By Cameron Caldwell and Callum Magee (University of Glasgow), Udhaav Jhunjhunwala (Singapore Management University), Chan Seomun (University of Warwick), Chirag Gupta (NYU Stern)
Overview of the Deal
To fund its $6.7 billion cash takeover of Momenta Pharmaceuticals, a NASDAQ-listed biotech firm, Johnson & Johnson (J&J) has raised $7.5 billion from the Debt Capital Markets. J&J is an American multinational corporation that operates its business in various sectors including medical devices, pharmaceuticals, and consumer packaged goods.
The bonds are categorised into six tranches where maturity dates range from September 2025 to September 2060. The firm took advantage of its best AAA credit ratings, offering a profoundly low yield of 0.572% for its bonds maturing in September 2025.
Almost every business that secured AAA credit ratings in the early 1990s lost its top tier ratings over the past 30 years. Exxon Mobil, an integrated oil and gas giant, lost its AAA ratings in 2016, while General Electric, Coca-Cola, UPS, and Pfizer also lost its top tier ratings. Besides Microsoft, an American tech behemoth, J&J is the only other major U.S. firm that always gets the best triple-A ratings from credit rating agencies.
Macroeconomic Trends
Countries around the world are struggling from the effects COVID-19 has had on their Economies. Travel restrictions, lockdowns and a risk-averse population have caused some Economies to lose the total GDP gained since the 2009 Financial Crisis. With over 23 million confirmed cases, 0.26% of the world population, countries are far from reaching the 70% immunity point needed for herd immunity to kick-in, in order to prevent the ever-increasing spread of COVID-19. As a result, Pharmaceutical companies are racing to develop and patent a COVID-19 vaccine as it seems to be the only real short-term solution to preventing the spread of the virus, something governments are relying on to get their Economies back on track. However, experts have stated that 18 months to develop a vaccine is an aggressive time-frame, as the average time scale to develop one is 10 years. This time-scale may eat away at consumers, deterring their consumer spending, with potential long-term effects of negative Economic growth and a deflationary spiral.
Governments around the world are providing heavy subsidies to local Pharmaceutical companies in order to help with their development of a COVID-19 vaccine. The UK Government issued £84 million in funding to researchers working on a vaccine at the University of Oxford and Imperial College London, where AstraZeneca agreed to provide 100 million doses when ready. The US Government has also agreed a $1 billion deal with Johnson & Johnson to supply 100 million doses of its experimental COVID-19 vaccine. These measures to help the development of the vaccine get through clinical trials quickly are proving effective. Russia for example, claims to have the first license to a COVID-19 vaccine after the president, Vladimir Putin, announced its approval ahead of conventional phase 3 testing. Although contentious, government support to Pharmaceutical companies are still helping with processing speeds in a time of national emergency.
Since the start of the pandemic, central banks have extended their quantitative easing measures significantly to boost their Economies. In doing so, the Fed in particular, has expanded into buying up junk-rated debt through ETFs, causing their prices to surge thus lowering the yields across all levels of bond risk. This has to lead to more than $2.5 trillion in global corporate debt being issued in the first half of 2020 as companies look to shore up their balance sheets and take advantage of low borrowing costs to help them through the current turmoil.
Company Details
Johnson & Johnson (J&J) is the world's largest and most broadly-based healthcare holdings company, specialising in medical devices, pharmaceuticals, and consumer packaged goods. Operating through 250 subsidiary companies globally, J&J is responsible for some of the world’s most prominent healthcare brands such as Band-Aid, Johnson’s Baby Products, and Neutrogena Skin and Beauty Products.
Founded in: 1886
Headquartered in: New Brunswick, New Jersey, U.S
CEO: Alex Gorsky
Number of Employees: 132,200
Market Cap: $398.66 billion
EV: $409.92 billion
LTM Revenue: $80.5 billion
LTM EBITDA: $27.21 billion
LTM EV/Revenue: 5.01x
LTM EV/EBITDA: 15.01x
Table 1: Current Capital Structure of Johnson & Johnson (Capital IQ)
Table 2: Bond Details of Johnson & Johnson (Cbonds)
Table 3: Credit Ratings of Johnson & Johnson (Capital IQ)
Johnson & Johnson successfully maintained its top credit ratings from the S&P, Fitch Ratings and Moody’s. Moody’s revised its outlook on J&J’s credit from ‘stable’ to negative. The announcement of Moody’s pessimistic projection of J&J’s credit from its long-term perspective follows the announcement of a $572 million fine verdict against the firm in an Oklahoma court. J&J is planning to appeal the verdict soon, which may end up lowering the final payment that the firm is obliged to pay. Alongside the opioid-related trials, J&J is facing various social risks - talc litigation and regulatory actions regarding drug pricing coming to the fore.
"The negative outlook reflects the potential for material litigation-related cash outflows that constrain J&J's otherwise strong free cash flow or reduce the strength of its capital structure"
Michael Levesque, Moody's Senior Vice President
Projections and Assumptions
Why was this deal done?
The primary reason for Johnson & Johnson’s $7.5 billion bond offering is to take advantage of the relatively low-interest-rate environment and finance its $6.5 billion acquisition of Momenta Pharmaceuticals, a Massachusetts based biotechnology company. On 19 August 2020, J&J entered into a definitive agreement to purchase Momenta in an all-cash deal. The acquisition would expand J&J’s portfolio of autoimmune disease treatments as well as give them access to Momenta’s experimental therapy. If the experimental therapy is approved, it could be used to treat several autoimmune diseases, and potentially bring in many first-in-class treatments. The remainder of the debt raised is stated to be set aside for general corporate purposes, helping the firm shore up its finances in the midst of the prolonged recovery from COVID-19.
Short-term Analysis
J&J is expected to see a slight decline of 2-5.5% in revenue for 2020, down from an initial forecast of 4-5% growth in sales. This is largely due to the negative effect that COVID-19 is having on its medical devices unit. As hospitals focus their attention on treating COVID-19 patients, elective surgical procedures are being deferred, reducing the demand for medical devices. It is forecasted that from Q3, the company will return to achieving mid-to-high single-digit topline growth due to the sustained strong performance of their consumer and pharmaceuticals business as well as the gradual recovery in their medical devices unit.
At the same time, J&J is in the process of developing a vaccine to tackle COVID-19. Their Ad26.COV2-S vaccine candidate induced robust immune responses in pre-clinical trials. While the pre-clinical trial was conducted on non-human primates, J&J is planning to launch a clinical trial with 60,000 participants in September 2020, twice the number of participants that Moderna and Pfizer are enrolling in their own vaccine trials. While the pace of J&J’s vaccine development might be lagging behind their competitors, the most promising element of their candidate is that the immune response was achieved with a single dose of the vaccine, as compared to two doses each for their competitors. In the long-run, a single dose vaccine is likely to generate greater demand due to the relative ease of administering it and cost-effectiveness. In fact, the company has already struck a $1 billion deal with the US government to supply 100 million doses of the vaccine, albeit only if it is approved by the FDA.
Large scale production and distribution of a vaccine will require significant upfront working capital and the additional funds raised by J&J can help it achieve this without additional fundraising.
Long-term Analysis
J&J’s long-term future is filled with uncertainty. This is primarily driven by three key factors which might see the company’s financial strength and AAA rating tested. Firstly, there is significant downside risk due to the potential for damages from ongoing litigations of their talc-based products and their role in the opioid crisis. Secondly, the non-pharmaceutical business areas are expected to see significantly slower growth in the next few years as a result of the pandemic. As a result of the economic downturn and unemployment, a large number of people will lose access to their health insurance leading to a subsequent downturn in the number of doctor visits and procedures. This, combined with increasing competition in the consumer business will limit growth. Thirdly, there is limited headroom to finance further acquisitions while maintaining their AAA rating. As a result of this financing, J&J’s debt to earnings is at a 15-year high, limiting their ability to raise additional debt without compromising their credit rating.
While the outlook might look bleak, J&J has the ability to combat this due to its size, geographical presence and long-held conservative financial policies. Further upside is provided by the possibility of a successful vaccine candidate boosting sales as well as the development of novel autoimmune drugs as a result of their acquisition of Momenta.
Financial Ratio Analysis
Table 4: Financial Ratios of J&J (Capital IQ)
Q1 saw profitability ratios up on previous years as demand for healthcare products increased and people began stockpiling. However, Q2 saw profitability ratios drop almost 3% in one quarter
Current and quick ratios are stable and at normal levels, signifying J&J have enough cash and liquid assets to cover its obligations. Their Altman Z score is also stable and at a safe level which suggests a positive outlook for their future
Total Debt/EBITDA is slightly greater than 1 which means J&J can pay off debts with their income. However, this has been slightly volatile, briefly dropping below 1 during Q1 in the coronavirus pandemic
EBITDA/Interest expense is high and well above 1 which means J&J has the ability to meet its interest expenses for the year
Risks and Uncertainties
Opioids and talc related trials and legislation to curb drug prices in the U.S are likely to drag down the credit ratings and financials of J&J in the near future.
Earlier this week, in a Landmark Oklahoma opioid trial, the judge ruled that the firm intentionally played down the risks while overselling its opioids’ benefits. Still, the fine falls short of $17 billion that the Oklahoma government had to seek out for addiction treatments. Furthermore, the Oklahoma trial is not the end for J&J. More than 2000 opioid-related lawsuits are awaiting the firm.
Opioid-related trials are not the only impediment that J&J is facing at the moment. The firm is fighting another 14,000 lawsuits over its baby-powder product, one of its best-sellers. Johnson & Johnson’s baby powder contains talc, an ingredient which FDA and the public allege to cause cancer. In early May, the firm announced to halt sales of the product, but still claims an irrelevance between the product and cancer.
Experts project Congress to pass the ‘drug-price reform package’ by the end of the year as both the President and Democrats seem to consider the policy as a strategy to claim a victory in the upcoming election. The bill, if successfully legislated, is expected to dent the revenue as drug prices will likely fall.
“We’re excited by the opportunity to further advance patient care by combining Johnson & Johnson’s world-class R&D, commercial and supply chain capabilities with Momenta’s talented people, pipeline and deep expertise in this important area [autoimmune diseases]”
Jennifer Taubert, Executive Vice President, Worldwide Chairman, Pharmaceuticals, Johnson & Johnson