Breaking up may not be so hard to do: Despite taking lumps over rash of product recalls, Guidant remains strong, according to analysts

October 24, 2005

Guidant Corp. will be just fine if Johnson and Johnson walks away from its $25.4 billion purchase of the medicaldevice maker, Wall Street analysts say.

Even so, the Indianapolis company would have to grapple with some tricky issues, they say, including quelling lingering product-safety concerns among doctors and stabilizing the executive ranks.

Guidant has been battered by a series of product problems and recalls in recent months. On Oct. 18, it took another punch when J&J executive Robert Darretta told analysts Guidant's problems had prompted his company to consider "alternatives under our merger agreement."

Guidant shares sank more than $8 before closing at $64.10.

Despite the setbacks, analysts say there's no cause for alarm.

"They can clearly regroup," said Benjamin Andrew, an analyst with William Blair & Co. in Chicago. "While there's no guarantee they'll get back all of their lost market share, they should recover at least some of it.

"It's still a good business, just currently at a reduced scale."

J&J announced Dec. 15 it planned to buy Guidant for $25.4 billion for $76 a share, $30.40 of it in cash and the remainder in stock.

Analysts view Darretta's comment as a negotiating tactic aimed at lowering that price. J&J will explore new terms before walking away, said John Chen, an analyst who covers mergers for New York-based Cathay Financial LLC.

"In the end, I think that's probably what's fair for all parties," he said. "Guidant most likely is not worth as much today as when the deal was cut."

Guidant countered Darretta's remark with its own announcement a day later. In a written statement, CEO Ronald Dollens said that "while neither company depends on this transaction for its continued future success, Guidant believes that the strategic rationale for combining the two companies" remains strong.

Chen said there's nearly a 50-percent chance the companies will agree to a reduced price. He sees only a 10-percent chance J&J will walk away and notes such a move would invite litigation from Guidant.

In a report, analyst Robert Faulkner agreed J&J wants to negotiate first, but said he has no doubt about "J&J's willingness to walk if the mess is too big."

"J&J does not customarily buy businesses in need of fixing," wrote the analyst for New York-based JMP Securities LLC.

If Guidant stays independent, it will need a new CEO. Dollens had announced last year that he planned to retire by the end of 2004.

However, he changed his tune after the companies announced the merger, saying he'd stay until it closed. Another top executive, vascular intervention President Dana G. Mead Jr., left quietly in May to join a California venture capital firm.

Guidant didn't announce Mead's departure, even though he ran one of the company's main business segments and was one of its highest-paid executives. The company Web site now lists John Capek as vascular intervention president.

Capek also was a "key member of the team negotiating the company's pending merger with Johnson & Johnson," according to the Web site.

Company spokesman Steve Tragash did not return phone calls seeking comment.

In addition to shuffling executives, the company has lost some of its sales force, JMP's Faulkner said in an interview with IBJ.

"I think whenever a company is in the process of integration, as Guidant is, the organizational structure shifts and creates uncertainty internally," he said. "Essentially, all those pieces would need to be bolted down again."

Defibrillator recalls and other product problems shook doctor confidence in Guidant, William Blair analyst Andrew said. However, he said the company already is showing signs of a rebound.

He noted that implant rates for Guidant's defibrillators have started to recover after sinking in the wake of recall news.

Many of Guidant's rivals in the cardiac-rhythm management business, including Minnesota-based St. Jude Medical, also have struggled with product problems, said Jan Wald, an analyst with St. Louis-based A.G. Edwards & Sons.

"All companies, I would believe just given the nature of the devices, have a pretty similar failure rate," said Wald, who used to work for Guidant. He added that he thinks Guidant discloses more on these problems than does its competition.

Guidant has been a significant player in the cardiac-rhythm management market for a decade, and that reputation won't disappear because of a rough few months, he said.

"The issues that it's facing now are short-term, I think, and repairable," Wald said.

If talks between Guidant and J&J break down, Wald said, Guidant "wouldn't look much different than it did last year."

Indeed, Guidant's stock price on Oct. 19 was $64.90, up $1.38 from the same date a year earlier.
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