Friday, February 24, 2012

At J&J, The Weldon Legacy Is Marred By Scandals...J&J Chef Announces Retirement

After two years of scandal and controversy, Johnson & Johnson took a step that a vocal number of critics had been seeking months ago. The health care giant announced that ceo Bill Weldon would retire in April, although he will remain chairman for an unspecified period of time, and that he will be replaced by Alex Gorsky, one of two succession candidates who currently oversees the medical device and diagnostics business.

The move capped a fractious episode for the maker of such venerable products as Band-Aids and Johnson’s Baby Shampoo. Since January 2010, the health care giant has recalled tens of millions of products, mostly over-the-counter items such as Tylenol, Benadryl and Motrin, but also syringes, hip replacements, contact lenses and prescription drugs, due to manufacturing problems that seemed to permeate every corporate nook and cranny. Oh yes, there were shortages of Tampon and certain shampoos, too.

By now, the fallout is well known. The quality control gaffes led to a consent decree with the FDA; highly publicized congressional hearings; various government investigations; hundreds of job losses; the closure of a key plant; a reorganization of the McNeil Consumer Healthcare unit; eroded consumer confidence; numerous lawsuits, and hundreds of millions of dollars in lost sales. Consequently, J&J dropped to 7th place on the annual Corporate Reputation poll from Harris Interactive, its lowest-ever ranking.

Wall Street, however, has been more patient with Weldon. Rather than clamor for his head, investors have taken the long view and decided that J&J remains greater than the sum of its parts, especially since the health care giant has benefited from acquisitions that occurred on his watch, such as the Tibotec unit that sells HIV meds. Over the past year, in fact, J&J stock has increased roughly 18 percent, despite the recall debacle.

Still, the Weldon legacy may well reflect scandals. And yes, there was more than one. Consider the drumbeat of news about the safety of hip replacements sold by its DePuy unit. A recent report indicated marketing continued in Europe and other countries even after the FDA rejected the product for the US. Another revealed that a J&J executive wrote in a company e-mail that the FDA rejected the device after reviewing company studies showing significant premature failures, which contradicted public statements.

There has also been a string of legal setbacks surrounding the marketing of the Risperdal antipsychotic. J&J has reportedly reached a tentative deal to pay up to $1 billion to settle a federal probe that would resolve civil charges, and also agreed to a misdemeanor charge over the same issues. Last month, though, J&J marched into a Texas courtroom to defend a lawsuit brought by state officials, who charged the company orchestrated a controversial program that was designed to boost prescriptions in the public sector nationwide. But J&J quickly settled for $158 million after just one week of scathing and unflattering testimony (see here).

All of these problems figured prominently in a widely publicized, but ultimately unsuccessful shareholder derivative lawsuit, which a special board committee, not surprisingly, argued was meritless - its own investigation found no red flags or indications of systemic failure that were overlooked by the board or the J&J executive team. And the committee maintained there was no evidence Weldon engaged in or had knowledge of any wrongdoing. A federal judge dismissed the suit last fall (read here and here).

By then, J&J stock had been ascending, as investors decided the myriad problems were largely baked into the stock. This has offered Weldon needed support, of course, since increasing shareholder value is one of the few positive developments that he can point to during this stretch. But for long-term investors, the last two years were not quite as stellar as the more recent gains in J&J shares might suggest.

Consider this: in early January 2010, when the recall mess began, J&J stock traded just north of $60. Right now, shares go for $65, an 8 percent gain. Meanwhile, the Dow rose from 10,583 to 12,938 during the same period, a 22.2 percent increase. Granted, an 8 percent rise is not shabby and this does not include dividends. Nonetheless, one is tempted to wonder if J&J stock would have performed even better had the health care giant not experienced so many setbacks for so long across so many of its businesses.

In other words, the Weldon reign, which began a decade ago, will marked by the proverbial ‘what if?’ What if worldwide staffing in healthcare compliance and quality and control had not been so dramatically reduced several years ago? What if the restructuring of the McNeil unit, which involved absorbing the Pfizer consumer business and a subsequent hiring freeze, had been handled differently? These were failings conceded by J&J special committee in defending against the shareholder lawsuit.

Like a smart acquisition – such as Cougar Biotechnology, which yielded the Zytiga prostate cancer med – these mistakes also occurred on the Weldon watch. And while some other drug or device may one day reach the market thanks to a well-crafted deal, the scramble to regain shelf space and market share will challenge McNeil for some time to come. Similarly, restoring corporate reputation, which J&J has held out for decades as a valuable, if intangible asset, will also take hard work. And this is not the kind of work that an outgoing ceo should want to leave for others to clean up.

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