Friday, March 21, 2008

Boston Scientific is Married to Co-Founder Peter Nicholas -- 'Til Death Do Them Part'

On April 26, 2006, interventional medical device maker Boston Scientific (BSX-$12.43) acquired Guidant Corp—the then second-largest maker of implantable cardiac defibrillators (ICD) and pacemakers (behind Medtronic) for $27.3 billion.

Instrumental in negotiating the deal to purchase Guidant was Peter M. Nicholas, co-founder of BSX. Messer. Nicholas retired in May 2005, but retained title as Chairman of the Board, the dais from which he lobbied other directors and major shareholders to sign off on the Guidant deal.

Nicholas argued that BSX was growing too reliant on its TAXUS (paclitaxel-eluting) coronary stent technology for growth, which accounted for 32 percent of revenue in fiscal 2006. No new proprietary blockbuster on its event horizon, Nicholas articulated to board members the need for BSX to look outside the company for [high margin] industry drivers capable of diversifying BSX’s product mix, re-invigorating top-line growth, and overall competitive position.

Nicholas, known for his aggressive 'winner-take all' decision-making style, set his sights on Guidant Corp, a major provider in the $10 billion global cardiac rhythm management (CRM) market.

Unfortunately, this bet-the-franchise corporate brinkmanship lead to miscalculation and overreaching. And, Nicholas was competing, too, with Johnson & Johnson for his prize. To buy Guidant, BSX increased its share count by 80 percent and took on $6.5 billion in debt—on which it is paying more than $300 million a year in interest.

Rushed due diligence failed to discover that Guidant was a company with defective implantable defibrillators (with a known history of short-circuiting), resulting in safety-related product recalls and slowing growth.

Tallying the Cost

Guidant has yet to prove to be accretive to the company’s bottom-line.

Analysts opine that the deal is arguably the second-worst ever, trailing only the $164.7 billion AOL-Time Warner debacle of 2000-01.

Faced with lingering fundamental problems—including the Company’s highly leveraged balance sheet (total debt of $8.19 billion at December 31, 2007), decelerating growth in the defibrillator/pacemaker and drug-coated heart stent markets, and competitive margin pressures—investors fled BSX, with the share price plunging more than 46 percent since the close of the deal, wiping out $15.8 billion in shareholder value.

During the third quarter of 2007, Standard & Poor’s Rating Services and Fitch Ratings downgraded the company’s credit ratings from investment grade to BB+, citing the company’s slowing rate of cash flow and debt-repayment issues.

Looking to improve its balance sheet, in the 4Q:07, management sought to better align expenses with revenues, divesting five non-core businesses to reduce operating expenses and debt load.

In addition, BSX moved forward with head-count reductions, and simplified its business model to better position the Company to focus on core markets—cardiology and endosurgery.

The cost of the Guidant failure to the Company: (i) acquisition-related charges (after tax) of $4.48 billion, or $3.52 per diluted share, in 2006; (ii) acquisition-, divestiture-, litigation- and restructuring-related charges (after tax) of $1.092 billion, or $0.73 per diluted share in 2007.

An argument might be posited that Nicholas, who beneficially owns 70.33 million shares, or 4.7 percent, of the outstanding stock of BSX, has seen net payback—the depressed valuation of his holdings—wrought by the ill-conceived Guidant deal.

When considering payback as in punishment for poor performance, our readers should know by now that the consequences of said payback never directly and indirectly affect Named Executive Officers the same as common stockholders.

Pay for Failure

The 10Q Detective argues that all Named Executive Officers—including Nicholas—are no more entitled to safety nets than the average employee is asked to put ‘on-the-line’ on a diurnal basis, and that their employment terms should not outlast the situations that give rise to severance.

You know I've lived a few mistakes and I stand by them.
Oo, it's me, myself, and I till death do us part, yeah.
Till death, till death do us part, yeah, yeah, No, no, no, no.
~ Motley Crue ("Til Death Do Us Part")

Unfortunately, from a governance point of view, Pete Nicholas’ Post-Employment Agreement provides that benefits continue to flow to him, regardless of whether he is asked to step down as Chairman of the Board:

  1. As Chairman of the Board, Nicholas receives an annual retainer of $210,000 and an annual grant valued at $120,000 in restricted stock. For the fiscal year-ended December 31, 2007, Nicholas owned 1.25 million outstanding stock options (granted to him in his capacity on the Board).
  2. In 2007, Nicholas received additional compensation of $1.45 million, including—but not limited to—a 'Founders Benefit,' medical benefits, charitable donations, and transportation services of $225,000, $24,937, $1.0 million, and $30,865, respectively.
  3. Mr. Nicholas continues to have the use of an office at BSX’s Natick headquarters or other Boston Scientific facilities and secretarial and administrative support, on an as-needed basis.
  4. When Mr. Nicholas steps down as Chairman, he will retain the title of director emeritus. As defined, he will continue to receive the equivalent benefits of an active board member.

Boston Scientific is stuck with Nicholas--Till Death Due Them Part.

Editor David J. Phillips does not hold a financial interest in any stocks mentioned in this article. The 10Q Detective has a Full Disclosure Policy.

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