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For some time I had felt that Johnson & Johnson (NYSE:JNJ) has been neglecting its MedTech business while building up the Pharmaceutical business into an impressive player in oncology and immunology. While I liked management’s more recent comments about investing more time, energy, and resources into MedTech, including more growth-oriented R&D, I thought that M&A could be a valuable tool to accelerate the process.
Apparently so did JNJ management, as the company announced a major deal on November 1 with a deal for Abiomed (ABMD) that could be worth more than $18 billion, and that moves JNJ back into interventional cardiology in a big way. The deal is pricey and comes with above-average risk, but if Abiomed can deliver on multiple pivotal trials with market-expanding potential, and if JNJ can more effectively market Abiomed’s technology on a global scale, the deal could still be value-additive over time.
While the deal is huge in MedTech terms, it accounts for less than 10% of JNJ’s market cap today and isn’t a big near-term needle-mover for valuation. A successful outcome could add more than $10/share to my fair value estimate for JNJ, but that is largely gated by clinical trials that won’t finish for some time. JNJ isn’t a bargain-basement name, and the shares have moved up since my last article, but I think it still has worthwhile GARP credentials for investors wanting some healthcare exposure.
Paying Up For Growth
Johnson & Johnson announced on Tuesday that it would be acquiring Abiomed for up to $18.2B in cash, including a $16.6B upfront payment (or $380 per ABMD share) and up to $35/share in contingent payments tied to three separate triggers.
The upfront amount that JNJ is paying works out to about 14.3x expected 2023 sales for Abiomed, and that makes this an exceptionally pricey deal. Depending upon how you define “large”, this is the first-ever large MedTech deal with a multiple of over 10x forward revenue. To that end, it’s rare to see MedTech deals worth $1B or more at 10x or greater multiples – ResMed (RMD) paid 12x for Medifox Dan earlier this year, Stryker (SYK) paid 13.5x for Vocera, Siemens Healthineers (OTCPK:SMMNY) paid 37.6x for Corindus in 2019, Medtronic (MDT) paid 17.6x for Mazor in 2018, and Stryker (SYK) paid 14.7x for MAKO in 2013.
While Abiomed is a very different type of business, I do see some similarities with the Corindus, Mazor, and MAKO deals (all types of robotic systems) insofar as Abiomed is an early-mover in a field with significant potential (circulatory support devices, or heart pumps that help assist the heart with its pumping functions) but also significant controversy and uncertainty as to whether that potential can and will be realized.
Abiomed today is a company with close to $1B in revenue, likely to grow at a mid-teens rate for the next couple of years. Should multiple key pivotal trials read out positively, though, there is an opportunity for Abiomed to significantly expand its addressable market and its share within its addressable markets. As is, JNJ is acquiring another $1B-plus/year revenue business, one that is growing meaningfully faster than the underlying MedTech market, and one where global expansion is a real opportunity, and one that JNJ can contribute to in a meaningful way.
Opportunities To Build Value
One of the issues that has limited Abiomed so far is the lack of sizable randomized clinical trials to prove the value of the device in multiple settings. While the Impella pump has been approved for several years in a range of indications (high-risk PCI, AMI cardiogenic shock, heart failure, et al.), uptake has been limited in part by a lack of confidence in the clinical arguments for the device. Management has decided in recent years to address this deficiency, and there are now multiple clinical trials underway.
The PROTECT IV study is evaluating the use of Abiomed’s Impella heart pump in high-risk percutaneous coronary interventions with an aim of establishing a lower risk of death, stroke, heart attack, and/or hospitalization and a Class I device recommendation.
The RECOVER IV study will examine the role of the Impella in improving outcomes for AMI (acute myocardial infarction) cardiogenic shock, a situation where the heart cannot maintain necessary output after a heart attack, and where survival rates can be 50/50 in some cases. Again, the primary goal here is to establish superiority and a Class I recommendation for the Impella.
Last and not least is the STEMI-DTU study, which will establish the efficacy of the Impella in improving outcomes in STEMI (ST Elevation Myocardial Infarction), a type of heart attack that mainly affects the lower chambers, killing the muscle of the ventricles, and where up to 10% of patients die within 30 days. A successful outcome here could expand Abiomed’s addressable market by $5B.
If these trials are successful, Abiomed’s revenue opportunity is likely several multiples of the current $1 billion or so run rate. The CVRs tied to this deal reflect that – $7.50/share is for PMA approval in STEMI patients without cardiogenic shock by Jan 1, 2028, $10/share is for the first publication of a Class I recommendation in high-risk PCI or STEMI within four years of data publication, and $17.50/share is tied to $3.7 billion or more revenue by mid-to-late 2027.
Of course, Abiomed (and now JNJ) doesn’t have the opportunity all to itself. Abbott (ABT), Cardiovascular Systems (CSII), and Magenta (MGTA) all have (Abbott) or are developing (CSII, Magenta) left ventricular assist devices that can compete in some indications, though the market is still significantly under-penetrated today.
The Outlook
Buying Abiomed is a bold move. Were I running JNJ, I’d have probably targeted a company like Inari (NARI) or Penumbra (PEN) or perhaps looked to shore up the spine or extremities business. But this is a bolder move, and one that could produce significant long-term revenue and cash flow upside if the clinical trials work out (I believe they will, based on the body of data Abiomed has accumulated to date) and JNJ can leverage this technology globally. As I’ve long been calling for more “go big or go home” types of moves here, I can’t fault the ambition.
JNJ’s third quarter earnings were not thesis-changing for me. Revenue was a little ahead of target, but not meaningfully so after adjusting for the COVID vaccine contributions. The oncology business is growing well, and the ortho business is looking lackluster, but neither are new developments, nor was the ongoing evidence of cost/margin pressure.
I continue to look for long-term revenue growth in the neighborhood of 3%, though I do see potential upside in the pharma pipeline (particularly in oncology), and Abiomed certainly adds some trial-gated growth upside in the MedTech business. I’m also still looking for long-term FCF growth in the 6% range, with near-term EBITDA margins in the mid-30%s.
The Bottom Line
As JNJ shares have moved up a bit since my last update, the prospective return on a discounted cash flow basis has slipped slightly but is still in a 7% to 8% range that I’d call “good enough”. A margin-based EV/revenue approach is more favorable, though, and can support a fair value target in the $190s.
The Abiomed acquisition is expensive and risky, but I think JNJ can afford to, and ought to, take a few more chances these days in the pursuit of leadership in higher-growth emerging therapeutic areas. I like this evidence that management is becoming bolder, and coupled with a reasonable valuation, I still think there’s a case for owning these shares.
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