JNJ Paying Up For Quality

It was only a week ago that I wrote about Micrus Endovascular (Nasdaq: MEND) as a hot med-tech stock that investors should take a look at and consider for a growth-oriented portfolio. Well, I hope they looked quickly, because Johnson & Johnson (NYSE: JNJ) announced this morning that it was acquiring Micrus for $23.40/share in cash.

That is a total deal value of $480 million, but a rather small premium of only about 5%. The stock has had a strong run since mid-May, though, and some of the move from $16-and-change could have been a product of rumors and whispers about a deal. Given the relatively recent deal between Covidien (NYSE: COV) and ev3 (Nasdaq: EVVV), it seems even more probable that people were connecting the dots and assuming that MEND would get a bid.

Although I am a JNJ shareholder, I have ripped the company plenty of times for its M&A strategy -- the company often pays too much and gets too little.

I really actually do like this deal, though. First, JNJ is by no means overpaying. JNJ is paying about 4.2 times trailing sales for Endus, and that is a good price. Growing small-cap med-tech companies often normally trade at 4 or 5 times trailing sales, and buyout premiums usually push that to a 6-8x range.

Second, Micrus has good technology on the market that integrates nicely with Johnson & Johnson's existing neurovascular intervention business. Not only have Micrus's products shown strong clinical results, they have actually sold well in the market and become something of a threat to rivals like Boston Scientific (NYSE: BSX). In my analysis, then, the combination of MEND's high-quality embolization coils and JNJ's existing business is a strong one.

I have to say, though, that I wonder if these deal actually goes through at this price. There are several other companies that could make a lot of hay from the Micrus assets, and the deal price is not so high that these other companies could not come in with a sweeter offer. If you are a Micrus shareholder, that is something to look forward to; if you are a JNJ shareholder, it is something to dread.

Who else could get involved? How about Medtronic (NYSE: MDT), Cook, or Bard (NYSE: BCR)? Certainly BSX could be interested as well, but I doubt that they have the balance sheet liquidity to do the deal, and I really doubt that Micrus shareholders would be thrilled about getting BSX shares instead of JNJ cash.

At the bottom line, I had modeled that MEND was worth about $25 a share. Given that MEND's management was willing to take less than that, I wonder where my model might have been a bit too optimistic. In any case, that spread between my fair value and the deal price is what a former boss of mine would describe as "close enough for jazz", so I am not going to worry about it too much. Moreover, I have also felt that JNJ needed to get more aggressive in finding new growth opportunities, so this is a deal and a price than I can live with pretty happily.

I would still recommend investors buy shares of JNJ. I also wonder if MEND shares are not worth a shot as an arbitrage play - so long as you can get the shares at a price that will still leave you with a profit after commissions, it might be worth the gamble to see if another bidder appears. 

Disclosure - I own shares of JNJ.