Merck (NYSE:MRK) plans on spinning off to its shareholders the shares of Organon & Co., a separate company that will trade on the NYSE. The new ticker symbol will be “OGN.” And there is every likelihood that OGN stock will do extremely well.
The stock is already trading as of May 14 on a when-issued (WI) basis around $35.75 per share, as of June 2. The “regular way” trading of OGN stock will begin on June 3.
The company has 60 medicines and products across its three core franchises: Women’s Health, Biosimilars and Established Brands. It already makes over $4.5 billion in revenue, according to a recent press release by Merck.
Here is how the spinoff of Organon actually works. Merck shareholders receive one-tenth of a share of Organon common stock for every Merck common share outstanding as of the close of business on May 17, 2021. So if you own 10 shares of MRK stock, you get one share of OGN stock. With 100 shares of MRK stock, your account will automatically be credited with 10 shares of OGN stock on June 3.
Calculating Organon’s Market Value
On May 3, Merck held an Investor Day featuring Organon. Page 74 of the accompanying slide deck shows that there will be about 250 million shares outstanding once the spinoff occurs. This means that its pro forma market capitalization is about $8.9 billion (i.e., 250 million shares x $35.75 per share).
However, the deck indicates that this is not a fully diluted number. Moreover, the latest 10-Q filing from Merck on May 5 shows there are 2.532 billion MRK common shares outstanding. This implies that on a 1-for-10 spinoff basis, there will be 253.2 million shares outstanding. That raises the market value to $9.05 billion.
Moreover, given that the company’s revenue is forecast to be from $6.1 billion to $6.4 billion, the price-to-sales (P/S) ratio will be quite low. This puts it at 1.5 times sales at the midpoint of the $6.1 billion to $6.4 billion market value. This assumes the price stays at $35.75.
What OGN Stock Is Worth
That is probably way too inexpensive for this company. For example, the slide deck indicates that the gross margin will be in the 60% range. Its adjusted EBITDA (earnings before interest, taxes, depreciation and amortization) margin will be between 36% to 38%. Page 19 of the deck shows that its 2020 adjusted EBITDA was $2.8 billion.
Moreover, page 28 of the 10-Q indicates that Organon will take on 1.25 billion euros in debt ($1.535 billion) plus $4.1 billion in senior secured notes. It will also have a credit line of $3 billion and a 750 million euro line of credit. It is not clear how much of those credit lines will be drawn down. For our purposes, we can assume that those are backup lines.
Therefore, assuming there will be $1 billion in cash on the balance sheet as part of the spinoff (a guess), the total enterprise value (EV) works out to $13.635 billion. This is calculated by adding $5.635 billion in debt less $1 billion in cash on hand to the $9 billion pro forma market cap.
As a result, the pro forma EV-to-adjusted-EBITDA multiple works out to be 4.89 times. This is seen by dividing $13.635 billion by $2.8 billion in 2020 adjusted EBITDA.
Where This Leaves Organon Shareholders
This is too cheap a valuation. For example, Merck trades for about 16 times its trailing-12-month EV/EBITDA. On an adjusted EBITDA basis, it is at about eight times or so. Therefore, even using a 20% discount, Organon stock should be at 6.4 times adjusted EBITDA.
That would put its market value at $17.92 billion. After deducting the net debt of $4.635 billion, the equity market value is $13.285 billion. This is 47.6% higher than today’s when-issued market value of $9 billion.
In short, the value of OGN stock is probably about $52.77 per share, or 48.6% higher than today’s price. Whether the stock will initially trade at that level is another question. A good number of the spinoff shares will likely be sold by MRK shareholders. They will consider it another dividend that can be turned into cash. However, over time, and depending on the actual numbers on the balance sheet, the stock should do well for its new shareholders.
On the date of publication, Mark R. Hake did not have a position in any security in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.
Mark Hake writes about personal finance on mrhake.medium.com and runs the Total Yield Value Guide which you can review here.