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Why The Biggest Pharma Company In The U.S. Is Breaking Up - YouTube
Channel: CNBC
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Johnson & Johnson is the biggest
pharmaceutical company in the US
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based on its market cap. It was
named number 36 on the 2021
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Fortune 500 list of the largest
United States corporations by
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total revenue. Johnson and
Johnson has experienced dividend
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growth for nearly 60 years and
has consistently outperformed
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the S&P 500 over the past 25
years.
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The analyst community has been
talking about splitting up J&J
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for years - as long as I've
known the company.
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Johnson & Johnson announcing
that is going to be splitting
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into two publicly traded
companies.
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The pharma and medical device
company, which will be called
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Johnson and Johnson, and then
the Tylenol, Listerine, Band-Aid
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company.
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They're now separating the
consumer business away from
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pharmaceutical and the medical
device division. And I think
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that's going to create
significant shareholder value.
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But some investors question why
J&J would choose to break up
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now. The company is embroiled in
a series of lawsuits regarding
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its talcum powder, as well as
its role in the opioid crisis.
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J&J also took a hit when the CDC
recommended Americans receive
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one of the mRNA Covid vaccines
from either Pfizer or Moderna,
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rather than J&J due to "the risk
of serious adverse events."
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The timing situation is
critical, just because people
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have been very intrigued as to
why now
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Johnson & Johnson is one of the
most influential companies in
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the pharmaceutical industry.
It's really seen as a bellwether
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for the space.
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Why is the largest
pharmaceutical company in the US
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breaking itself up and what does
it mean for investors?
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Johnson & Johnson is made up of
three unique business segments:
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Consumer, medical devices -
which is also called Med Tech -
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and pharmaceuticals.
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The consumer business sells
everything from Tylenol to
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Neutrogena. The pharmaceutical
and medical device side of the
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company develops vaccines, like
its single dose Covid vaccine
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cancer treatments, joint
replacement materials and other
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biomedical technology.
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Separation right now makes a lot
of sense. You're going to have
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two companies with good
financial strength and cash
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flows in order to pursue the
objectives that they need to to
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have normal growth for the
foreseeable future.
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Analysts say the split allows
J&J to bring in a management
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team to specifically focus on
the consumer division, while
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also giving that segment new
branding and marketing
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The strategy of running these
consumer businesses is very,
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very dissimilar to a medical
device or a pharmaceutical
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business. There's a lot more
direct to consumer, obviously,
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the sales and marketing effort,
the social media effort is very
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pronounced in consumer, it's
much less so for the other
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businesses. So allowing a
management team just to focus on
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what has to be done in order to
resume growth or drive better
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revenue growth over the next
couple of years, I think is very
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smart on their part.
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Our pharma and our medical
device business tends to be much
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more of a business to business
relationship in the way that we
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work through other
intermediaries, you know,
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compared to the consumer
business. And most importantly,
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where we see things going into
the future, we feel it now is
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the right time to make this kind
of a move. And again,
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ultimately, it's going to allow
us to reach more patients, more
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consumers have more innovation,
and execute in a much more
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focused way.
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It's a somewhat common practice
for companies with diverse
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segments to break apart. Pfizer,
Eli Lilly and Merck all
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reorganize their business
structures within the last five
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years by spinning off segments
into separate companies.
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What the market is saying is
that companies should focus on
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their core competencies and let
us diversify. We've already seen
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several examples of large pharma
separating out non core assets.
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I think they finally came to
terms with the fact that they
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weren't really seeing value in
the share price from having that
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consumer business.
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When you're a conglomerate, you
never get credit for the various
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different pieces. And quite
frankly, you probably shouldn't,
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because some other parts of the
company are not investing the
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way they should. They're not
focus the way they should. And
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so when you separate out various
different businesses, we now as
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analysts and portfolio managers
can appreciate what the each of
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the businesses are. And they do
over time, there have been
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studies that have been done,
both Remain Co. and New Co. can
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outperform because they are on
their own.
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So far, investors reaction to
the divide has been mild with
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the stock only moving modestly
higher on the news. The stock
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went on to underperform the week
following the announcement.
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The market hasn't really reacted
to the news. There are some
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risks to this execution from
separating out the consumer
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business. And I think investors
aren't fully convinced yet of
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the standalone earnings
potential of both companies. So
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from a consumer perspective, I
think people wonder how the
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consumer business can compete
with companies such as Procter &
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Gamble, and some of these
larger, more established players
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in the space.
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J&J's business move may also
help attract a different type of
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investor.
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You're going to get people that
are consumer staples and
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consumer oriented. You'll get
them focused on the consumer
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piece. And of course, you're now
more of a pure play healthcare.
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And so you'll get more health
care analysts.
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You finally get a situation in
J&J, where the balance of the
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business is not impacted by
what's going on, good or bad,
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with the consumer business. But
unfortunately, there's been more
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bad than good for J&J over the
past call it five to 10 years,
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probably.
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Johnson & Johnson coming out
with the statement saying that
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due to a product review
resulting from the Covid-19
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pandemic, they have decided to
cut about 100 different products
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from their assessment, including
all of their talc based
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Johnson's Baby products.
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Let's not forget that the talc
litigation is with consumer
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product right and the talc
litigation has been horrendous.
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Johnson & Johnson has
experienced a number of legal
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battles and liability issues
regarding all three segments of
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its business. In July 2021,
Johnson & Johnson reached a
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settlement that requires the
company to pay $5 billion over
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the next nine years due to its
involvement in the opioid
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crisis. But it's the legal
challenges on the consumer side
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of the company that has grabbed
the most media attention.
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More than 20,000 lawsuits have
been filed alleging Johnson &
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Johnson's baby powder resulted
in mesothelioma and ovarian
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cancer. These legal challenges
have been ongoing for years,
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with a slew of headlines coming
out about juries awarding
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plaintiffs millions of dollars
Johnson and Johnson discontinued
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selling its talc-based baby
powder in the US and Canada in
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May 2020 as demand for the
product fell.
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In June 2020. The courts ordered
j&j to pay a $2.1 billion fine
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in the Baby Powder cancer case.
There may be more settlements
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and fines to come as the
lawsuits make their way through
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the courts state by state.
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I think one of the main reasons
that this stock trades where it
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does which is discount to the
market overall. It's the
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unknown. Once we get the
resolution, I honestly think
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it's going to be kind of almost
liberating. Okay, we got it, we
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figured it out. Whatever the
dollar amount is, now we can
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move it along and focus again on
the pharma business and the med
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tech business.
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These may seem like big numbers.
But to put it in perspective,
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J&J reported a profit of more
than $15 billion in 2019, and
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$14.7 billion in 2020. The
company reported $19.9 billion
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in free cash flow in 2019. And
that number went up to $20. 2
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billion in 2020.
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I don't think the legal issues
will be an impediment to the
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company's growth going forward.
I do think there's some headline
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risk to it. We often get
questions as to if that's the
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reason J&J is separating out its
consumer business. And I don't
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think that's the case. I think
they separated out the consumer
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business because the business
model has changed and the
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synergies that they used to have
with pharma med device are now
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different.
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Johnson & Johnson declined CNBC
requests for comment on its
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decision to separate as well as
the on-going litigation. The
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company told The Wall Street
Journal in November 2021 that
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the lawsuits alleging the use of
Johnson's baby powder cause
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cancer didn't play a role in the
decision to break up the
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company.
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In October 2021, J&J put the
talcum claims into a separate
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company, which filed for
bankruptcy protection. That
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means it's going to be
considered a separate entity
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from the consumer business.
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What they're trying to do is
increase the attention on what's
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actually happening with the
business at the remaining J&J,
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having a liability shell absorb
the pain related to talc and the
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painkiller situation, and then
the consumer business hang on to
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the rest.
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So it is something that we have
seen other companies do before I
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think that J&J will be able to
prevail and basically having an
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efficient way to deal with all
these liabilities and then
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remove it, I think, from the
headline risk.
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If they can create these
liability shells in order to not
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protect the company so much, but
just to limit the effect it's
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having, I don't think investors
care as long as they're the
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company responsible for paying
out any claims.
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Johnson & Johnson's different
segments tend to offset one
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another.
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The risk to J&J longer term is
that there are issues that are
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more pervasive within either
pharma or med tech. And the
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consumer business no longer
provides an offset in the event
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that the fundamentals around
that unit improve.
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When you think about the future
of consumer if that business
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model is evolving, and the
synergies that were historically
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there are not there anymore, and
you require greater investment
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in order to grow that business,
then I think the offset to cash
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flow, if there's any hiccup in
pharma med device won't be
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there, the way that it used to
be.
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They're gonna obviously have to
do a very good job of making
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sure the growth rates with the
balance of the business continue
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to be robust or improve from
here.
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Wall Street has also expressed
concerns about how smoothly the
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process of spinning off will go.
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Some of the things that people
have asked about that the
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company hasn't given a ton of
color on is the stand up costs
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associated with separating out
this consumer business. Any
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potential synergies and the tax
implications and exactly how
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they're going to affect this.
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There are a few other potential
risks such as the possibility of
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health-care reform or patent
expiration.
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That's why they're so excited
about their pipeline, because
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while a few of their drugs are
going to go off-patent in a few
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years, and that's your near-term
risk, your longer-term story as
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well wait, we've got a big
pipeline and now we're kind of
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more of a streamlined company,
where we can take our cash flows
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and reinvest and do even more
and do even better and grow even
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stronger.
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Some analysts were questioning
why Johnson and Johnson didn't
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split into three companies by
separating its pharmaceutical
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and medical device units.
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It's a topic of debate. And it's
not clear that over the longer
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term if that might not be
something they could pursue. But
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I think today, the board and the
company feel that pharma and med
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devices still has a lot of
synergies. They talk about but a
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lot of opportunities that are
shared from a market perspective
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between the two businesses. And
the way that products are
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developed and commercialized are
still similar enough where they
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can actually work together to
get it done. But I would say
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that over the longer term that
would potentially make sense.
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And I think one of the things
when I talk to investors about
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J&J, what's really tough is,
it's hard to find an investor
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that has a broad enough
perspective to really get their
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arms around. All three
businesses being pharma, med
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device, a consumer people are
usually focused on one of those
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three segments.
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I would say that when you have a
business that we're most of the
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analyst community doesn't really
pay attention to and you siphon
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that off, it's probably gonna be
a positive.
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I think I'm gonna continue to
add to this position. They're
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trying to create shareholder
value any way that they can.
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This is one you kind of put away
and I think just gonna let it
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ride and let them figure out how
the whole thing evolves. I think
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it's very exciting though.
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