Johnson & Johnson (NYSE:JNJ) is considering paying about $3 billion to settle a lawsuit over its recalled hip implants. The company’s orthopedics medical devices & diagnostics unit DePuy recalled 93,000 implants in 2010 after finding out that more than 12% of them failed within five years.  This rate seems to be increasing and patients have complained about pain, metal debris and replacement surgeries. J&J intends to settle 11,500 cases which will imply a compensation of $300,000 per case. 
Although that’s a big amount, it doesn’t move the needle given J&J’s huge size, its diversified businesses and the fact that last year’s acquisition of Synthes will help the company expand its leadership in global orthopedics market. In other words, we do not think that J&J’s medical devices and diagnostics business is threatened by the lawsuit. In the worst case scenario where the company has to pay the entire settlement amount immediately, the decline in its net cash position will have a negative impact of just about 1% to our price estimate.
J&J’s market capitalization is touching almost $250 billion, and we expect the company to earn close to $70.7 billion in total revenues in 2013 up from $67.2 billion last year. A significant portion of this growth will be driven by its medical devices and diagnostics business, which constitutes roughly 60% of its value according to our estimates. Orthopedics division, which includes DePuy and Synthes, accounts for more than 20% and is well poised for future growth. Let’s take a look at why J&J is confident about its orthopedics medical devices business.
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Johnson & Johnson Is Well Positioned With Broadest Orthopedics Portfolio
DePuy is J&J’s largest segment within the medical devices & diagnostics portfolio representing 23% of the sales in 2012. The franchise consists of four companies – DePuy Orthopedics, DePuy Spine, DePuy Mitek and Codman & Shurtleff. The products offered include orthopedic devices and supplies, surgical devices and instruments for spinal disorders, orthopedic sports medicine products, soft tissue repair devices, and neurovascular/neurosurgery devices such as brain pressure monitoring systems.
Synthes, which J&J acquired in 2011 for $21.3 billion, is a global manufacturer of medical devices for orthopedics market including trauma and spine. The combined DePuy/Synthes orthopedic division has the broadest orthopedic portfolio globally. The company has a strong market position which can be attributed to its diversified product offerings, established brand, R&D focus, strong sales and marketing capabilities and vertical integration.
The Overall Spinal & Orthopedics Devices Market Is Growing
J&J’s orthopedic devices & diagnostics revenues stood at close to $7.8 billion in 2012. We expect this figure to jump to $9.3 billion in 2013 mainly due the impact of Synthes acquisition. In the long term, the company will benefit from its strong brand and the overall growth in the global spinal & orthopedics devices market. We expect this market to touch $82 billion by the end of our forecast period, compared to $56.6 billion in 2012. Here are some of the key factors that will drive this growth.
Joint Reconstruction Market Is Growing Fast
The joint reconstruction market, which includes hip, knee, and shoulder replacements and trauma products, has been growing at a rapid pace and we expect this trend to continue. The demand for hip and knee replacement procedures is increasing due to a rise in the aging population and a growing number of younger patients going for joint arthroplasty procedures. New product innovations, procedure techniques and positive clinical outcomes of the products introduced in the past four years have also fueled the market growth.
Growth In Spinal Surgical Devices Market
The global spinal surgical devices market stood at $5.5 billion in 2010, and is expected to touch $6.5 billion by 2015.  A significant portion of this growth will be driven by non-fusion devices which still form a small proportion of the overall market. The advantage of these devices over the traditional spinal fusion techniques pertains to higher degree of motion preservation. This is fueling the demand for non-fusion spinal implants. Additionally, vertebral repair is a fast growing sub segment of spinal surgical devices market and has seen ramped up demand due to the aging population in the U.S., Japan and other countries, and higher incidence of osteoporosis-related fractures. The revenues from this segment stood at $532 million in 2010 and are expected to reach $858 million in 2015. 
Source: BCC Research (http://www.bccresearch.com/market-research/healthcare/spinal-surgical-devices-hlc075a.html)
Our price estimate for Johnson & Johnson stands at $88, implying a slight discount to the market price.Notes: