Boston Scientific Overcomes Johnson & Johnson to Acquire Guidant—A Lesson

question 95

Essay

Boston Scientific Overcomes Johnson & Johnson to Acquire Guidant—A Lesson in Bidding Strategy

Johnson & Johnson, the behemoth American pharmaceutical company, announced an agreement in December 2004 to acquire Guidant for $76 per share for a combination of cash and stock. Guidant is a leading manufacturer of implantable heart defibrillators and other products used in angioplasty procedures. The defibrillator market has been growing at 20 percent annually, and J&J desired to reenergize its slowing growth rate by diversifying into this rapidly growing market. Soon after the agreement was signed, Guidant's defibrillators became embroiled in a regulatory scandal over failure to inform doctors about rare malfunctions. Guidant suffered a serious erosion of market share when it recalled five models of its defibrillators.

The subsequent erosion in the market value of Guidant prompted J&J to renegotiate the deal under a material adverse change clause common in most M&A agreements. J&J was able to get Guidant to accept a lower price of $63 a share in mid-November. However, this new agreement was not without risk.

The renegotiated agreement gave Boston Scientific an opportunity to intervene with a more attractive informal offer on December 5, 2005, of $72 per share. The offer price consisted of 50 percent stock and 50 percent cash. Boston Scientific, a leading supplier of heart stents, saw the proposed acquisition as a vital step in the company's strategy of diversifying into the high-growth implantable defibrillator market.

Despite the more favorable offer, Guidant’s board decided to reject Boston Scientific's offer in favor of an upwardly revised offer of $71 per share made by J&J on January 11, 2005. The board continued to support J&J's lower bid, despite the furor it caused among big Guidant shareholders. With a market capitalization nine times the size of Boston Scientific, the Guidant board continued to be enamored with J&J's size and industry position relative to Boston Scientific.

Boston Scientific realized that it would be able to acquire Guidant only if it made an offer that Guidant could not refuse without risking major shareholder lawsuits. Boston Scientific reasoned that if J&J hoped to match an improved bid, it would have to be at least $77, slightly higher than the $76 J&J had initially offered Guidant in December 2004. With its greater borrowing capacity, Boston Scientific knew that J&J also had the option of converting its combination stock and cash bid to an all-cash offer. Such an offer could be made a few dollars lower than Boston Scientific's bid, since Guidant investors might view such an offer more favorably than one consisting of both stock and cash, whose value could fluctuate between the signing of the agreement and the actual closing. This was indeed a possibility, since the J&J offer did not include a collar arrangement.

Boston Scientific decided to boost the new bid to $80 per share, which it believed would deter any further bidding from J&J. J&J had been saying publicly that Guidant was already "fully valued." Boston Scientific reasoned that J&J had created a public relations nightmare for itself. If J&J raised its bid, it would upset J&J shareholders and make it look like an undisciplined buyer. J&J refused to up its offer, saying that such an action would not be in the best interests of its shareholders. Table 1 summarizes the key events timeline.
Table 1
Boston Scientific and Johnson \& Johnson Bidding Chronology
$\begin{array}{|l|l|}\hline\text { Date } & \text { Comments } \\\hline \text { December } 15,2004 & \text { J\&J reaches agreement to buy Guidant for } \$ 25.4 \text { billion in stock and cash. } \\\hline \text { November } 15,2005 & \text { Value of J\&J deal is revised downward to } \$ 21.5 \text { billion. } \\\hline \text { December } 5,2005 & \text { Boston Scientific offers } \$ 25 \text { billion. } \\\hline \text { January } 11,2006 & \text { Guidant accepts a J\&J counteroffer valued at } \$ 23.2 \text { billion. } \\\hline \text { January } 17,2006 & \text { Boston Scientific submits a new bid valued at } \$ 27 \text { billion. } \\\hline \text { January } 25,2006 & \text { Guidant accepts Boston Scientific's bid when J\&J fails to raise its offer. }\\\hline\end{array}$
A side deal with Abbott Labs made the lofty Boston Scientific offer possible. The firm entered into an agreement with Abbott Laboratories in which Boston Scientific would divest Guidant's stent business while retaining the rights to Guidant's stent technology. In return, Boston Scientific received $6.4 billion in cash on the closing date, consisting of $4.1 billion for the divested assets, a loan of $900 million, and Abbott's purchase of $1.4 billion of Boston Scientific stock. The additional cash helped fund the purchase price. This deal also helped Boston Scientific gain regulatory approval by enabling Abbott Labs to become a competitor in the stent business. Merrill Lynch and Bank of America each would lend $7 billion to fund a portion of the purchase price and provide the combined firms with additional working capital.

To complete the transaction, Boston Scientific paid $27 billion, consisting of cash and stock, to Guidant shareholders and another $800 million as a breakup fee to J&J. In addition, the firm is burdened with $14.9 billion in new debt. Within days of Boston Scientific's winning bid, the firm received a warning from the U.S. Food and Drug Administration to delay the introduction of new products until the firm's safety procedures improved.

Between December 2004, the date of Guidant's original agreement with J&J, and January 25, 2006, the date of its agreement with Boston Scientific, Guidant's stock rose by 16 percent, reflecting the bidding process. During the same period, J&J's stock dropped by a modest 3 percent, while Boston Scientific's shares plummeted by 32 percent.

As a result of product recalls and safety warnings on more than 50,000 Guidant cardiac devices, the firm's sales and profits plummeted. Between the announcement date of its purchase of Guidant in December 2005 and year-end 2006, Boston Scientific lost more than $18 billion in shareholder value. In acquiring Guidant, Boston Scientific increased its total shares outstanding by more than 80 percent and assumed responsibility for $6.5 billion in debt, with no proportionate increase in earnings. In early 2010, Boston Scientific underwent major senior management changes and spun off several business units in an effort to improve profitability. Ongoing defibrillator recalls could shave the firm’s revenue by $0.5 billion during the next two years. In 2010, continuing product-related problems forced the firm to write off $1.8 billion in impaired goodwill associated with the Guidant acquisition. At less than $8 per share throughout most of 2010, Boston Scientific’s share price is about one-fifth of its peak of $35.55 on December 5, 2005, the day the firm announced its bid for Guidant.
-What might J&J have done differently to avoid igniting a bidding war?

---

Definitions:

Accounting Principles

Fundamental guidelines or rules that form the basis for accounting practices and financial reporting.

Unrealized Profits

Profits that have been earned but not yet realized through a transaction, often related to investments that have increased in value but have not been sold.

Economic Activities

Actions that involve the production, distribution, and consumption of goods and services in an economy.

Accounting Information

Data related to the financial transactions and status of an individual, business, or organization, used for reporting and decision-making purposes.