Smart People Can Do Dumb Things

This excerpt is from today's Wall Street Journal (subscription required). It's a nice follow up to the previous article on executives and ego.

Smart people do dumb things most particularly when their egos get in the way. Pride goeth before the fall. I see this in my negotiations consulting frequently: highly competitive people can be more intent on winning than they are in strategic good sense. That said, we all make mistakes. Some, like this one, can be expensive indeed:

Great Buyout Tactics
Don't Guarantee Success
July 26, 2006; Page C1

Tactical brilliance isn't the same thing as smarts.

When Boston Scientific swooped in to bid for heart-device maker Guidant late last year, it looked like one of the savviest moves in the recent takeover boom. Johnson & Johnson had agreed to buy Guidant and then lowered its offer dramatically as its target struggled with defects and recalls for its implanted heartbeat defibrillators.

Jim Tobin, Boston Sci's frank chief executive, explains how the deal went down this way: J&J "didn't see something other than that they could buy it for less than they agreed to pay in the first place. There was no grand strategy. That opened the door for us and we stepped in." In short, J&J executives "painted themselves into a corner."

Boston Sci, on the other hand, had a clear line of attack: "The game theory from our point of view was that they might not come back at all given that they were limited" by their low-ball bid, Mr. Tobin says.

In the view of Wall Street, J&J had bungled the negotiation badly. In December, I agreed¹, writing that the company's bidding tactics were "myopic and greedy." The argument went that now Boston Sci either would win Guidant or force J&J to pay more and look foolish while doing so.

Who looks foolish now? Losing Guidant seems like the better outcome. Usually it's absurd to declare an acquisition a success or failure within the first several months. Boston Sci closed its $27 billion purchase of Guidant only in late April. But there's little question that investors have lost faith. Guidant has had more recalls since the acquisition, and growth in the defibrillator market has tapered sharply. Further, concerns about the safety of drug-coated stents -- tiny metal scaffoldings that prop open arteries -- have mounted.

J&J was either smart or lucky or a little bit of both. And its investors are much better off. Since the deal closed in late April, Boston Sci's stock has cratered 26%. J&J's stock is up about 6% in that time, and it got an unusually rich $705 million breakup fee when the deal fell apart.

Questioning the wisdom of the acquisition puzzles Mr. Tobin. Knowing then what we knew now, would he have taken over Guidant? "Absolutely," he says. "The issues that have arisen so far -- we've been in this only 90 days -- were known in due diligence in advance. They are exactly what we expected." The stock's performance, he adds, "would indicate we have surprised some people and I don't understand how that could be true."

Already Wall Street is bracing for disappointing numbers from the combined company. The company now is expected to earn $1.57 a share in 2008, down from the average analyst estimate of $1.65 three months ago, according to Reuters Estimates.

Right after it outmaneuvered J&J, Boston Sci forecast that its revenue would rise between 12% to 14%, resulting in as much as $12.3 billion in 2008 and $13.8 billion in 2009. Bernstein Research now expects that revenue will be $10.6 billion in 2008 and $11.1 billion in 2009.

Mr. Tobin concedes the defibrillator market has slowed more sharply than expected: "If there is one surprise in this, it is the overreaction of the marketplace." He expects the market to bounce back.

There are many lessons for Wall Street here:

Don't be dazzled by short-term tactical masterstrokes.