An activist investor at Artisan Partners is angered by J&J's M&A strategy and underperforming medical device segment.

Qmed Staff

Johnson & Johnson's sluggish medtech and consumer sectors and its aggressive M&A strategy are killing the company, according to the activist investor Artisan Partners Limited Partnership, which owns some $445 million of the company's stock.  

Artisan notes that JNJ has spent more than $150 billion on mergers and acquisitions in the past decade, which include paying $17 billion for Pfizer's consumer business in 2006 and $19 billion for Synthes in 2012. JNJ has announced that it has spent some $5 billion on restructuring costs related to the Synthes merger, yet the purchase has failed to boost the profitability of J&J's medical device segment. "Despite this $24 billion investment, the medical device business is generating adjusted EBITA of less than $8 billion, roughly the same level of profit it made in 2010," reads part of a letter to JNJ from Daniel J O'Keefe, managing director and portfolio manager at Artisan Partners. In addition, the profits from the JNJ division that formerly belonged to Pfizer are smaller now than they were before the acquisition.

Despite spending $150 billion on M&A, integration, capital expenditures, and research and development in a decade, the company's earnings before interest, taxes, and amortization has increased about $7 billion. "By any measure, the return on capital reinvested in the Company has been unacceptable," reads part of the letter.

The letter continues by criticizing JNJ CEO Alex Gorsky's public proclamation that the company would like to make another large acquisition. "Mr. Gorsky was responsible for the Synthes acquisition in 2012 and in my view, the results have been disastrous," O'Keefe continues.

As of mid-January, Gorsky seemed skeptical of making a big acquisition soon. In an interview with Bloomberg, he said: "Because we're more of an innovation-focused company, the ideal deal for us is early, great innovation, great science, then we scale it, versus going in and simply ripping out costs and trying to find other synergies."

O'Keefe also balks at Gorsky's compensation, which, he argues, greatly outstrips the performance of the company. In 2015, he made $25 million in total compensation. "[I]t is difficult to understand why the Board of Directors awarded the CEO and his predecessor [William C. Weldon] compensation totaling more than $200 million from 2007 through 2014," O'Keefe writes.

Gorsky has also drawn heat for the company's aggressive promotion of Risperdal. Last year, The New York Timesexplained that Gorsky had been directly involved in a plan to market the drug to the elderly and to boys despite its possibility of causing strokes and boys to grow breasts. The company pleaded guilty to the allegations and paid $2 billion in legal expenses. (The drug, however, generated some $30 million in global profits.)

Since 2007, Johnson & Johnson has spent more than $8 billion in charges related to litigation and product liability expenses, and spent billions more on restructuring charges totally $16 billion or more than $5 per share.

A substantial proportion of those litigation expenses trace back to the company's medical device segment, which has seen several of its products become lawsuit magnets, including the DePuy ASR metal-on-metal hips and transvaginal mesh. The company is facing 26,000 federal cases related to its transvaginal mesh products. In addition, fraud charges have been filed related to its Acclarent business; two of the company's executives are facing 18 cases of fraud.

Artisan goes on to refer to JNJ's medical device and consumer businesses as some of the "worst-performing participants in their industry."

Because there is "no evidence" in the conglomerate having a financial upside, O'Keefe therefore advocates splitting the company into three businesses to improve the focus and accountability devoted to each, while acknowledging the different business models inherent in each. The letter also advocates for a developing "publicly-disclosed financial targets for the faltering medical devices and consumer businesses."

Artisan is also a major holder of Medtronic stock.
 

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