Guidant Acquisition Cloaked in Intrigue

When it was first announced, the potential acquisition of Guidant Corp. (Indianapolis) shook the medical device industry. More than a year later, the story continues to provide the biggest jolt to the industry, but for different reasons.

When Johnson & Johnson (J&J; New Brunswick, NJ) made the $25.4 billion bid in 2004, the talk was of how any firm was now fair game to be bought, and of how a dominant cardiovascular company might be created.

Now, the talk is of how Boston Scientific Corp. (Natick, MA) was able to outbid J&J, offering more than $27 billion, and whether it can weather the problems that have plagued Guidant in the past year. Is Guidant damaged goods or not? In 2005 and into 2006, no one seemed to know.

Everything seemed fine for the J&J bid until one day in May, when problems with Guidant's implantable cardioverter-defibrillators (ICDs) were made public. They had short-circuited and failed dozens of times, causing several deaths, yet the company had not informed clinicians about the problem. It had informed FDA about problems in one model, but the alert had been buried in the morass of postmarket annual reports and had never been addressed. Other reports indicated that the problem could occur in other Guidant ICD models.

As a result, Guidant and FDA took a massive beating in the media, and Guidant's stock price took a hit. The questions about Guidant's quality problems and the effect on its revenues and share price gave J&J pause. After regulatory approval of the deal came down, J&J tried to back out and Guidant went to court to force its completion. The two sides worked out a deal for a reduced price, $21.5 billion.

That would seem to be the end of the story and confirm that Guidant's value had dropped since the initial bid because of the quality problems. But Boston Scientific had other ideas. In December, it announced that it would offer $25 billion for Guidant, thus placing a company considered to have serious problems in the middle of a bidding war.

Why would a company perceived as problematic be so sought after all of a sudden? It's the technology. Guidant is one of only three players in the growing and lucrative cardiac rhythm management (CRM) market. Companies that want to break into it may only be able to do so by acquiring one of them. And one of the players, Medtronic Inc. (Minneapolis), is considered too big to be acquired. That makes Guidant more attractive than what one might expect.

“This is one of the rare oligopoly technologies in medtech, and one company was for sale,” says Thomas Gunderson, managing director and senior research analyst with Piper Jaffray (Minneapolis). “Boston Scientific must expect that the problems are short term and can be fixed, and that the same reasons for making a deal a year ago are still true: You get CRM and a stronger cath lab business.”

The deal also fits Boston Scientific's strategy, says Greg Aurand, senior medical devices analyst at Zacks Investments Research Inc. (Chicago). “Boston Scientific is focused on acquisition,” he says. “That's traditionally how it has grown its business. I think it could mesh well with Guidant, just as well as J&J could. Boston Scientific wants CRM, and this could also give it another drug-eluting stent platform.”

Boston Scientific's entry gave J&J two options: raise its own offer or hope that Boston Scientific would withdraw its offer after performing due diligence. “J&J had a fiduciary duty to its shareholders,” Gunderson says. “[Guidant] is not the same company it was [when J&J made its first offer]. It can't possibly have the same value. If J&J could get it for a lower price, it should. Legally, it almost has to.” But J&J decided the strategic fit was too good, and in mid-January upped its offer to $24.2 billion. Guidant accepted the deal, saying the ability to close a J&J deal more quickly offset the difference in price. But Boston Scientific refused to give up the fight, raising its offer to $27 billion in response. That proved to be too rich for J&J.

During the bidding war, another crucial party emerged: Abbott (Abbott Park, IL). It struck a deal with Boston Scientific to provide $6.2 billion in side deals, stock sales, and low-interest loans. In exchange, Abbott will receive all of Guidant's stent business. That arrangement should defuse antitrust concerns, though some analysts speculate that J&J will appeal to the government to block the deal on those grounds.

The third player in CRM is St. Jude Medical (St. Paul, MN), and some on Wall Street expect that the loser of the Guidant battle will make a bid for St. Jude. “When J&J bid for Guidant, there was a lot of talk about Boston Scientific responding by bidding for St. Jude,” says Aurand. “So I could see J&J buying St. Jude if Boston Scientific ends up with Guidant.”

Gunderson, however, does not share that opinion. “Guidant is for sale and St. Jude is not,” he says. “One could argue that any public company is for sale, but that's not the same as being a willing seller. Eventually, if someone wants to be in the CRM business bad enough, the only opportunity will be with St. Jude. But St. Jude would be the only one at the dance, and my guess is that would mean paying a 30% premium.” St. Jude declined to comment on that topic.

When the CRM battles finally shake out, that would likely mean the end of major merger and acquisition activity in the device industry for a while, says Gunderson. Part of the reason is that there simply aren't many device companies large enough to pull off deals of this scale. “I don't expect to see more like this; I think it was a convergence of rare elements that made Guidant a good acquisition,” he says. “I think 2005 will be a peak for mergers and acquisitions in medtech. Then the focus will be on integrating. In four or five years, new companies will come along and we'll go through this again.”

Meanwhile, negative publicity for Guidant continues. In late December, FDA issued a warning letter to Guidant over GMP violations at its plant in St. Paul and said it would not issue export permits for devices made there. If the action persists, it could have serious financial consequences. —Erik Swain

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