zaterdag 15 juli 2017

The Complex History of Johnson & Johnson

I have a soft spot for Johnson & Johnson.  What many investors don’t realize is that Johnson & Johnson proper doesn’t actually do anything in the sense that most people think it does.  Rather, it’s a holding company with controlling stakes in 265 individual operating businesses; firms with their own executives, employees, boards of directors, bank accounts, offices, products, and services that do business in every country on the planet.  The parent holding company’s job is to provide operational support for these subsidiary companies, including sourcing low-cost capital through borrowings (it is one of only three industrial businesses with an AAA credit score) and moving money from one to another in a way that allows lucrative opportunities to be seized; e.g., distributions can be declared from a profitable, but slow growing company, and dumped into a new idea that needs to scale quickly.  The holding company itself has increased the dividend payable per share to its stockholders every year, without exception, for 52 years; through recessions, wars, inflation, you name it.

The 265 individual companies that fall under the parent Johnson & Johnson holding company umbrella generally belong to one of three categories:

  • Consumer Healthcare: Things like baby powder, baby shampoo, baby lotion, Listerine mouth wash, Tylenol pain reliever, Rogaine hair loss treatment, Band-Aid bandages, Aveeno face washes, Neutrogena skin care, Lubriderm skin care, Bengay muscle relaxer, Neosporin disinfectant, Pepcid heartburn relief, Nicorette nicotine gum, Motrin, Benadryl, Sudafed, Mylanta, Visine eye drops, and Acuvue contact lenses to name a few.
  • Medical Devices: Everything from sterilization products for hospitals to blood glucose monitoring systems.
  • Pharmaceuticals: World-class drugs treating everything from cancer and diabetes to HIV and schizophrenia.

For example: Have you ever heard of McNeil-PPC, Inc.?  Probably not.  According to Wikipedia, its predecessor was founded on March 16, 1879 by Robert McNeil, who was 23 years old and paid $167 for a drugstore “complete with fixtures, inventory and soda fountain” in Philadelphia.  Decades later, it expanded into pharmaceutical distribution.  In 1959, it was acquired by Johnson & Johnson.  By infusing additional resources into the firm, McNeil-PPC, Inc. setup its own subsidiaries, including one called McNeil Nutritionals LLC.  That latter business entered a joint partnership with Tate & Lyle, the British agricultural giant, to develop an artificial sweetener.  After years of scientific discovery and perfection, the product known as Splenda was born.

If you didn’t know about this, when you visited Splenda’s website and saw “McNeil Nutritionals, LLC” as the owner, you wouldn’t know some of those earnings are being paid up to McNeil-PPC, Inc., which in turn find their way to the parent Johnson & Johnson company in New Jersey.  If tomorrow, a really promising drug appeared on the horizon, Johnson & Johnson’s parent company could declare dividends from McNeil-PPC, setup a new operating LLC, infuse the cash into it as part of the capitalization structure, reassign executives and talent to get it off the ground, and shave off ten or more years of ramp-up work.

urthermore, what makes Johnson & Johnson unique is that it is one of the only businesses in the Fortune 500 that explicitly rejects the “shareholder maximization is the highest priority” dogma that arose during the 20th century.  The enterprise is guided by its Credo, which is a work of art.  Quite literally.  The words, engraved at corporate headquarters, were penned prior to the 1944 initial public offering by the firm’s most famous Chief Executive Officer, letting new owners know that, while generating a return for them was important, it was far down the list to serving patients, doctors, suppliers, and employees; the theory being that there are multiple constituents with a vested interest in the prosperity of a firm, and that sometimes, doing the right thing long-term required sacrificing earning power today.  It’s a moral and ethical triumph that, I believe, should be replicated by other corporations and taught in business schools.

Following the Credo is what saved the firm’s reputation during the Chicago Tylenol murders of 1982.  When it became clear someone had tampered with capsules, slipping cyanide in them and killing those who took the pills, Johnson & Johnson immediately put the safety of their customers ahead of the income statement.  They did not attempt to minimize or deny the situation.  It pulled 330 million pills off the shelf and went from 34% market share to 0% overnight, according to Alan Hilburg.  He said they didn’t have a crisis plan, they had the Credo.
The company also immediately retooled their factories to create a visual metaphor for safety, introducing an aluminum tamper-evident seal, plastic coating, and pill capsules that couldn’t be broken apart easily.  Within 90 days, the consumer trust was so high that market share skyrocketed to 46%.

What’s so magical about the Johnson & Johnson credo?  Judge for yourself.

Our Credo

We believe our first responsibility is to the doctors, nurses and patients, to mothers and fathers and all others who use our products and services. In meeting their needs everything we do must be of high quality. We must constantly strive to reduce our costs in order to maintain reasonable prices. Customers’ orders must be serviced promptly and accurately. Our suppliers and distributors must have an opportunity to make a fair profit.

We are responsible to our employees, the men and women who work with us throughout the world. Everyone must be considered as an individual. We must respect their dignity and recognize their merit. They must have a sense of security in their jobs. Compensation must be fair and adequate, and working conditions clean, orderly and safe. We must be mindful of ways to help our employees fulfill their family obligations. Employees must feel free to make suggestions and complaints. There must be equal opportunity for employment, development and advancement for those qualified. We must provide competent management, and their actions must be just and ethical.

We are responsible to the communities in which we live and work and to the world community as well. We must be good citizens — support good works and charities and pay our fair share of taxes. We must encourage civic improvements and better health and education. We must maintain in good order the property we are privileged to use, protecting the environment and natural resources.

Our final responsibility is to our stockholders. Business must make a sound profit. We must experiment with new ideas. Research must be carried on, innovative programs developed and mistakes paid for. New equipment must be purchased, new facilities provided and new products launched. Reserves must be created to provide for adverse times. When we operate according to these principles, the stockholders should realize a fair return.

It’s worked in spades.  Johnson & Johnson has been one of the most successful blue chip stock investments of all time.  The underlying economic engine and incentive systems unleashed by the business model are so superior to most other firms, that even if you bought it at absurd valuation levels, such as during the Nifty Fifty era, you still beat the S&P 500 if you held it for 25+ years.  It has a structural advantage its competitors can’t match.

Specifics are always useful so to give you an idea of real-world numbers, let’s imagine you go back to the 1980’s when Misses Greedy Dwarf and I were born.  Say that our parents and grandparents got together and, between them, kicked in $50 a month for us, respectively, by sending a check to the Johnson & Johnson dividend reinvestment program.  It was already one of the biggest healthcare companies in the world.  Nearly every widow in the country owned it.  It had a prominent place in the portfolio of most mutual funds.  This was not some little-known firm but, rather, a global medical conglomerate with the founding family ranking on the then-newly established Forbes 400 list.  This would have taken nearly nothing; hardly any sacrifice; veritable pocket change.

What would we have today had this occurred in some alternate universe?  Ignoring the minor fees which wouldn’t have made much difference, anyway, here’s what each of us would have brought into the marriage property sitting on our joint balance sheet:

    • Misses Greedy Dwarf: 396 months, at $50 each, for total out-of-pocket savings of $19,800.  It would have grown to 3,719 shares worth around $339,582.97.  She would be collecting $11,157 in annual cash dividends.
    • Greedy Dwarf: 394 months, at $50 each, for total out-of-pocket savings of $19,700.  It would have grown into 3,650 shares worth around $333,272.98.  I would be collecting $10,950 in annual cash dividends.

Combined, that’s 790 aggregate months of saving, at $50 each, for total out-of-pocket cash contributions of $39,500.  It would have grown to 7,369 shares worth around $672,855.95.  We’d be collecting $22,107 in annual cash dividends.

Here’s the crazier part.  Imagine that our fictional alternate-dimension family handed us the stock certificates today and stopped contributing entirely.  We decided to lock the shares away, ignoring them and never putting any new money into it other than reinvested dividends.  If the firm compounded at less than its long-term average (it is much bigger, after all, so let’s shave off a few points), by the time we were Warren Buffett’s age the stake would have grown to $243,926,664.  That’s not a typo, it’s a quarter-of-a-billion dollars.

Even assuming some higher inflation inputs, the purchasing power equivalent would be just shy of $32,000,000 in today’s money.  Compounding is a nutty thing when you get your hands on a great asset, even in small amounts, and leave those assets alone for almost a century.  I can say with near absolute certainty that Johnson & Johnson will be in most of the family trusts we end up setting up for our children and grandchildren.

How did it come into existence?  By what workings did the modern Johnson & Johnson corporation, with all of its good, arrive on the commercial scene?  Travel with me back in time.

The Birth of Johnson & Johnson

In the 19th century, Sylvester and Louisa Wood Johnson had eleven children.  They were “farmers and cattle breeders in Crystal Lake, Pennsylvania” according to Barbara Goldsmith’s 1987 recounting, Johnson v. Johnson.

One of their sons, Robert Wood Johnson (1845-1910), relocated to East Orange, New Jersey to work with a man named George Seabury, with whom he established a pharmaceutical partnership called, appropriately enough, Seabury and Johnson.  Robert hired two of his younger brothers, Edward Mead Johnson (1853-1934) and James Wood Johnson (1856-1932) to work for him.

In 1883, when Edward Mead was 30 years old, and James Wood was 27, they decided they wanted to be their own bosses.  They quit their brother’s firm and setup a new business called Johnson & Johnson, using a simple logo the latter wrote by hand.  This business prospered.  Robert saw how well they were doing and, again according to Goldsmith’s examination of the family historical record, approached them about working together despite having parted ways not that long ago.  He left Seabury and Johnson, signing a non-compete agreement that banned him from the industry for a decade.  However, in 1886, he sought an exemption from the state that allowed him to discard his earlier promise on the theory that consumers benefited from the competition.

Robert infused his money into Johnson & Johnson and the boys were granted incorporation of their enterprise in 1887.  The “new” Johnson & Johnson consisted of “fourteen workers on the fourth floor of a small New Brunswick, New Jersey, factory”.  Barely a month and a half later, as the controlling stockholder, Robert demoted James from the position of President and assumed the role himself.

A driven, overbearing man, Robert was obsessed with preventing germs and infection, much to the benefit of society.  As Goldsmith put it, “In a time when the post-operative death rate in hospitals ran as high as 90 percent, when the cotton used in surgical dressings was made from the sweepings from the floors of textile mills, the Johnson brothers began to utilize [English surgeon Joseph Lister]’s methods of sterilization on a large scale to produce ‘the most trusted name in surgical dressings’.  Using an India-rubber-based adhesive, the Johnsons manufactured pre-packaged surgical dressings that were the forerunners of the Band-Aid.”

By the time he died in 1910, Robert Johnson had built the Johnson & Johnson company into “a plant consisting of forty buildings” and held 84% of the corporation’s stock.1  All was not lost, though, because back in 1882, he had married a woman named Evangeline who was the daughter of an affluent doctor.  They had three children.

  • The eldest son, Robert Wood Johnson, Jr. was born in 1893.
  • The middle son, John Seward Johnson, was born in 1895.
  • The youngest daughter, Evangeline Armstrong Johnson, was born in 1897.

Though he had little to no interest in his family – all he cared about was the business and couldn’t even be bothered to step away long enough to attend vacations with them – he left the Johnson & Johnson stock to his children.  Specifically, he instructed that his common stock, along with its voting power, be split evenly among the two sons so that each ended up with 42% of the Johnson & Johnson business, and he set aside a small block of preferred stock for his daughter as he didn’t believe women should be involved in running enterprises nor equally inherit; a misogynist belief that ran through the empire up until recent decades when female family members were forced to hand over control of their decision making to their brothers and, at the business, women weren’t even allowed in the executive dining room.

With uncle Edward Mead Johnson already working on his new firm and no longer a part of the Johnson & Johnson he founded (see footnotes), the boys’ uncle and company co-founder, James Johnson, stepped back into the role of President, taking the 17 and 15 year old into his home.  Robert Jr., realizing he was the only living Robert at this point, dropped the diminutive (he would later become “General Johnson” following World War II) and was hired at Johnson & Johnson as a lowly millhand.  Goldsmith says in her research that James used to confide in his daughter at the unpleasant nature of serving as the President of a company he co-founded, yet having to come home to answer to his teenage nephews, who between them were unstoppable due to the combined 84% stake they held.

General Robert Johnson and Seward Johnson Establish the 1944 Johnson & Johnson Family Trusts

It is with these two brothers – General Robert Johnson and Seward Johnson – that the 20th century Johnson & Johnson saga begins.  It is they, and their personalities, mistakes, and behaviors, that caused so much destruction and, in the case of the former, societal good.

For 22 years, James Johnson ran Johnson & Johnson for his nephews, who did things like take trips around the world to scout for new manufacturing plants. He protected and grew the business, churning out earnings and dividends for the stockholders, while providing products that saved lives and eased suffering.  When James died in 1932, the now-experienced-38-year-old Robert Johnson, a brilliant, driven egomaniac, took the reigns of his birthright and named himself President of the firm after coming to agreement with his submissive brother, Seward, that they would always act in concert, and it would be he, and he alone, who sat in the big chair at Johnson & Johnson.

Upon assuming his position, he went about re-telling the history of Johnson & Johnson so that the original two founders, uncles Edward Mead and James, were written out and his late father, Robert Sr., was treated as the founder in newspapers, magazines, and biographies.  One account says that the company portrait of James, who had raised him after his father’s death and loyally served as the President of the business he founded, was shoved in a closet for almost two decades, as if he had never existed.  It was only after his aunt shamed him into rehanging it that it was brought out of storage.

Although he made a total mess of his family, reportedly destroyed his own son before reconciling, and set in motion of series of events responsible for the implosion of the Johnson family clan, General Johnson was one of the greatest corporate executives who ever lived.  He also radically improved civilization through his charitable work.  Today, the Robert Wood Johnson Foundation is the largest health-based philanthropy in the United states, with almost $10 billion in assets, distributing around $400 million per annum to do everything from researching ways to develop human capital to finding methods to fight childhood obesity.

One family member described him as charming on the outside but a shark on the inside.  Other than his treatment of women, he followed the Johnson & Johnson credo, which he developed and penned himself, in both spirit and letter.  He would fire anyone, on the spot, who put profits ahead of quality.  He would interview even the lowliest employee so he could figure out what could be improved without the bureaucracy obfuscating his view of ground-level conditions.  He demanded total, complete, and absolute loyalty and control.

General Robert was obsessed, in outcome, anyway, with the power of compounding.  He wanted both the firm, and its stock, to grow so he had a policy of low dividend payouts, reinvesting most profits into growth.  In 1944, he decided an IPO would be the best way to raise capital for expansion, accelerating the rate at which his empire was spreading across the world.  He used this as an excuse to solve three other problems:

  1. Even though he owned 42% of the stock and Seward owned 42% of the stock, Robert wanted majority voting power so he could reign without contest.
  2. He wanted the family to leave the stock untouched so it could compound into a truly impressive amount of wealth.
  3. He wanted the male members of the family to continue holding all of the influence, with the females subjected to them.

He convinced his brother to put 45% of his holdings, or 18.9% of the entire Johnson & Johnson company, into a series of six trusts over which he (Robert) and two “yes-men” associates would serve as trustees including the right to vote the stock (Seward had five children already born and was about to become father to a sixth).  Robert didn’t trust outsiders so he had Johnson & Johnson’s in-house counsel, Kenneth Perry, draw up the trust instruments.  Concerned only with his own power and desire to see the fortune compound, the trust instruments were iron-clad and severe in command, modeled after the now-well-known generation skipping trusts made famous by the Rockefellers.  According to Goldsmith:

  • Each of these trusts contained 15,000 shares of Johnson & Johnson, then valued at $500,000 [Note: This is around $6,779,500 in today’s inflation-adjusted terms.  Also note, one of the heirs insists her trust only began with $250,000, not $500,000, so there is some degree of ambiguity].
  • Seward’s children would receive annual annuities ($6,000 per year, or $81,350 in inflation-adjusted terms) plus discretionary payouts, which Robert clearly didn’t intend to exceed more than token amounts.
  • Each child would have the right to declare beneficiary / beneficiaries for the trust.  Upon their death, the trust would dissolve and the person or people listed as beneficiaries would inherit everything
  • Seward’s son, Seward Jr., would become trustee of his sisters’ trusts upon his 21st birthday, and be entitled to vote their stock on his 33rd birthday.  The women couldn’t be trusted to run their own affairs.

Robert also setup his own, similar trusts for his bloodline at the same time.

The combination of low dividend payouts and high trust retention, along with beneficiaries themselves getting next to nothing relative to the trust value that was accumulating, led to a series of family tragedies, battles, deaths, and scandals that make a Mexican soap opera look tame in comparison.  There was a Polish maid who got her hands on more than $300 million of the family fortune and turned it into $3.6 billion.  There were allegations of rape and incest.  There were drug overdoses and suicides.  There was an alleged murder plot.  There were numerous lawsuits that resulted in tens of millions of dollars going to lawyers.  There were family members who married and divorced as if they were changing coats.  On the plus side, there were staggering charitable donations that benefited civilization.

One of Seward’s children accurately summed up the trusts General Robert convinced his brother to establish as thus: “Those trusts weren’t set up for love and caring, they were done because Uncle Bob wanted to control the vote on ninety thousand shares of stock without experiencing the tax consequences of ownership.  Those trusts were never supposed to take care of us, we were supposed to be taken care of in other ways.  I might sue my trustees.  Every time I ask them for something, they throw it up in my face that they have to protect the remainderment for my heirs.  I wrote them a letter and quoted the trust agreement; it said that this money was being put away for my welfare, my good, not for someone to get after I die.”

The Johnson Family Trusts Were Effective But the Family Culture Was a Failure

The interesting thing about the trust funds that General Johnson had established is they were extraordinarily successful.  They did what they were intended to do – consolidate voting power, transferring significant assets into the grandchildren’s hands as each $500,000 trust blossomed into $600,000,000+ while stopping the second generation from spending it – but the family culture failed due to intractable character flaws of both Robert and Seward.  They hurt, in some form or another, nearly everyone with whom they were involved.  The case study I did of the family fortune for the purposes of learning about the mistakes (and how best to avoid them) is one of the few times I felt physically ill.  Coming from a good family, I can’t wrap my head around the fact people grew up that way, with so much neglect, abuse, entitlement, self-sabotage, and lack of purpose.  There is a brokenness there that seems hopeless.  No amount of capital can possibly compensate for the short end of the stick some of them were handed.  Frankly, I don’t know how a sensible person could grow up in that environment and emerge normal.  I hope some of them find happiness.  While the fortune left behind has done wonders for scientific and healthcare philanthropy, it’s torn asunder their family tree; certainly more of a curse than a blessing in my estimation.

For all of his foresight, General Johnson failed on the wisdom front.  He helped his family amass more money than they could ever spend, but he didn’t help them amass wealth.  In fact, he left them impoverished in a lot of ways that matter.  As I see it, wealth is a combination of several things coming together: Good health, financial independence, achievement, excellence and pride in your work, a loving family that you know has your back and wants the best for you (give me the sound of multiple generations running around laughing and talking, the scent of a roast in the oven, and a good book off in a corner and that’s my idea of heaven), personal integration so you know you’re living your moral and ethical values, surrounding yourself with people who challenge you, an understanding somewhere deep within your soul of who you are as a person that nobody can take away from you – that core identity that makes you who you are.  Wealth is waking up and looking around saying, “There is nowhere else I would rather be, nobody else with whom I would rather be experiencing this moment, and nothing else I would rather be doing.”  Yes, the money is a wonderful tool in facilitating that but that is all it is – a tool.  Alone, it isn’t enough.  It will never be enough.  Money should never be the most interesting thing about you.

In any event, the Johnson family hasn’t had anything to do with Johnson & Johnson, at least in any meaningful sense, for decades.  The $257 billion enterprise is the highest quality, most diversified health care blue chip in the world.  I have little doubt that, all else equal, the probabilities indicate a decent-size block today should be worth an obscene amount in fifty years due to that structural advantage I mentioned, even if there are ugly periods in the interim.  Professional non-family management has had the reins for more than a generation as the Johnson family stake continues to fall in firm importance, crowded out by the shares you, your friends, and your family hold in index funds, mutual funds, dividend reinvestment plans, and brokerage accounts.  If you told me I could only hold ten stocks for the rest of my life, it would be on the list.


1 His brother, Edward Mead, was no longer involved in operations by this point.  In 1895, he started a side business called The American Ferment Company.  In 1897, he left Johnson & Johnson to work on it full time, setting up shop in Jersey City, New Jersey.  In 1905, he formerly incorporated as Mead Johnson & Company; the specialty product being digestive aid.  A few years later, in 1910, Mead Johnson & Company developed a blockbuster infant formula that had the distinction of being the first physician-recommended breast milk replacement in the United States.  The firm ended up moving to Evansville, Indiana, to get better access to the raw agricultural commodities it needed, and grew fantastically.

The role of CEO passed down the line, from father-to-son, for three generations until Bristol-Myers acquired it in a buyout.  The deal, announced in August of 1967, involved an all-stock purchase (both common and preferred) worth $240 million.  Wikipedia, which sources Reckert, Clare M. “Exchange of Stock Set; Merger Deal Set by Bristol-Myers“, The New York Times, August 25, 1967, states that prior year sales were $131 million with earnings of $7.3 million.

In 2009, Bristol Myers Squibb (as it was now known, following other mergers) conducted a two-part split-off (or “carve-out” as it is sometimes called) that involved an initial public offering for 10% of the business.  Mead Johnson, which had expanded to $2.9 billion in sales by this point, raised $720 million in gross proceeds, far exceeding the $562.5 million that had been hoped.  The cash helped strengthen Bristol Myers Squibb’s own balance sheet.  The remaining 90% of the stock was made available to shareholders who were willing to swap their stock in Bristol Myers Squibb for stock in Mead Johnson.  This facilitated what amounted to a tax-free asset exchange and a massive share repurchase.

Today, Mead Johnson is a stand-alone, $18 billion nutritional behemoth.

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The Complex History of Johnson & Johnson

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