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By Alex Morozov, CFA | 07-02-2009 12:37 PM

Why J&J Bought a Big Piece of Elan

Morningstar's Damien Conover and Alex Morozov discuss what J&J's stake in biotech Elan means for both companies.

Alex Morozov: Good morning, I'm Alex Morozov, the associate director of the health-care team here at Morningstar. This morning Irish biotechnology company Elan has announced that it's signed a deal with J&J, where Johnson & Johnson and Elan combined for $1.5 billion.

The deal is very interesting because Elan has been rumored to be a target of acquisition since early 2009. In fact, Morningstar has looked through list of our biotechnology companies in our universe and identified Elan as the company that is most likely to be acquired by a large pharmaceutical company. The news this morning has definitely validated this opinion.

With me today is our senior pharmaceutical analyst, Damien Conover. Welcome, Damien.

Damien Conover: Thanks for having me, Alex.

Morozov: Damien, why don't you give us some details on the transaction?

Conover: So this transaction's a little bit more complicated than other arrangements that we've seen in the pharmaceutical space. What we're seeing here is Johnson & Johnson getting access to a huge neuroscience component of Elan.

And how that's working specifically, as you mentioned, J&J is going to put about $1.5 billion into Elan in return to a 50% access to the Alzheimer's program that Elan has and a 20% exposure to the remaining piece of Elan, which really is Tysabri, their multiple sclerosis drug.

Morozov: What has made Elan such an attractive target, in your opinion? And what is J&J going to get out of this deal?

Conover: From Elan's perspective, they are kind of at the forefront of neuroscience research. This is an area that all pharmaceutical companies want to get into, but it's also very hard to do because the science is so complex and they haven't made a lot of progress.

Elan, on the other hand, has made a lot of progress. They've got the Phase III Alzheimer's drug that looks like it could potentially revolutionize the treatment for Alzheimer's patients. On top of that, they've got a lot of earlier-stage products in both MS and Alzheimer's that could potentially become blockbusters, but more several years down the road.

Morozov: And now Johnson & Johnson gets access to this pipeline. What does that mean for Johnson & Johnson, in your opinion? Does that make them immediately a great big player in this Alzheimer's drug space?

Conover: Definitely. Right now, Johnson & Johnson didn't have a huge exposure to neuroscience as far as in the multiple sclerosis or Alzheimer's areas. With Elan, now they have instant access to multiple sclerosis and a huge potential winner in Alzheimer's.

Morozov: $1.5 billion. Is this an 18% stake? What do you think, is it a dilutive deal to shareholders? What is Elan going to do with this money?

Conover: From Elan's perspective, I think it's a net positive. Now the deal does two things. One, it eliminates a little bit of the upside from its own product. But at the same time it brings in a tremendous amount of capital and reduces some of the risk to developing this product on their own or on their own with Wyeth.

So I think from Elan's perspective, it makes it a little bit less risky company. And it allows them to pay down debt and get to more of a cash flow stabilization instead of cash flow burn. So I think it's a net positive for Elan.

And it also does one other thing that's really important. It validates the product bapineuzumab. This is their Alzheimer's product. And I think with Johnson & Johnson investing in it, it means that this product has a much higher potential of reaching the market.

Morozov: With Johnson & Johnson investment, does this make Elan less attractive as a potential acquisition for the outright sale of the company? What do you think is the next step for J&J and Elan here?

Conover: Now you're left with Elan, that before this acquisition already had a lot of partnerships with other companies. Now you add in this layer, and you're really looking at a company that has so many partnerships it's going to be hard for Elan to be purchased outright by any other company besides Pfizer or Johnson & Johnson, or potentially Biogen Idec.

So you have three companies left that potentially could pull the trigger on acquiring Elan. But then, you also have to weigh that against all the other companies that probably won't be as interested in buying Elan.

I think the net takeaway from this is that Elan still looks like it will be fully taken out, but really with only three potential acquirers.

Morozov: Great. Thank you, Damien.

Conover: Thanks, Alex.

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