Johnson & Johnson [JNJ: NYSE] – Market Cap as of 19/02/2019 $364.53bn

Introduction

On February 13th, the healthcare giant Johnson & Johnson announced the acquisition of the privately held surgical robotics firm Auris Health, for approximately $3.4 billion in cash. The terms of the agreement also include additional payments to Auris of $2.35 billion, based on Auris hitting certain milestones.

As Auris will be part of Johnson & Johnson medical-devices division, the deal marks the company’s expansion into the healthcare robotics market as well as the cancer drug market. Dr. Moll, CEO and founder of Auris Health, will join Johnson & Johnson when the transaction closes.

Johnson & Johnson

Johnson & Johnson (NYSE: JNJ), headquartered in New Brunswick, New Jersey and incorporated in 1887, is one of the world’s largest manufacturer of health-care products. The company engages in the research and development, manufacture and sale of a range of products in the healthcare industry through around 250 operating companies.

With more than 130,000 employees in the year 2018 J&J generated revenues of around $82 billion, which represents an increase of 6.7% from 2017. The split among the three main segments shows that pharmaceutical (50%) has the highest share of sales, followed by medical devices (33%) and consumer (17%).

Looking at the geographical breakdown of J&J’ sales, US and Europe are the company’s largest markets, accounting for more than 35% and 15% of sales, respectively. The company has been working to expand its presence in Asia and other regions that are emerging as high-growth opportunities. The Asia/Pacific region and Africa together account for more than 12% of revenue, which increased by 10.5% from last year.

In terms of profitability J&J recovered from a poor number in 2017 of $1.3 billion to $15.3 billion in 2018. The slump in the previous year was mainly due to a US tax reform that lead to a billion charge for years of accumulated foreign earnings.

The company is currently implementing an inorganic growth strategy and engaging in both large and small mergers & acquisitions. To mention some of the most recent, in 2018 J&J purchased Orthotaxy, a French software-enabled surgical technologies developer such as the technology for total and partial knee replacement as well as companies like Abbott Medical Optics, TearScience and Sightbox that are operating in the eye care industry.

Moreover in 2017 the firm engaged in the largest deal of its history, the purchase of Swiss biotech Actelion, which focuses on rare diseases, for $30 billion. In 2015 J&J and Verily Life Sciences, part of Google parent Alphabet, also formed a robotic-surgery company called Verb Surgical.

Auris Health

Auris Heath, based in Redwood City, California, is s a privately held developer of robotic technologies for medical applications. Dr. Frederic Moll, who is the founder and CEO of the firm, is a robotic pioneer and founded priory three publicly traded companies: Hansen Medical, Restoration Robotics and Intuitive Surgical.

Auris Health develops robotic technologies and its first product that is initially targeting lung cancer, a platform called Monarch, has been approved by the US Food and Drug Administration. Monarch allows surgeons to reach small and hard-to-reach lung nodules early to diagnose and treat lung cancer.

Investors in Auris Health include Partner Fund Management, Coatue Management, a tech-focused hedge fund, and Mithril Capital. In November 2018 Auris Health announced an equity financing of a $220 million led by Partner Fund Management, valuing the company at $2 billion.

Industry Overview

In an era in which technological advancements play a key role in deciding the future of most industries, medical technology or medtech is no exception. With the pace of the manual-to-robotic transition in the surgical context picking up, it is not surprising that robotic surgical devices are leading the industry growth in medtech.

Up until quite recently, the robotic surgery market was dominated by Intuitive Surgical, since the launch of its first flagship robotic surgical device, da Vinci, in 2000. In 2017, the first system to compete head-to-head against da Vinci entered the market – Senhance, by a small startup TransEnterix. The market started to heat up further with the entrants of medtech giants such as Medtronic with its 2018 acquisition of Mazor Robotics, a leader in surgical robot systems for spine surgery. The bygone year also witnessed companies developing surgical robots raising $296m capital in the period between July 2016 and July 2017.

The global medical robots’ market is expected to grow to $26.2b by 2025, according to data provider Accuray Research. The high growth in this segment can be attributed to the increase in volume of robotic procedures performed worldwide and growing demand of instruments and accessories due to the highly recurring nature of robotic surgical procedures. As the market gets denser with strong competitors, it is also interesting to note that a majority of the companies at the forefront of robotic surgical systems are startups, which naturally rely on funding and capital raising for continued advancement due to the expensive nature of procurement in the field. In fact, prior to being acquired by Johnson & Johnson, Auris Health had raised a total of at least $700m cumulatively through several rounds of private equity financing deals, following its catheter-based Monarch platform gaining US approval. The largest fundraising in this series in Europe was the one of UK based startup CMR Surgical, which raised more than $100m of investment. The medtech industry in the past year witnessed a series of relatively small-sized deals, the largest of which was the $4.24b acquisition of BTG plc by Boston Scientific. With the pursuit of ‘smaller’ entrants for capital along with limited organic growth opportunities due to broader affordability headwinds, the industry has also been witnessing a diversification quest of sorts, with rumors of Amazon entering pharma and GSK in 2018 investing $300m in 23andMe, a personal genomics company that had collected genomic information for 5 million people.

Deal Structure

On 13th February 2019 Johnson & Johnson’s Ethicon unit has bought Auris Health. The deal is worth up to $5.75bn of which approximately $3.4bn will be paid immediately in cash while the remaining $2.35bn will be paid upon reaching certain predetermined milestones.

In addition, Dr Frederic Moll, the founder of Auris Health, will join Johnson & Johnson when the transaction is expected to close, that is by the end of the second quarter of 2019.

Deal rationale

Johnson & Johnson’s acquisition of Auris is not the first in the company’s streak of deals to diversify and brand itself as a healthcare company rather than just a pharma, devices or consumer company.

The pharma giant was seen to miss its revenue expectations a couple of quarters over the past two to three years. This was in part due to the sales dip of its best-selling drug Remicade owing to the market entry of European ‘copycat’s, and in part due to the tough competition and a strong dollar for a company that relies on overseas sales for almost 50% of its revenue. For a conglomerate such as J&J, growth across all its segments are key to maintaining its revenue levels in line with expectations. The company has since innovated on its strategy, sold off certain businesses such as diabetes care devices, and done a series of deals with the most recent ones clear indicators of the company’s entry into the field of surgical robots. In fact, J&J owes 50% of its growth over time to these strategic mergers & acquisitions. It has spent about $40b in acquisitions over the two years from 2016-2018, and currently has a positive earnings forecast for 2019.

With the acquisition of Orthotaxy, a privately held developer of software-enabled robotic technology for surgery in 2018, Johnson & Johnson’s joined the growing list of medtech players strengthening surgical robotics offerings expanding the technology’s applications. In 2015, the company surgical-device business unit Ethicon partnered with Verily, Google’s life sciences business unit, to create Verb, a robot-assisted surgical platform. This latest acquisition of Auris Health helps the company gather momentum to achieve its vision for growth and expansion into other interventional applications. Owing to Auris Health’s foremost focus on detecting and treating lung cancer, the deal also boosts the acquirer presence in the field of robotic surgery, providing it a ready-to-sell system for the lung cancer market. This is an area in which Johnson & Johnson’s already has a major focus with its ‘Lung Cancer Initiative’, an initiative launched in 2015 to combine the resources of the healthcare giant with expertise at Boston University to speed the development of interventions and cures for lung cancer. The company expects the Monarch robotics platform to play a key role within the Lung Cancer Initiative within the company, and, more broadly, to be used to support the company’s approach to open, laparoscopic, robotic, and endoluminal surgeries.

Market Reaction

The shares in Johnson&Johnson slightly decrease by 0.1% to $134.05 in the early morning trading when the deal was announced. The outflow of cash financing the deal can be seen as the main driver of the decrease in the price per share, nevertheless the market’s reaction was not significant, as a sign that the cash will be recovered in the future.

On the day of the announcements investors mistakenly bought shares of Auris Medical instead of Auris Health (which is privately held). Auris Medical stock (EARS: NASDAQ) surged as much as 30% on Wednesday morning and this is not even the first time: in fact, also on January 23 the stock jumped more than 30% when the news that J&J was pursuing a deal with Auris Health came out.

Advisors

Johnson&Johnson has been advised by JPMorgan Chase & Co. while Auris Health has been advised by Centerview Partners.


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