Johnson & Johnson: How To Buy Your Way To Growth

The relationship between a large pharmaceutical company and a small biotech company is mutually beneficial. As larger pharmaceutical companies expand their portfolio and try to replace older blockbuster drugs with expiring patents, it has become too challenging to keep up with the constantly evolving innovations. Therefore, it has become much more efficient for pharmaceutical companies to acquire smaller companies’ innovations and technology. Smaller companies have robust scientific innovations but not the same level of commercialization expertise and the financial resources that big pharma has. The “holy grail” is accretive growth. This is when two companies fused together grow faster than either would have grown separately.

With many exciting mergers and acquisitions in the pharmaceutical industry, let’s take a look at how the biggest pharmaceutical company in the world, Johnson & Johnson, came to where it is today. It all started with just three brothers, antiseptic surgical supplies, and a first-aid kit. But every merger and acquisition along the way helped its products reach over a billion people today. Starting with 1958, J&J bought out McNeil Laboratories which produced Tylenol. Within one year of ownership, J&J switched it from a drug that required a prescription from a doctor to an over the counter (OTC) product, making it easily accessible for millions of people. Then they started to buy out other OTC products and companies, including Pepcid, Mylanta, Clean & Clear, Neutrogena, Motrin (ibuprofen), and Aveeno (just to name a few). If that wasn’t enough, it accelerated the growth of its consumer health unit by paying $16.6 billion for the consumer health unit of Pfizer, which included products such as Benadryl, Sudafed, Neosporin and Listerine.

These moves illustrate two of the core principles of accretive acquisitions. The first concept is called “scale.” By acquiring so many brands, J&J slowly eliminated the pricing competition that comes with having too many rivals. They also gained more and more leverage over retailers: a company that owns 100 brands can command better shelf space and better purchase terms than a company that owns just two or three brands. The second core principle of accretion is growing profits through operational efficiency. As J&J grew it’s revenue by piling on brand after brand, it’s costs largely stayed the same. When they consumed these smaller companies, they frequently laid off entire departments of marketers, finance people and even warehouse personnel. J&J already had those support structures in place. The more brands they bought, the more revenue they had, but the operation costs remained largely fixed. The result? Automatic growth in profits and in dividends. Over the last twenty years, J&J has grown its quarterly payout from $.44 to $4.20. The share price has increased from $36 to $136. J&J is the textbook perfect example of accretive profit growth through acquisitions!

But it’s crazy to think that all of these consumer products, which can be seen in almost every grocery store and pharmacy, makes up merely 16% of Johnson and Johnson’s sales. Other divisions have grown more quickly. Now the company believes that there are even further profits to be had by changing tactics.

Through over 275 companies, Johnson & Johnson has three business segments: pharmaceuticals, medical devices, and consumer. The branded pharmaceutical growth heavily outweighs the consumer growth. In November 2021, it was announced that Johnson & Johnson will be splitting into two companies by separating pharmaceuticals and medical devices from its consumer health unit. This separation will enable Johnson & Johnson to approach these different industries with more targeted strategies that accelerate growth. Branded pharmaceuticals make up 55% of Johnson & Johnson’s sales. But this also did not happen overnight.

J&J got its main start in the pharmaceutical industry through the acquisition of Janssen Pharmaceuticals in 1961. Now, it is hard to imagine Johnson & Johnson without Janssen, not just because of the COVID-19 vaccine. J & J’s top selling product is Stelera, which is used to treat inflammatory diseases such as psoriasis, arthritis, and Crohn’s disease. Its revenue of $9.13 billion in 2021 accounts for 17% of J&J’s pharmaceutical revenue and 9.3% of its overall revenue. Other blockbuster drugs to note from Janssen are Darzalex with a 2021 revenue of $6 billion and Imbruvica of $4.3 billion, which are both used to treat blood cancer. If that was not enough, J&J’s pharmaceutical segment continues to grow. For example, its revenue grew 11.05%, from its Q4 2019 revenue of $10.76 billion to Q4 2019 revenue of $11.95 billion.

Other notable acquisitions include Actelion in 2017 for $30 billion. In August 2020, it acquired Momenta Pharmaceuticals for $6.5 billion.

The remaining 29% of J&J’s sales is attributed to its medical devices, ranging from joint replacements, screws and plates to contact lenses. Through the acquisition of DePuy Synthes for $19.7 billion in June 2012, it strives to be the leader in orthopedics (muscles, bones, joints, ligaments, and tendons). In 2001, J&J also acquired Alza, which was a leader in drug delivery systems, focusing on creating oral formulations so that patients do not have to inject themselves and making them once-a-day extended release, so that patients do not have to take the same pills several times a day. Even the advent of the contact lens was the result of a successful acquisition of Frontier Contact Lenses in 1981. By 1988, Acuvue was introduced, which is now the best-selling brand for contact lenses.

Johnson & Johnson has a successful diversified portfolio that has not disappointed investors. In fact, as a dividend aristocrat, its dividend of 2.46% has increased annually over the past 56 consecutive years. With 10,000 Americans per day aging into Medicare, the company’s growth is not expected to slow down anytime soon. J&J’s second quarter (Q2) sales in 2021 increased 27.1% from its 2020 Q2 sales. On a grander scale, J&J’s total revenue grew from $70 billion in 2015 to $93.8 billion in 2021. Even with this massive track record of growth, and the demographic wind at it’s back, JNJ is still valued at just 21 times earnings, vrs approximately 23 for the S&P 500. There have been some fears about JNJ’s liability related to talcum power lawsuits. But a recent legal ruling look very likely to limit those monetary damages.

J&J has been the classic example of a dividend growth stock for decades. Strong demographics and the coming strategic spin off of the lower growth consumer division could even accelerate growth from here. At 21 times earnings, the company has been mistaken for a hawker of band aids and Tylenol. In reality, most of their revenue growth comes from high tech medical innovations. Johnson & Johnson could be a perfect Rx for growth for the patient investor.