by James Brumley | December 26, 2012 12:47 pm
More than a year in the making, Abbott Laboratories‘ (NYSE:ABT[1]) split is just around the corner. As of Jan. 1, current owners of Abbott will be owners of Abbott, and they’ll get a piece of a company called AbbVie, which will trade under the ticker ABBV.
Superficially, most investors are excited because spin-offs are generally viewed as a way to unlock value. The question is, does AbbVie justify its likely $55 billion market cap (so far) once the numbers are crunched?
In the grand scheme of things, Abbott Laboratories doesn’t look much different than other diversified healthcare names like Johnson & Johnson (NYSE:JNJ[2]) or Merck (NYSE:MRK[3]). None of them are purely pharmaceutical companies. In fact, between the three, these companies have a hand in pet-care, suntan lotion, nutrition, diagnostics and of course, pharmaceuticals. Only Abbott, however, has decided its two business lines would each be better off if run separately.
AbbVie will continue operating the pharmaceutical division, which may be just as meaningfully called the Humira division. In Q3, the company sold $2.3 billion worth of the rheumatoid arthritis drug, good for 23% of Abbott’s total revenue. Once AbbVie branches off, the pros say the newly named organization will produce $18 billion in annual sales, half of which will stem from Humira.
The medical products’ side of the business will retain the Abbott Laboratories name, although it’s a categorization that doesn’t do the company justice. Abbott’s devices, diagnostic equipment and nutritional products arm also sells a drug-coated heart stent that’s the top-selling product in that particular category. It generates more than $1.5 billion in annual revenue, and now that J&J is getting out of the stent business, the Abbott product’s sales should accelerate.
Either way, Abbott Laboratories is expected to be the faster-growing division once the split is complete. Revenue should total roughly $22 billion in the division’s inaugural year.
While the spin-off news was first shared in late 2011, a handful of key details — the ones that really matter — have materialized only in the past few days. The big one is the likely market capitalization for each unit.
Yes, it’s possible to dissect those numbers, even though the split’s yet to happen. Shares of AbbVie are already trading on a “when issued” basis, and their current price implies the company is worth $55 billion. That’s 3x the projected 2013 top line. It’s a tad frothy, but nothing out of line, especially given the division’s growth prospects. CEO Miles White expects AbbVie to be the more potent of the two, with annual growth rates in the high single digits.
Post-spinoff Abbott Labs is valued at $48 billion, or about 2.2x projected annual sales — a much more palatable figure. Then again, this unit is expected to grow its bottom line at a slower pace than the device division, so it may rightfully command less of a premium. Perhaps that lower price/sales figure also reflects the fact that the pharma business is a riskier one, with lengthy and costly drug developments being par for the course.
That said, investors need to keep one detail in mind as they draw their value conclusions: Following the split, Abbott will be responsible for $7.5 billion in debt and retain $5 billion worth of the company’s current cash balance. AbbVie will inherit $16 billion in debt obligations, and will take $7 billion in cash with it.
Dividends? Shareholders who owned Abbott and itd 3.1% yield will find even more income with their AbbVie yield, which is expected to pay out 4.8%. Abbott the device and diagnostics company will be paying out only about 0.9% of its current share value.
If nothing else, the pending Abbott split is a courtesy to investors, giving them a choice of risk/reward scenarios they can’t get with a Johnson & Johnson or Merck.
Sure, both divisions pose legitimate concerns. The pharma side, as an example, relies on Humira to provide a quarter of its sales, a proportion that should actually rise now that the company’s cholesterol drugs Tricor and Niaspan are within reach of their patent cliffs. But AbbVie has a very robust pipeline, including Daclizumab (with Phase III results due in 2014), chronic kidney disease drug bardoxolone (in Phase III) and elotuzumab for multiple myeloma (in Phase III).
Another dozen or so compelling Phase II drugs are also in the pipeline. Though nothing is apt to recreate Humira’s success, AbbVie has plenty of drugs in the hopper.
Overall, both divisions will make for fine companies, and neither is anything that current or future owners should be ashamed of owning. But it’s pretty clear that the device and equipment side of the business is the one to own if there’s only room for one of these names in your portfolio.
As of this writing, James Brumley didn’t own any securities mentioned here.
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