Why Johnson & Johnson Should Buy Prilosec From Procter & Gamble

(MoneyWatch)  When Procter & Gamble announced that it was getting out of its prescription pharmaceutical business, the obvious question was, "Why would P&G want to get rid of Prilosec OTC, the giant of the antacid category?" But CEO A.G. Lafley said that the company would keep Prilosec and Pepto Bismol, only selling its less well-known Rx brands like Actonel.

Nonetheless, a little bit of poking around inside P&G's Q1 earnings statement (P&G is on a non-calendar year) shows that P&G could, perhaps, realize more value from Prilosec by selling it. And Johnson & Johnson would be the perfect buyer.

Even though Prilosec is the dominant brand in the antacid category, that dominance is being eroded by generic competition. Here's what P&G has to say about the current condition of Prilosec (emphasis added):

Health Care net sales were up four percent during the quarter to $3.7 billion. Sales growth was driven by five percent favorable foreign exchange and a two percent impact from increased pricing. This was partially offset by a negative three percent product mix impact driven primarily by lower shipments of Prilosec OTC...

Pharmaceuticals and Personal Health volume declined high-single digits due to a double digit decline in Prilosec OTC from the loss of marketplace exclusivity...

Net earnings increased two percent for the quarter to $658 million as sales growth, lower overhead spending as a percent of net sales and divestiture gains were mostly offset by higher commodity costs.

In sum, heightened competition from in-store private-label brands and increasing commodity costs are hurting Prilosec sales.

In packaged goods, these problems are not new for P&G; the company is a master at dealing with them. P&G usually fights off competition by doing brand extensions, such as Mr Clean car wash. The new brand's increased sales offset the losses of -- and sometimes even boost -- the main brand over time.

But Prilosec isn't a packaged good -- it's a drug -- and thus lies outsiode P&G's skillset. A line extension is the one thing you cannot do with drugs. If P&G wants to do a calcium-enhanced version of Prilosec, for instance, it would have to spend years going through the FDA to get approval. Luckily, there's one player in the business who is a specialist at the long-term marketing of OTC meds which face generic competition and restricted line extensions -- J&J. The company already proved its chops in its takeover of Pfizer's OTC meds, which has become a success for them.

And if you look at what J&J has done for Pepcid -- with Pepcid Chews and Pepsid Complete -- you can see that here's a company that knows how to extend the life of an old, old brand. Plus, it would be worth J&J paying a premium for Prilosec because it could manage competition between Pepcid and Prilosec, with the two brands no longer cannibalizing each other in price wars.

All we need now is a nice investment bank to put a price on the deal. Anyone?

Image by Flickr user cygnus921, CC.