Letter from the Artisan Partners Global Value Team to the Johnson & Johnson Board of Directors
January 28, 2016 09:52 AM Eastern Standard Time
SAN FRANCISCO--(BUSINESS WIRE)--Today Daniel J O'Keefe, Managing Director and Portfolio Manager of the Artisan Partners Global Value Team, delivered the following letter to the Johnson & Johnson Board of Directors, which expressed Mr. O'Keefe's views with respect to the management of that company.
"I believe that if you look at our track record of how we've utilized that cash to make the right capital investments in companies, that we've been successful at that."
January 28, 2016
Mr. Alex Gorsky
Dr. Mary Beckerle
Dr. Mary Sue Coleman
Mr. D. Scott Davis
Mr. Ian E. L. Davis
Dr. Susan L. Lindquist
Dr. Mark B. McClellan
Ms. Anne M. Mulcahy
Mr. William D. Perez
Mr. Charles Prince
Dr. A. Eugene Washington
Mr. Ronald A. Williams
Johnson & Johnson
One Johnson & Johnson Plaza
New Brunswick, NJ 08933
Artisan Partners Limited Partnership, on behalf of investment advisory clients in its Global Value investment strategy, has been an investor in Johnson & Johnson ("JNJ" or the "Company") since 2007. As of September 30, 2015, the most recent date for which such information is publicly-available, client accounts managed by Artisan Partners held approximately $445 million of JNJ common stock.
Some of you may be aware that I have engaged with the management of JNJ on two separate occasions over the past several months on matters that are of great concern to me and in my view should be of great concern to anyone interested in the Company's long-term value. For your reference, I have attached a copy of the presentation I shared with management in early fall 2015.
The reason for this letter is that my concerns today are as great as they were almost six months ago, perhaps greater. In short, my concerns are as follows:
JNJ's extensive M&A activity has destroyed significant value.
JNJ paid $17 billion for the Pfizer consumer business in 2006 and the profits of the consumer business are smaller today than before the acquisitions.
JNJ paid $19 billion for Synthes in 2012, has since spent $3 billion restructuring it, and recently announced another $2 billion restructuring. Despite this $24 billion investment, the medical device business is generating adjusted EBITA of less than $8 billion, roughly the same level of profit it made in 2010.
Over the period from 2006 through today, the Company has spent more than $150 billion on mergers & acquisitions, integration & restructuring, capital expenditures and research & development. Yet over that time, EBITA has increased by only about $7 billion. By any measure, the return on capital reinvested in the Company has been unacceptable.
Given JNJ's M&A track record and its significant cash resources, it is extremely troubling to hear Alex Gorsky publicly proclaiming his desire to make yet another large acquisition. Mr. Gorsky was responsible for the Synthes acquisition in 2012 and in my view, the results have been disastrous. It is shocking to me that during the recent earnings call, Mr. Gorsky made the following comment about JNJ's use of cash for M&A: "I believe that if you look at our track record of how we've utilized that cash to make the right capital investments in companies, that we've been successful at that." In my opinion, this statement simply is not consistent with the facts.
Management is focused on, and its compensation is based upon, a flawed measure of value creation — adjusted earnings per share (Adjusted EPS).
Since 2007, JNJ has expensed more than $8 billion of litigation and product liability expenses. In addition, the Company has incurred approximately $2 billion in R&D write-offs, taken roughly $3 billion of integration and restructuring charges related to the Synthes acquisition and just announced another $2 billion restructuring of the medical devices business. These perpetually recurring "non-recurring" items have totaled roughly $16 billion, or more than $5 per share. These are real costs to shareholders, yet are excluded from management's compensation and incentive plan.
Management's 2015 Adjusted EPS number excludes goodwill amortization, restructuring charges, in process R&D charges, DePuy ASR hip program costs and litigation expenses. Incredibly, the Adjusted EPS number nonetheless includes the $1 billion dollar plus gain from the sale of the Cordis business. An Adjusted EPS number that excludes all the supposedly extraordinary (yet chronically recurring) charges to earnings, but that somehow includes the one-time gain from the sale of a subsidiary, is clearly not a credible measure of business performance.
In light of the value destruction, litigation charges, chronic restructuring and longstanding underperformance of two of the Company's three divisions, it is difficult to understand why the Board of Directors awarded the CEO and his predecessor compensation totaling more than $200 million from 2007 through 2014.
There is no evidence that JNJ's conglomerate structure creates value for shareholders.
Two of the three businesses are among the worst-performing participants in their industry. In my view, separation of the three businesses would create immediate near and long-term value as greater focus and accountability is brought to bear.
In light of the foregoing, I urge the Board of Directors to consider taking the following actions immediately:
Conduct a thorough review of JNJ's acquisition history and restructure capital allocation controls in order to prevent further value destruction on the scale of Synthes and Pfizer Consumer.
Adopt "Return on Capital" based incentives and eliminate Adjusted EPS as a measure of value creation.
Adopt new, publicly-disclosed financial targets for the faltering medical devices and consumer businesses. Absent their return to industry-leading performance, the Board should commit to spin those businesses off to shareholders so that new, focused and accountable management teams can lead them into the future.
I look forward to speaking with the Board as a whole on these matters or with the independent directors of the Board. It is the responsibility of the independent directors to oversee management and to safeguard shareholders' investment. I urge you collectively to act. Because I feel strongly about these matters, I have made the contents of this letter available to the public.
Daniel J. O'Keefe
Managing Director, Portfolio Manager
Artisan Partners Limited Partnership
Mike Roos, 800-399-1770