12 billion in debt, “dramatically increasing the leverage at the company and potentially pushing [it] into low investment grade or quite possibly junk status.”

JMP Securities analyst Robert Faulkner wrote in his note on the deal that the hefty acquisition “may cure what ills Boston Scientific. Most importantly, the deal also potentially cures our key issues with Boston Scientific, including lack of visibility on earnings, growth and threats to its stent business.”

It is unclear whether Guidant would be forced to pay the reported $625 million break-up fee attached to its merger deal with J&J if it opts for the Boston Sci offer. Although the J&J/Guidant deal has already been cleared by regulators, it still requires the approval of Guidant’s shareholders.