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J&J Gains Orthopedic Heft With Synthes But Faces Challenges

By Jon Kamp Of DOW JONES NEWSWIRES Johnson & Johnson's (JNJ) $21.3 billion purchase of Synthes Inc. (SYST.VX) will vault J&J to the top of a $37 billion orthopedics market that increasingly values scale--but hurdles remain before the health-care giant will be able to reap the deal's benefits. The acquisition will put J&J near the top of all major segments in the orthopedics market, which includes products for trauma, the spine, and hips and knees. That scale could help J&J deal with hospitals looking to purchase as much as possible from a shortlist of vendors. It also could prompt rivals to explore consolidation to get bigger. "I wouldn't be surprised," J&J Chief Executive William C. Weldon said in response to a question on whether the Synthes deal may lead other medical-device firms to consider bulking up. However, J&J's deal comes in a challenging environment that threatens to limit the acquisition's potential upside. Hospitals are working to control costs, putting pressure on device makers to compete on price. Plus, merging orthopedics firms has proven tricky in the past. "History has shown that the integration of spine deals and ortho deals in general have been difficult," Jefferies & Co. analyst Raj Denhoy said. He sees J&J's growth assumptions for the trauma and spine markets--two key areas where J&J is bulking up--as aggressive. The Synthes deal adds a company that grew sales nearly 9% to $3.7 billion in 2010 to the slower-growing but much bigger $24.6 billion device franchise at J&J. That franchise already includes DePuy, one of the largest orthopedic firms in a sector where top competitors include Zimmer Holdings Inc. (ZMH) and Stryker Corp. (SYK). Big device companies are increasingly trying to leverage their size and the breadth of product offerings as a competitive advantage. This could be a way to get more hospital business in exchange for price concessions, but it's also a way to increase clout and potentially combat those price declines. "I really don't expect this (deal) to offer any advantage to hospitals at all," said Joe Volpe, supply chain vice president for Wheaton Franciscan Services Inc., a nonprofit health system in the Midwest. "It just reduces competition in the market place, it doesn't increase it." Synthes already is the largest player in the trauma market, which has appeared less vulnerable than other orthopedics markets plagued by economic pressure or more scrutiny from health insurers. Combining it with J&J's existing trauma business has raised some antitrust questions among analysts, although J&J thinks the deal will increase competition and won't require any business divestitures. If competition rises, it might be in the spinal market rather than in trauma. In that somewhat fragmented market--outside clear heavyweight Medtronic Inc. (MDT)--Wells Fargo estimated Synthes and DePuy each have roughly 11% share. But Synthes and DePuy have different sales and compensation models that could complicate integration efforts, and competing spinal firms could pick up sales staff that get left aside. Sales representatives and outside distributors can take their longstanding relationships with doctors with them, and Volpe, the hospital official, expects a post-deal "scramble" for surgeon relationships. JPMorgan analyst Michael Weinstein said in a research note that "every meaningful deal in spine, even going back to the 1998 DePuy-Acromed merger, has resulted in substantial disruption due to overlapping sales and distribution." Spine competitors also include Zimmer, Stryker and smaller players such as NuVasive Inc. (NUVA) and Alphatec Holdings Inc. (ATEC). J&J, for its part, is taking a cautious integration approach. "We're going to be very thoughtful and deliberate about the way we go about combing in our spine units," Alex Gorsky, vice chairman of the executive committee at J&J, said in an interview. "We think that can be done with minimal disruption." If J&J pulls that off, the big question will be whether other companies also have to add heft to compete. Weldon said it's tough to predict, and analyst Denhoy questioned whether J&J's Synthes purchase is a one-off move that would be hard to replicate. Susquehanna analyst David Turkaly expects consolidation among smaller companies, but also sees Smith & Nephew (SNN) and Zimmer as potential targets. Among J&J's biggest competitors, Stryker declined comment and Zimmer brushed off the idea it needs more size to compete. "Irrespective of competitor activities, we expect Zimmer to remain competitive across all of musculoskeletal markets we serve," the company said in an emailed comment. The company also noted its "a comprehensive portfolio" in trauma. -By Jon Kamp, Dow Jones Newswires; 617-654-6728; jon.kamp@dowjones.com --Peter Loftus contributed to this article.

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