Guidant deal looking better with time

Traditionalists would say it's time to buy Boston Scientific Corp. and Guidant some paper, the customary one-year anniversary gift, but stock holders might not be in a gift-giving mood. Boston Scientific shares have plunged 30 percent since the Guidant acquisition closed.

Yet as the official anniversary passed Saturday, the $27 billion deal could still prove a good idea. Before it bought Guidant and its heart-rhythm business, Boston Scientific was primarily a maker of drug-coated stents, and big concerns about those devices have erupted over the last year. Guidant's big market, meanwhile, may be regaining its footing.

David Katz, chief investment officer for New York-based Matrix Asset Advisors Inc., a big Boston Scientific shareholder, didn't initially like the deal. Boston Scientific appeared to have a robust stent business at the time, and Guidant came with some pretty big problems.

The tables have turned, however.

"We actually think that the deal makes a great deal more sense today than appeared a year ago, and think that Boston's management did the right thing," Katz said. His firm holds about 2.27 million shares of Boston Scientific, with a basis of about $23, and has increased its position over the last year.

"I thing long-term shareholders are going to be rewarded from here," Katz said.

Boston Scientific, with its flagging stock price, $9 billion in mostly Guidant-related debt and two questionable primary markets, is not there yet. But James Tobin, the company's president and chief executive since 1999, said that Boston Scientific takes a long view, and that he believes the Guidant deal will eventually deliver expected benefits.

"We have embarked on . . . what appears from the outside to be a risky strategy," Tobin told Dow Jones Newswires . "The risk in that is high, and people shy away from risk in a market situation like we're in right now. So it's not surprising that people want to see kind of the corner get turned until they start betting in our direction."

But he added that Boston Scientific is "accomplishing what we set out to accomplish," and said he doesn't think "anybody at the company is wringing their hands" and second-guessing the Guidant deal.

When Boston Scientific made its run at Guidant, it was heavily reliant on coated stents, the tiny devices that prop open arteries, and also exposed to any troubles that might emerge in the stent market. In the first quarter of 2006, the last full quarter without Guidant, Boston Scientific's Taxus stent represented 39 percent of revenue.

At it happens, Taxus is now under pressure amid growing competition and market-battering concern about links between older coated stents and clots.

Taxus is still a huge product for Boston Scientific, but the exposure has been lessened a bit. In the fourth quarter last year, with the addition of Guidant, Taxus slipped to a quarter of Boston Scientific's revenue total.

Stent exposure could be lower still, except for the key problem that's faced Guidant and its chief competitors, Medtronic Inc. and St. Jude Medical Inc., over the last year: a much slower-than-expected market for implantable defibrillators. The devices for patients with fragile hearts, known as ICDs, once experienced rapid growth that was expected to resume last year. But fallout from 2005 recalls proved very tough to overcome.

Guidant had a big role in these troubles. Problems with its products came to light in 2005, and the company has faced allegations that it concealed flaws. The last publicly released tally showed more than 1,175 related lawsuits.

Guidant's woes damaged its market share and made planned acquirer Johnson & Johnson leery enough to wrestle for a lower purchase price. That, in turn, opened the door for Boston Scientific to launch a bidding war and eventually win over Guidant's board.

The problem, some believe, is that Boston Scientific aggressively bid without a good sense of where ICDs were headed. "They grossly miscalculated," said Phil Nalbone, an analyst with RBC Capital Markets. "It leads one to wonder about the level of due diligence" before the deal, he said.

As Tobin said, the ICD market is 20 percent smaller at this point than Boston Scientific had anticipated. But he also noted that market projections were wrong across the industry, and said Boston Scientific believes the arrival of the market size and sales numbers it expected with Guidant has been postponed.

"I don't think anybody believes that the ICD market will not grow in the future," he said. "My belief is it will be sooner rather than later."

There are finally some signs of ICD market stabilization, if not progress, bolstered by St. Jude's report last week of a 15 percent year-over-year climb in first-quarter ICD sales.

There has also been improvement at Boston Scientific, which reported last week that it resolved all issues at a Minnesota plant that prompted a Food and Drug Administration warning letter in 2005. The disclosure sparked a 6.6 percent gain last Monday in Boston Scientific shares.

Tobin feels some customers were waiting for a signal of support from the FDA. "I think you'll see business pick up as a result," he said.

Guidant's share of the overall heart-rhythm market, which includes ICDs and pacemakers, was about 23 percent when Boston Scientific bought the company, according to Tobin. It bottomed out around 17 percent or so, after another recall in mid-2006, but is about halfway back to where it was a year ago, he said.

The chief executive also said that Guidant's turnaround is far ahead of the pace he projected last year.

Saturday marked another Guidant-related anniversary, one that was pretty cheerful for Abbott Laboratories Inc. , which bought Guidant's vascular business and helped Boston Scientific swing its deal.

Abbott appears the early winner, as the Xience drug-coated stent it gained through Guidant shined in a pivotal trial match-up with Taxus and looks like a serious contender.

But Abbott's good fortune also benefits Boston Scientific, in a way, as the latter company gets to sell a version of Xience called Promus while sharing profits. That gives Boston Scientific a hedge, of sorts, if new devices like Xience erode Taxus's market share. Over the longer term, Boston Scientific gets to make the successor to Promus on its own, Tobin said.

Shareholder Katz said he thinks the arrangement with Abbott assures Boston Scientific will retain a strong place in the stent market down the line.

As Tobin said, "This is a company that thinks in long-term ways."

Critics would say Boston Scientific is forced by circumstance to take that view because things haven't looked too great in the short term. Since the Guidant deal closed, J&J, which stayed on the sidelines, has seen its shares climb 11.5 percent. Shares of Abbott, which has the Guidant franchise that's now generating enthusiasm, have jumped 36.6 percent.

Yet, asked where Boston Scientific would be today without Guidant, Tobin didn't pull any punches: "We'd be in deep doodie."