BEHIND THE NEWS: Guidant’s woes turn J&J deal into game of chance

Just a few months ago, some analysts were grumbling that Guidant Corp. was selling to Johnson & Johnson for too low a price. Why did Guidant accept $76 a share, they wondered, when on its own the company might be on its way to $80 or even $90?

Guidant CEO Ron Dollens’ response: That’s possible, but the medical device field is fraught with risks and uncertainties. Given that, he told IBJ in December, $76 a share, or a total of $25.4 billion, “works very nicely for us.”

Guidant shareholders have felt those risks acutely in recent weeks, as the company reported a succession of defibrillator defects that have put in question whether its sale to the New Jersey-based company will close, at least under the original terms.

The key gauge of that uncertainty is Guidant’s share price, which slipped below $64 June 24, the day the company announced it was temporarily pulling five types of heart defibrillators from the market because of a defect.

The defect involves a magnetic switch that becomes stuck in the off position. It was the latest in a string of defect disclosures since late May, a parade of bad news that has rattled doctors and patients as well as investors.

The stock has since rebounded and was trading last week at $67.50. Even so, the shares would not be trading at an 11-percent discount to the $76-a-share price J&J agreed to if Wall Street were confident that price would stick.

So where does that leave investors? Often, investors initially overreact to bad news. If that’s the case here, and the deal closes under the original terms, investors can make a juicy profit scooping up shares at current prices.

Uncertainty, in fact, can be lucrative. Consider ITT Educational Services Inc., the for-profit school operator, whose shares fell by nearly half in early 2004 after criminal investigators raided the Carmel headquarters and 10 campuses.

The day after the raid, San Franciscobased Blum Capital Partners began a buying spree, and it’s continued to snap up shares. As the stock has rebounded, Blum has amassed a paper profit exceeding $100 million.

For Guidant, one of the biggest uncertainties now is how long it will take the company to fix the defibrillator-switch flaw and get the devices back on the market-weeks or many months?

Analysts also don’t know whether the spate of announcements reflects a systemic quality-control problem or is a reaction to the withering criticism Guidant received in late May, after The New York Times reported the company had not told doctors about a defibrillator short-circuiting problem until after a patient died.

“In our opinion, the million-dollar question yet to be answered is whether [Guidant] knew it had problems with its [defibrillator] franchise and then decided to sell the company, or is this just overreporting … to make up for historically under-reporting issues?” Susquehanna Financial Group analyst Mark Landy wrote in a report.

Lazard Capital Markets analyst Stephan Ogilvie places the odds of J&J closing the deal at the agreed-upon $76 a share at just 10 percent. On the other hand, he thinks there’s just a 25-percent chance J&J will abandon the purchase-a bleak scenario analysts estimate would push down Guidant shares into the mid-$50s.

“As we see it, the [defibrillator] crisis escalation has given JNJ so much additional bargaining leverage that we believe the chance of JNJ walking away altogether rather than revaluing the acquisition has actually gone down,” Ogilvie said in a report.

What do J&J and Guidant have to say about all the speculation? Nothing enlightening. Guidant officials have zipped their lips and not commented on the prospect of closing the deal in press releases.

J&J issued its most recent statement on the deal June 17.

“The events reported by Guidant are serious matters,” the statement said. “Johnson & Johnson is engaged in discussions with Guidant to help the company understand the issues.”

Marsh bags another million

Marsh Supermarkets Inc. CEO Don Marsh received a small pay increase in the company’s latest fiscal year, collecting $1.29 million in salary and bonus, $14,000 higher than a year earlier.

The pay, disclosed in Marsh’s newly filed proxy statement, covers the fiscal year that ended in early April, a challenging period for the company. In that span, Marsh’s Class A shares shed 19 percent of their value, and the company’s Class B shares dropped 2 percent.