February 24, 2012 / 8:48 PM / in 6 years

New J&J CEO must fix sullied image, integrate Synthes

CHICAGO/NEW YORK (Reuters) - Johnson & Johnson’s (JNJ.N) new CEO will need to take bold steps to help the giant healthcare company repair its reputation following costly product recalls and oversee its biggest acquisition ever.

Alex Gorsky, 51, vice chairman of the Medical Device and Diagnostics Group, rose through the ranks of J&J from his start as a salesman in 1988. He will be J&J’s ninth top executive, all of them chosen from inside the company.

Some investors say his expertise in medical devices helped secure the top job, but question whether yet another top executive groomed within the 125-year-old company’s ranks will be able to make needed changes.

“It will help to bring someone in for a fresh start,” said David Heupel, portfolio manager at Thrivent Investment Management, which owns J&J shares. “I‘m not sure it’ll make a vast difference, but a new face probably will be viewed favorably.”

Gorsky will take the helm in April at a critical time for J&J as it tries to rectify a series of massive, embarrassing recalls of products ranging from artificial hips to infant Tylenol.

No less of a challenge would be integrating the company’s planned $23.1 billion purchase of Swiss medical device maker Synthes Inc SYST.VX.

Chris Velis, chairman and CEO of Medical Capital Group, which invests in medical technology ventures, noted J&J’s lackluster stock performance -- the shares have risen less than 2 percent during outgoing Chief Executive Officer William Weldon’s 10-year tenure -- and said Gorsky should make some material changes.

“He needs to send a clear message and develop a strategy and explain where he is going to take the company,” Velis said. One of the most pressing changes would be to centralize quality control at the nearly 250 companies under the J&J umbrella.

Gorsky also needs to get cutting-edge medical technology into the company, whether through internal development or acquisition, Velis said.

“A large division of that organization is going to be threatened by new technology on a routine basis. Take the potential merger of Synthes -- they are buying a tremendous amount of scale, but neither company has been successful at bringing cutting-edge technology to the market,” he said.

A J&J spokesman declined to make Gorsky available or address investor comment.

INTEGRATING A NEW SALES MODEL

Gorsky will become CEO on April 26, which coincides with a deadline for European regulators to decide on the Synthes deal.

“He has to execute well on Synthes. It’s going to be a fairly complex integration because Synthes sells a lot of its products direct, training people right in the operating room sometimes,” said Gabelli & Co analyst Jeff Jonas, whose firm holds J&J shares for its clients.

He noted that it is expensive and complicated to sell products both directly, as Synthes does, and through distributors, as J&J does.

“It’s difficult to balance the two. You want one (sales) channel. Otherwise, it’s disruptive,” Jonas said.

Synthes makes artificial spinal disc implants and other products used in spine surgery, as well as plates, screws and rods used to repair the bones of trauma patients. The company generated sales of $4 billion last year, and its addition would give J&J’s Medical Devices and Diagnostic unit, already the biggest in the world, an even larger profile internally.

J&J’s medical device sales totaled $25.8 billion in 2011, but growth has flattened out in recent years, partly due to the company’s own problems with recalls and partly due to weak overall market conditions which saw a sharp cutback in medical procedures. Prescription drug sales were $24.4 billion last year and consumer products sales were $14.9 billion.

Analysts said J&J may need to divest part of Synthes’ spine business to get the deal approved.

Gorsky’s medical device challenge also includes getting the DePuy Orthopedics unit back on track after its costly recalls of metal-on-metal hips. The company last month said it would take a $3 billion charge, largely related to that recall.

“It will be a significant challenge, especially when integrating Synthes at the same time,” Jonas said. “They have to stay focused on M&A activity, which they have done historically.”

He suggested possible acquisitions of heart-imaging systems and devices that use energy to treat atrial fibrillation, a common heart arrhythmia, as well as balloon and stent technology to treat clogged arteries in the legs and neck.

MANAGING THROUGH A CONSENT DECREE

The quality control problems at J&J’s McNeil consumer healthcare unit -- which makes over-the-counter medicines like painkillers Tylenol and Motrin -- were deemed so pervasive that U.S. health regulators took over supervision of three manufacturing plants in March.

Under a consent decree, the U.S. government will oversee errant McNeil plants for at least five years, an independent expert was retained to inspect manufacturing facilities and the U.S. Food and Drug Administration could levy fines up to $10 million annually should it feel the agreement has been violated.

The consumer products recalls cost the company nearly $1 billion in 2010 sales.

“They have to snuff this out quickly and get aggressive and get to the heart of the problem,” said Chuck Lauber, a portfolio manager at Tributary Capital Management, which sold its J&J stake when the manufacturing issues emerged.

J&J shares have barely budged since Gorsky’s appointment was announced earlier this week, itself an indicator that few expect any big moves from his leadership.

“I’d be surprised if he made any radical changes,” said Les Funtleyder of Miller Tabak & Co, which owns J&J shares. “Gorsky was an Army Ranger, so he could kill you with his bare hands, but I‘m not sure there’s anything special about him, other than he’s been there for a long time.”

Editing by Michele Gershberg and Gerald E. McCormick

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