September 30, 2005
J&J and Guidant??? Will there be a wedding???
Johnson & Johnson (NYSE: JNJ) and Guidant Corporation (NYSE: GDT) entered into an merger agreement on December 15, 2004. Under the terms of the agreement, JNJ will create a subsidary corp and merge it into GDT leaving GDT as a wholly owned subsidary of JNJ (a so-called forward triangular merger). However, the more interesting story with this merger is whether the deal actually goes through.
Yesterday, the New York Times reported that the Food and Drug Administration commenced a probe against Guidant looking at how the company disclosed problems with its defibrillators and pacemakers. (AP story by Ashley M. Heher can be found here). As a result of the announcement of the probe, shares of GDT were down about 3% to close at 68.17 Thursday on the NYSE.
Now under the terms of the merger agreement: "each share of Guidant common stock (other than shares owned by Guidant, Johnson & Johnson and Merger Sub) will be converted into the right to receive a combination of (i) $30.40 in cash and (ii) a number of shares of Johnson & Johnson common stock with a value, based upon the volume weighted average trading prices of Johnson & Johnson common stock for the 15 trading days ending 3 trading days prior to the closing, of $45.60, so long as the volume weighted average trading price per share of Johnson & Johnson's common stock during this period is within the range of $55.45 to $67.09. Outside of this range, each share of Guidant common stock will be converted into the right to receive a combination of (i) $30.40 in cash and (ii) a fixed number of shares of Johnson & Johnson common stock equal to 0.6797 if the volume weighted average trading price is above the range and 0.8224 if the volume weighted average trading price is below the range. Outstanding Guidant stock options at the time of the closing will be converted into options to purchase Johnson & Johnson common stock"
JNJ currently trades within the range of $55.45 to $67.09 at 63.75 as of the close on Thursday. Therefore, assuming that JNJ trades within the stated range of the agreement, JNJ will be paying $76 per share of GDT ($30.40 in cash and $45.60 in stock). With GDT currently trading around $68 and the deal expected to close within the next few weeks (JNJ's website says within Q4 '05 and CNBC reported this morning that the expect the deal to close within the next three weeks), JNJ will be paying $8 a share more than the current share price of GDT if the deal were to go through. Thus, if you believe that the deal will go through, you can make a quick $8 per share or approximately 12% in the matter of three weeks.
Unlike cash deals, such as GE's proposed buyout of IDX Systems yesterday, where the arbitrage spread is quite low because of the high probability of the deal closing, this deal between JNJ and GDT has had many problems and the markets look like they believe that the deal will not go through. The FDA prode will no doubt trigger several escape clauses in the merger agreement and JNJ will have the legal option of walking away from the closing or renegotiating a lower price.
Disclosure: I do not own shares of either JNJ or GDT, nor am I giving any investment advice. I am just trying to note how the markets are not expecting this deal to go through.
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