Abbott Laboratories (ABT), a diversified healthcare company operating in many different segments, recently announced the spin off of its research pharmaceutical business into a new publicly traded company called AbbVie Inc. (ABBV). In this article, I'll explain why I believe investors should consider purchasing both of these stocks.
Most Spin Offs Outperform Parents
Spin offs generally appreciate in value by allowing the market to better value separate operations. According to a 25-year study entitled "Restructuring Through Spinoffs", published in 1993 by Penn State University, spin offs tend to outperform peers and the S&P 500 by approximately 10% per year in the first three years after the spin off.
A separate study of 168 restructurings conducted in 1999 by McKinsey reached the same conclusions, saying that the spin offs generated two-year annualized returns of 27%, compared to 14% for the Russell 2000 and 17% for the S&P 500. And of course, there are many examples of recent spin offs that seem to confirm these statistics over time.
Finally, it's important to note that the Penn State study also found that parent companies of these spin offs tend to outperform the market by 6%, suggesting that there still may be a benefit in holding stock in the parent versus the general market. Combined, these studies provide a statistical basis for holding both of these stocks relative to the S&P 500.
Reasons to Purchase Abbott
Abbott benefits from the spin off by freeing itself from its pharmaceutical business, which is capital intensive and adds a significant risk premium. After the spin off this month, the leaner company now has a focus in nutritionals, medical devices, diagnostics, and generic drugs, which are already profitable and growing divisions that are much more attractive to investors.
For investors, this means that the company went from 12x forward earnings and a 9% long-term annualized growth rate to 17x forward earnings and a growth rate of between 12% and 15%, with ongoing potential for multiple growth. Meanwhile, the company indicated in its October 2011 press release that the split could also open the door to "significant margin expansion".
Combined, these factors will make Abbott one of the fastest growing diversified medical product companies in the world, with significant exposure to emerging markets and significant potential growth on the bottom line to kick.
Reasons to Purchase AbbVie
Abbott's AbbVie spin off has become a multi-billion dollar research-based pharmaceutical company with a sustainable portfolio of market leading brands, like Humira, Lupron, Synagis, Kaletra, Creon and Synthroid. And perhaps more importantly, it has a solid clinical pipeline targeting Hepatitis C, immunology, chronic kidney disease, oncology and other verticals.
Perhaps the most attractive element of the new entity, however, is the juicy 4.38% dividend yield that it offers income investors. In today's environment, the company therefore benefits from not only an aging population in the developed world (its primary market), but also a struggle to find yield in which many investors seek out blue chip dividend stocks.
The statistical outperformance of spin offs, attractive pipeline of products, and dividend yield make a compelling case for ownership, but investors can also consider the very reasonable 12x earnings multiple as an added bonus. After all, other large pharma companies like Pfizer Inc. (PFE), Merck & Co. (MRK) and Sanofi SA (SNY) all trade at significantly higher multiples.
The Best Ways to Play Them
A good way to invest in these two companies may be through a combination of stock and options. Investors may want to consider purchasing AbbVie stock, given its high dividend yield, while using long-term LEAPS options to gain exposure to Abbott's capital appreciation, in order to maintain proper portfolio balance for those already holding Abbott.
Even though investors may want to wait until volatility dies down, Abbott's at-the-money 30 JAN 14 LEAPS call options are trading at just 3.90. Investors can therefore purchase exposure to 100 shares of ABT for $390 plus commissions, with options that have a $33.90 breakeven and that can be exercised anytime between now and January 17, 2014.