J&J-Synthes Deal Faces In-depth European Probe

Johnson & Johnson has hit a potential stumbling block in its quest to rule the world’s orthopedic reconstruction market.

The New Brunswick, N.J.-based company is facing an expanded European Union (EU) investigation into its blockbuster $21.3 billion bid for Synthes Inc. The deal—initially expected to close in the first half of next year—has been referred to a second-phase-in-depth probe by the EU’s antitrust unit, a move that gives authorities until March 19 to decide on the case.

The four-month window gives EU chieftains some time—however brief—to determine whether the proposed merger would limit competition. An initial investigation conducted by the EU concluded the transaction would combine two of Europe’s largest suppliers of spine devices. The probe also indicated the deal would turn Synthes into the world’s largest producer of trauma products and devices for facial and skull fractures, and J&J into the global leader of shoulder replacements and components.

“The proposed acquisition would remove a competitor from some markets which are already concentrated,” EU antitrust chief Joaquin Almunia said in a prepared statement. “The commission needs to make sure that effective competition is preserved in order to maintain innovation and prevent harm to patients.”

The antitrust body expressed concern about the deal’s potential to leave competitors in many markets unable “to exert a sufficiently strong restraint on the behavior of the merged entity.” In addition, regulators fear the deal would hurt innovation, which significantly could counteract the EU’s efforts to lower prices for healthcare products through increased competition among medical device manufacturers and drug makers.

While Phase II investigations are not uncommon for complex, high-stake, high-price deals, they can slow the acquisition process. Over the next few months, the EU’s antitrust unit will collect statements and evidence from parties that significantly would be impacted by the deal. After reviewing and evaluating all the evidence, statements and data related to the acquisition, regulators either can block the purchase, require J&J and/or Synthes to sell off units, or change the way the companies conduct business in order to eliminate concerns about competition. It is unlikely that EU officials would block J&J’s bid for Synthes, but it cannot be ruled out—in 2001, regulators blocked a $47 billion merger between General Electric Co. and Honeywell International Inc. that previously had been approved by U.S. authorities.

Divestments would depend on regulators’ views about medical device prices. J&J and Synthes could be pressed by the EU to divest part of their spine business because the merger would give the combined company a 30 percent share of the market, making it the second-largest spinal products provider behind Medtronic Inc.

Despite such potential consequences, both Synthes and J&J executives remain confident about the merger’s chances of obtaining the EU’s blessing. “Phase II investigations are customary for transactions of this size and scope,” J&J spokesman Bill Price told Bloomberg in an e-mailed statement. “We expect the transaction to close in the first half of 2012.”

So do Synthes managers. In fact, the company is so hopeful of the deadline that it is forging ahead with a planned Dec. 15 stockholders meeting in Switzerland to vote on the proposed merger. Board members with the Oberdorf-based company (its U.S. headquarters is located in West Chester, Pa.) agreed to the merger in April after concluding the firm faced challenges that would bog down growth in the orthopedic device market.

If approved, the acquisition would be the largest in J&J’s 125-year history and would make it the dominating force in the $5.5 billion global orthopedic reconstruction market. It also could help the diversified U.S. healthcare group overcome a wave of consumer product recalls and the loss of patent protection on its top-selling drugs.

“Orthopedics is a large and growing $37 billion global market and represents an important growth driver,” J&J Chairman and CEO William Weldon said when the proposed merger was announced. “Synthes is one of the premiere orthopedic companies and that kind of opportunity comes up very infrequently. We’re always looking for the best opportunities, wherever they exist, and whatever segment they fit into.”

J&J has agreed to pay 159 Swiss francs in cash and stock for each Synthes share—a 21.7 percent premium over Synthes’ closing share price of 130.60 Swiss francs on April 14, before rumors of a takeover first surfaced. Each Synthes share will be exchanged for 55.65 Swiss francs ($63.48 at the time the merger was announced), with the remaining 65 percent paid for by J&J stock. Shareholders will receive up to 1.9672 J&J shares for each Synthes share; the ultimate value of the deal could fluctuate depending on J&J’s share price and the exchange rate of the dollar versus the Swiss franc.