Description

Guidant Corporation. This situation has evolved to where it now seems to present a compelling risk-reward with a time-line of about 3 weeks. The idea is to buy Guidant Corporation, my view being that one is stopped $2.00 down by the existing JNJ deal, with the likelihood of 4-5 quick points should GDT reach a deal with Boston Scientific along the lines of Boston’s Scientific’s $72 proposal, with the not likely but possible outcome of JNJ coming back with a higher bid than BSX, which would mean a substantial profit.

In terms of downside from here, Johnson & Johnson’s bid for Guidant is worth $62.87. JNJ’s bid is comprised of .493 shares of JNJ at $60.10 (Friday’s close) = $29.62 +$33.25 in cash = $62.87. With Guidant at $64.75, there is $1.875 down, or 3% down. JNJ has regulatory approval, and there is virtually no material adverse change clause. This from the proxy:

"Terms of the Amended and Restated Merger Agreement. In addition, the representations and warranties of Guidant are qualified to exclude the effects on Guidant’s business relating to or arising from Guidant’s previously announced product recalls or any related pending or future litigation, governmental investigations or other developments and any information in Guidant’s Securities and Exchange Commission filings prior to the date of the amended and restated merger agreement."

So it would appear to me as if something new will have to happen that is pretty severe on top of what has already happened in order not to get the JNJ deal. Three things have happened since JNJ and GDT inked their revised pact that are negative, developments which I do not think threaten the JNJ deal.

1) GDT’s announced issues with the FDA regarding its manufacturing facility in Minnesota. While not ideal, these should be addressable and not impact the company’s ability to bring product to market over time.
2) Below expectation announced results. I believe that this is excluded as an out per the above as the results derive from the product recall issues.
3) The New York Times came out with a story that papers in one of the litigation revealed that Guidant put product on the markets predicting a certain defect rate without informing its various constituencies. I believe that this is also excluded as a material development as it is part of the litigation as well-- (although the words "Ford Pinto" did come to mind).

But we will need to return to these issues in the context of Boston Scientific’s bid for GDT.

As for the up-side, Boston Scientific recently bid a nominal $72, half cash, half stock. Once due diligence is complete, my guess is that they will renew that bid, potentially with some collar protection on the stock portion of their deal. By letting BSX do due diligence, GDT in effect conceded that such a bid would be superior to JNJ's deal. So if BSX reiterates its proposal after due diligence, I think GDT will accept it.

In the last week and a half of the year, GDT traded down about 3 points on the above news. No question that BSX will be considering these issues in the context of its bid. At the end of the day, stepping back and taking a “big-picture” view, I do not believe that the new developments listed above (which happened after BSX launced its bid) will ultimately change Guidant’s long-term strategic value to Boston Scientific. Indeed, BSX was said on 12/27 that it was moving forward with its due diligence and plans to acquire GDT; while this can not be taken to the bank as it made no mention of price and by mentioning due diligence the company gave itself a complete out, I have seen much weaker statements in these types of circumstances. Guidant has, and will continue to have, an important share in the cardiac rhythm business, which is what makes this property so desirable to both JNJ and BSX. If it decides to continue to try to buy GDT, BSX will no doubt want to make sure that it doesn’t bid too low and make it too easy for JNJ to top BSX’s bid… although part of my thesis is that if JNJ still really wants GDT, it will own it. Consider: with its $180mm market capitalization, an extra $10/GDT share is less than 3% of JNJ’s market cap.

And therein lies both the opportunity and down-side protection in this property. It seems overwhelmingly likely that one of these companies buys Guidant. And at the end of the day, the risk of there being no deal at all feels to me to be more than offset by the fact that JNJ has wanted GDT for a long time, and it has wanted it badly. As noted above, at $180bn market cap, JNJ can easily afford to top BSX if it wishes to. Even if it is just one chance in five (1 in 5), I feel that this is a genuine possibility and the real wild card opportunity in owning GDT at this point in time.

As a big player in stents, just as JNJ did, BSX will have to sort through the anti-trust issues of buying GDT and its stent business. As a result, any deal with BSX will trade at some spread, perhaps $3.00, although it will likely trade tighter until JNJ declares its intent.

So bottom line, I think there is two points down if BSX doesn’t bid, the likely outcome of 4-5 points up in about 2 weeks if BSX reiterates their $72 deal after due diligence, some chance of making less money to a superior BSX bid that is less than the $72 they put on the table, and the two wild-card outcomes: 1) no deal at all which I think is far less likely than 2) JNJ stepping back in with a higher bid and a bidding war.

(I suppose that there are a range of in between scenarios, like JNJ raising its bid to below BSX's bid and that this might play out a bit like MCI and Verizon and Quest. I think the stock will do well but not as potentially well in these types of scenarios.)

I’ll close with two thoughts. One, 2005 was a difficult year in Guidant for the markets. When you combine this variable with continued challenging head-lines for the Company in the last weeks of the year, you have a formula for a stock trading cheaper than it should. People are scared of this name, and markets are not the most courageous as year-end approaches.

Second, folks may want to look at the Guidant January 65 calls at roughly $2.00. These may be a superior way to play the situation in lieu of owning stock. You miss the next two points up but are risking no more capital than in owning the stock and getting the JNJ deal. You avoid the total disaster scenario and substantially participate in the bidding war scenario. Of course, while 3 weeks should be long enough to get a BSX deal, it is border line as to whether it will be long enough for JNJ to come back.

Catalyst

Company reaches definitive agreement with Boston Scientific, some possibilty in that case of Johnson & Johnson coming back with a topping bid.