Guidant Gets Clingy With J&J

J&J wants to cut the price, but Guidant calls the sides 'legally obligated' to merge.
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Updated from 2:22 p.m. EST

Johnson & Johnson

(JNJ) - Get Report

threatened to back out of its acquisition of

Guidant

(GDT)

, but the Indianapolis-based stent maker said the $25.4 billion deal must go on.

The news came as the companies' merger pact, agreed to last December, threatened to turn into a nasty court battle. Guidant shares dropped 4.3% to $60.40, and Johnson & Johnson slipped 1% to $61.30.

"This can be very disquieting for the entire medical-device and health-care capital markets," says Stephen Brozak of WBB Securities. He adds that, because of the size and scope of the deal, it "affects a cross section of health-care investors."

Wednesday's action started with Johnson & Johnson saying it and Guidant had held talks over the terms of their acquisition, but that no agreement was reached and the discussions have apparently broken down. The comments were the strongest the drug giant has made to date in a line of remarks pointing to its unhappiness with the hefty price it's paying for Guidant in light of the company's mounting legal and regulatory headaches.

Later in the day, Guidant replied that it "has informed Johnson & Johnson that the parties remain legally obligated to complete their transaction in accordance with the merger agreement."

Jeff Leebaw, Johnson & Johnson's a spokesman on the Guidant deal, had no comment beyond the company's press release.

Regulators cleared Johnson & Johnson, based in New Brunswick, N.J., to acquire Guidant on Wednesday, but the transaction has been in question ever since Guidant was hit in recent months by a series of recalls of its pacemakers and stents. Johnson & Johnson would pay $76 a share under the terms of the agreed-on deal, but Guidant shares have traded recently in the low $60s.

After Johnson & Johnson said last month it would "consider alternatives" under its agreement, Guidant's shares fell amid speculation that the acquisition plans would be canceled. Guidant's "silence was deafening" after that announcement, Brozak says.

John Putnam, an analyst with Stanford Financial Group, issued a research report last month in which he wrote that a "fair price for JNJ to acquire GDT would be $65 and we believe the market agrees with us."

He said in an interview Wednesday that he believes Johnson & Johnson will walk away from the deal unless Guidant is wiling to renegotiate.

"I don't think J&J has any intention of doing this at $76 a share," he says. "At the end of the day, J&J has the money to pay the breakup fee or penalty that would occur, and they wouldn't have the dilution that would occur if they paid $76 a share."

Guidant shares aren't worth more than $61 to $62 at this point, he says.

Putnam says a better but more expensive way for Johnson & Johnson to enter the defibrillator market would be to acquire

St. Jude Medical

(STJ)

, a maker of cardiovascular devices based in St. Paul, Minn.

Johnson & Johnson said it "continues to view the previously announced product recalls at Guidant and the related regulatory investigations, claims and other developments as serious matters affecting both Guidant's short-term results and long-term outlook. Johnson & Johnson believes that these events have had a material adverse effect on Guidant, and, as a result, that it is not required under the terms of the merger agreement to close the Guidant acquisition."

Guidant has previously indicated it doesn't share that view, but now there's "more acrimony and less seeing eye-to-eye than there was three or four months ago," Putnam says. Stanford Financial doesn't have an investment banking relationship with either company.

Johnson & Johnson has "had discussions with Guidant regarding a restructuring of the terms of the transaction, although those discussions have not resulted in any agreement between the companies. Johnson & Johnson cannot assure that the companies will resume those discussions or, if discussions do resume, whether they will be able to reach agreement on revised terms that would allow Johnson & Johnson to proceed with the transaction."

The Federal Trade Commission conditionally approved the deal, but it wants Johnson & Johnson to divest certain rights and assets of its businesses in drug-eluting stents, endoscopic vessel harvesting products and anastomotic assist devices.

The merger is required to close within two business days after the termination or expiration of the antitrust waiting period, the last required regulatory approval for the pact, Guidant says.

Last month, Johnson & Johnson said it was waiting on the FTC's decision to decide how Guidant would mesh with its medical-devices unit Cordis. At the time, the company said it was only working on the process for determining its plans after the acquisition.

The European Union has already cleared the Guidant acquisition on the condition that Johnson & Johnson shed its steerable guidewires and endovascular businesses.

Brozak sees Johnson & Johnson making an bid for the company at a price lower than where Guidant currently trades, but speculating on Guidant's response "would be opening Pandora's box." An attempt to revise the deal could lead to a lawsuit by Guidant, he says, possibly claiming a breach of the agreement.

WBB Securities doesn't have an investment banking relationship with Johnson & Johnson or Guidant.