J&J Leans Toward Orthopedics Spinoff After MedTech Sales Rise Just 2.5%

Johnson & Johnson's drug business carried the third quarter. Its device business did not.

MedTech sales rose 2.5% to $8.64 billion, below the roughly $8.74 billion analysts expected. The Innovative Medicine segment, J&J's pharmaceutical arm, grew 7.7% to $16.76 billion. Total third-quarter sales were $25.4 billion, up 5.9% and roughly in line with Wall Street estimates.

Chief Financial Officer Joe Wolk did not dress it up. "Medtech needs to improve quite frankly," he said in an interview.

Spin, not sale

Wolk said management is "leaning towards a straight spin" of its orthopedics business, DePuy Synthes, rather than selling it. "We think that's the greatest way to create value, and that's likely the path going forward," he said. He also said J&J is "not cash strapped" and doesn't "have to chase a bad deal."

The alternative was Apollo Global Management. Bloomberg reported last month that Apollo was in talks to buy the division at a valuation near $20 billion, and that the talks could still end without a deal.

One analysis from Business Model Analyst puts that price at about 2.2 times the unit's $9.3 billion in sales last year. It says Zimmer Biomet, the closest listed rival, trades near 2.9 times revenue. In that analysis, a spin lets J&J shareholders keep the gap. The same analysis points to J&J's Kenvue separation as a precedent for a parent extracting cash from a spinoff before it trades.

The separation is already costing money. J&J's adjusted earnings reconciliation carries a special item for orthopaedics separation costs: $119 million after tax in the first quarter, $258 million in the second and $369 million in the third. That adds up to $746 million so far this year.

Headwinds abroad

International MedTech sales were largely flat. Surgical devices fell 3.4% overseas. Wolk blamed geopolitical tensions and budget cuts by some European governments. He said the Middle East conflict pulled government spending in premium markets such as Kuwait, the UAE and Saudi Arabia toward defense. Pricing pressure in China added to the drag, according to a market-focused account of the call.

The weakness is not new. Last quarter, the device unit also came in slightly below estimates, partly on softness in the Abiomed heart pump business.

Analysts were unimpressed. "This quarter did not materially advance the growth narrative," RBC Capital Markets analyst Trung Huynh wrote, citing "another lacklustre Medtech quarter." Mizuho analyst Jared Holz wrote that device results were weak "really across the board," calling it "the area of most scrutiny today."

The drug side and the guidance

Pharma did the heavy lifting. J&J cited growth in cancer drugs Darzalex, Carvykti and Tecvayli, the autoimmune drug Tremfya and the psychiatric drug Caplyta. Tickeron put Tremfya's growth at 68%. Tremfya is positioned to replace Stelara, which is losing patent protection.

Adjusted earnings came to $2.59 a share against a consensus of about $2.52 to $2.53. J&J lifted full-year adjusted EPS guidance to $11.05 to $11.15, from $10.96 to $11.11. It raised its sales guidance to $101 billion to $101.4 billion. The company's own midpoint is $101.2 billion.

CEO Joaquin Duato said the quarter, "together with strategic investments in high-growth areas, gives us clearer line of sight to double-digit growth by the end of the decade."

The GAAP numbers look ugly. Net earnings fell to $210 million, or 9 cents a share, from $5.15 billion, or $2.12 a share, a year earlier. Most of the drop reflects the $5.5 billion J&J committed in July toward a proposed resolution of the ovarian talc lawsuits. Charges tied to the Firefly Bio acquisition and a collaboration with Sail Biomedicines added more.

The market reaction

Shares fell 3.7% by 9:32 a.m. ET Tuesday. A later quote from Tickeron showed the stock near $250.16, down about 5.15% from Monday's close of $263.73. The stock had gained 38% over the past 12 months through Monday, against 19% for the S&P 500.

That run leaves little room for a soft device quarter. Pharma is about twice the size of MedTech by revenue, yet the smaller unit has dominated investor attention.

What comes next

Wolk called the spin "likely," not final. J&J has not announced a timeline for the separation. The Apollo talks could still end without an agreement, so a sale is not off the table. Wolk has not said what happens to DePuy Synthes if a spin proves harder to execute.