Source: PaxForex Premium Analytics Portal, Fundamental Insight
Legal challenges are not new to Johnson & Johnson. In 2020 and 2019, the company spent more than $5 billion on litigation-related payments. But thanks to Johnson & Johnson's extensive financial resources, it was able to cover those costs. Perhaps the company's most pressing legal problem to date has been its talc-related liabilities.
Here too, yet, looks like the company has avoided the bullet by taking the controversial step of limiting its potential liability. But in doing so, it may have set a dangerous precedent for other medical companies to follow the lead if they get into trouble. And that could make investing in the industry even riskier than it already is.
Johnson & Johnson may well have paid out billions and billions in compensation to people who claimed to have gotten cancer as a result of the company's use of baby powder containing talcum powder. In 2018, a Missouri jury awarded 22 women a total of $4.6 billion in a joint lawsuit, but an appeals court eventually lowered that amount to $2.1 billion. That averages out to $95 million per person.
With the number of talc-related lawsuits currently at about 38,000 (and that number is likely to grow in the future as more people get sick), it's easy to see how a lawsuit could potentially ruin a business. While Johnson & Johnson is large, it is not invincible; in 2021, it had a net income of $20.9 billion and current assets of $61 billion.
Even if those 38,000 lawsuits average only $9.5 million in settlements (10 percent of the prior period average), that could result in a staggering $361 billion -- not including other legal fees. That's almost as much as the company's market value, which is roughly $460 billion.
Nevertheless, it may be challenging (if not impossible) to calculate how many of these lawsuits will be dismissed and how many may result in only nominal payments. And the company has considerable leeway not to report such significant liabilities, thereby alerting investors. Johnson & Johnson said in its most recent annual report that it "accounts for accruals for contingent losses related to legal issues, including talc, when a liability is probable and the amount of the loss can be reasonably estimated."
Given the number of lawsuits the company has faced, investors could not expect the company to be able to reasonably estimate the amount of its liabilities. But in any case, there is no doubt that Johnson & Johnson likely would have faced costs of tens, if not hundreds of billions of dollars because of these cases.
Johnson & Johnson found a way to cut its losses by transferring its talc liabilities to a new company, LTL Management, and then bankrupting it. This move is legal under Texas law and is called a "Texas two-step." Although the plaintiffs protested its use, a federal judge in February allowed the company to proceed. This prevents Johnson & Johnson from incurring crippling legal costs.
Steven Wohlens (former Assemblyman), who wrote a bill decades ago to help companies separate their assets and liabilities, says it was never intended for such use. He adds: "Had we known in 1989 that the provisions could be questionably interpreted for legal entities to avoid known liabilities, such as those resulting in serious and irreversible injuries and deaths, it would never have passed with the Texas two-step provision."
With the courts seemingly siding with Johnson & Johnson, the path for the company to avoid the liability it would otherwise face seems clear. For health care investors in general, this could set a dangerous precedent in an already risky industry where volatile stocks can live or die by the success or failure of a single product.
Perhaps the best example of this is the biotech company Biogen. When its Alzheimer's disease drug, Aduhelm, got accelerated approval from the Food and Drug Administration (FDA) last year, the company's stock soared the next day to $468.55 -- up 64 percent from the previous day's close. But amid controversy over the drug's effectiveness, the company's stock fell to less than half that value.
Ocugen is another example of a stock that has taken investors on a roller coaster ride. Hopes for the COVID-19 vaccine faded after the FDA recently refused to grant it approval for emergency use in pediatrics. What was once a promising growth stock has fallen 48% in just six months. Meanwhile, Moderna, which was a relatively unknown medical company before the pandemic, has grown more than 800% since 2020, all thanks to the successful COVID-19 vaccine.
By allowing the Texas approach, companies looking to become the next Moderna may see it as a way to take more risk for the sake of rolling the dice and making big gains on a new drug or product. Today, it's impossible to tell what could be the next success story and what could be a colossal failure. And if you give companies the potential to take more risks, the danger to investors could increase exponentially.
A Reuters report earlier uncovered documents showing that Johnson & Johnson knew for decades that its baby powder sometimes contained asbestos. However, the company did not report it to regulators or the public, and the courts seem to believe that the company did not act in bad faith, which may be of concern to those concerned.
Not only the victims of Johnson & Johnson's talcum powder will lose out in this decision, but also investors, as it could open the door to unfair practices by companies for whom profit is more important than quality and safety, ultimately making investments riskier.
Overall, J&J stock seems poised to turn into a top play for growth and earnings after the upcoming split.
As long as the price is above the 173.00 level, follow the recommendations below:
- Time frame: D1
- Recommendation: long position
- Entry point: 176.88
- Take Profit 1: 180.00
- Take Profit 2: 190.00
Alternative scenario:
If the level of 173.00 is broken-down, follow the recommendations below:
- Time frame: D1
- Recommendation: short position
- Entry point: 173.00
- Take Profit 1: 167.00
- Take-profit 2: 162.00
