Abbott Laboratories: Split-Up Long Time Coming

Shares of diversified health-care giant Abbott Laboratories (NYSE: ABT) have jumped since Wednesday when the company announced that it plans to separate into two different firms.

Specifically, the conglomerate will divide itself into a medical products firm (which will retain the “Abbott” name) and an as-yet-unnamed pharmaceutical research & development entity.

Current chairman and chief executive Miles White will be boss of the $22 billion-revenue medical devices business, which he said “will be one of the largest and fastest-growing global diversified medical products companies, with a compelling portfolio of durable growth businesses in medical technology, branded generic pharmaceuticals and nutritionals” as well as diagnostic businesses.

The pharma operation, which will be spun-off to existing Abbott shareholders, will be headed by long-time company executive Richard Gonzalez, the current executive vice president of global pharmaceuticals. This entity, which generates annual revenues of about $18 billion, will focus on branded (generic) pharmaceuticals and seek to develop new products in disciplines like “immunology, Multiple Sclerosis, chronic kidney disease, Hepatitis C, women’s health and oncology.”

Mark Coffelt, president of Empiric Advisors and portfolio manager of the Empiric Core Equity Fund (Nasdaq: EMCAX) told International Business Times the split makes sense and represents a classic case of a company seeking to maximize shareholder value of the underlying assets by separating a high-growth businesses from the lower-growth segments.

“Abbott is a fabulous company which is very shareholder-oriented,” he said. “They are aware that despite solid revenue and earnings growth, the stock has been flat or negative -- that is, going nowhere -- for at least the past five years. So now they’re obviously seeking to unlock some of that latent value.”

Coffelt noted that Abbott shares are currently trading at forward P/E of under 11 -- he estimates the medical device company alone should be value as high as 18 or 20 P/E.

“Look at a company like Mead Johnson Nutrition (NYSE: MJN), that’s trading at a forward P/E of almost 23,” he said. “Abbott may have noticed that, and decided their own nutritionals business should be valued much higher than it is.”

Indeed, the company’s recently-released third-quarter results may shed some light on Abbott’s decision to split.

While global revenues climbed by 13.2 percent, sales generated in the emerging markets surged 21 percent. (The “new” Abbott company, which White will take over, already gets 40 percent of its business from the fast-growing emerging markets; while the to-be-spun-off pharma unit is primarily focused on the slower-growth developed markets.

A split is typically based on the belief that a company’s individual parts are worth more than the sum of the whole.

Rick Wise, an analyst at Leerink Swann, estimated that Abbott (in its entirety) should be valued at between $60 and $65 per share -- of which the research drug segment should be worth between $35 and $40 per share.

(Abbott shares closed Thursday at $54.05).

Damien Conover, an analyst at Morningstar, told media that the split will also help to distinguish between Abbott’s different business lines.

You can unlock value here because you'll probably get a little bit more transparency between these two divisions, he said.

White himself referred to that when he spoke to analysts during a teleconference call.

What happened here is the pharma piece got so big, and is so different, that these two investments make sense separately, and both are of a critical mass and size that they have great sustainability going forward as independent companies, he said.

There is no question that both our research-based pharmaceutical and diversified medical product businesses have evolved over time in very different ways into two different, compelling investment identities.”

The split-up is expected to close by the end of next year.

Mike McGervey, president of McGervey Wealth Management in Canton, Ohio, told IB Times the split is also logical because the company’s disparate businesses have vastly different strategies and risk profiles.

“New drug discovery is a highly risky endeavor, whereas generic drugs and nutritionals offer very little risk,” he said.

Moreover, some analysts contend that Abbott shares have been depressed by investors’ perception of the future prospects of the company’s blockbuster rheumatoid arthritis drug, Humira.

Although it delivers an astounding $8 billion in annual revenues, the drug faces stiff competition from potentially cheaper generic versions. Abbott has also been accused of depending too heavily on this product.

Now, with the split, the Humira business will be “isolated” in the new pharma company – thereby, freeing the other split company to potentially soar in value.

Naturally, White denied that the separation was prompted by the company’s anxiety about Humira, which loses patent protection in 2016.

This split is not [predicated] around confidence in Humira, he said. It's about the identity of the businesses.

Still, investors are rightfully concerned that Abbott has failed to produce a new blockbuster drug product or therapies to replace lost sales from Humira once it goes off-patent.

In addition, Coffelt said, Abbott’s new spun-off pharma company could become an attractive takeover candidate for other big drug-makers -- thereby, increasing its own inherent value.

Some analysts have long been calling for Abbott to split up.

In January of this year, Jami Rubin, a pharmaceuticals analyst at Goldman Sachs, said that Abbott was victimized by investors due to its perceived over-dependence on Humira and should consider a spin-off.

At the time, she wrote: “[Abbott] does not appear to be getting credit for its diversified structure and trades more in line with a lower-multiple drug company. The market’s focus on the risk surrounding Humira’s long-term growth outlook appears to be overshadowing [Abbott]’s other growth assets, such as nutritionals, diagnostics, and devices.”

However, Coffelt cautions that big pharma as a whole is trading quite cheap -- battered by a number of negative factors including the difficulty and huge expense of bringing potentially blockbuster new drugs to market and the ramifications of President Barack Obama’s health care overhaul. Thus, growth will likely become more of a challenge for both drug makers and medical device companies.

It will not be interesting to see if other big diversified medical companies follow Abbott’s example and split up. Reportedly, Pfizer (NYSE: PFE) is considering such a disposition of its nutritionals and animal health units. Other big names like Eli Lilly (NYSE: LLY) and Bristol-Myers (NYSE: BMY) have sold off some non-drug-related businesses.

As a final point, not all diversified companies need to split apart to achieve maximized value.

McGervey cited general Electric (NYSE: GE) as a wildly diversified conglomerate with dozens of very disparate business lines that nonetheless is hugely successful – with no apparent calls for a break-up,

Indeed, GE is into everything from finance to energy infrastructure to mass media to nuclear power to electrical equipment systems to military aircraft to healthcare to household appliances and many other business segments.

“GE’s model seems to work well for them,” McGervey noted. “In this case, diversification is good because, overall the company will prosper regardless of the economy, wince some areas of the corporation will likely flourish while others flounder.”

At the other extreme of this discussion might be Apple inc. (Nasdaq: AAPL), which just happens to be the biggest and most high-profile corporation on earth.

“Apple basically only has four products, “McGervey said. “There’s the Mac computer, the iPhone, the iPad and the iPod, that’s it. It’s very non-diversified, but, of course massively successful.”

Thus, splitting off a company many not always make sense – although for Abbott Labs, it appears to be the right thing to do.