Details of the split
Pfizer (PFE) announced that it will split its business into three parts. While the separation of its genetics business into a separate unit had been widely anticipated, the split of its remaining business into two separate units took many analysts by surprise. Each of the three units will have its own emerging markets operation and the separation of the financials is expected to begin with the 2014 fiscal financial statements of Pfizer. The generics business will now be called the"value products group," and will include brands that have lost patent protection and products that will lose patent exclusivity by 2015. This business unit will also incorporate the company's portfolio of biosimilars. This is believed to be the precursor of a spinoff or a sale though the company refused to comment. The generics business will also handle partnerships for growing the off-patent business, including partnerships with Mylan Pharmaceuticals in Japan, China's Zhejiang Hisun Pharmaceutical and Laboratorio Teuto Brasileiro in Brazil.
The second unit will include drugs with patent protection beyond 2015 and will be called "innovative products." The third unit which was not expected in the course of the reorganization will include vaccines, oncology and consumer healthcare products. The company explained that the rationale for the third unit is that the products are operationally and commercially distinct with their own culture, research facilities and research focus. The company also did not want the vaccine business to be part of a larger primary care business.
Pfizer had already kicked off the reorganization process by spinning off its animal health unit Zoetis and taking it public. The IPO combined with a share swap meant that the company was able to avoid potentially large tax expenditures. The company also sold Capsugel in a deal worth $2.4 billion in 2011 to Kohlberg Kravis Roberts and its infant nutrition business in 2012 to Nestle (NSRGY.PK) for $12 billion and the sale proceeds were used to enhance its share buyback program.
Benefits of the split
Frank D'Amelio, Pfizer's chief financial officer, summarized the new strategy as follows: "This is all about getting these three businesses to hum internally, to operate with excellence inside the company." Analysts believe that this is a clever move that will provide investors with more clarity and transparency and allow an accurate valuation of the different parts of the company. It would also provide investors with value because some of the businesses after the split could well trade at P/E multiples in excess of the approximately 12.5 times at which the stock is currently trading. This strategy of separating a large diversified healthcare company into smaller pure play businesses has worked well for other companies. Abbott Laboratories (ABT), like Pfizer, was much too diversified to be able to control its risk and reward tradeoff. As a result, it spun off its blockbuster treatment, Humira, and its experimental pipeline drugs into a separate company, AbbVie, while retaining the other businesses. This worked very well for many investors. Conservative ones, concerned at the impending end of patent protection for Humira and Androgel, got to sell AbbVie and more adventurous ones were able to buy AbbVie because of the blockbuster potential of its pipeline drugs.
The urgency for the split
Pfizer had to do something drastic in order to resume its growth. It recently reported second quarter earnings of $0.56 per share, beating the Thomson Reuters consensus estimate of $0.55 per share but declining 10% from the same quarter of the previous year. Revenue also declined 7% to $12.97 billion, short of the consensus analysts' estimate of $13.01 billion. Much of the revenue decline can be attributed to the loss of patent exclusivity for the blockbuster Lipitor a treatment for high cholesterol, and volatile emerging markets. This decline was however partly offset by a 28% increase in cancer drugs especially the newer ones such as Inlyta and Xalkori. A large portion of second quarter income came from the public spinoff of animal health business Zoetis.
Over the last few years, generic manufacturers such as Actavis (ACT) and Teva Pharmaceutical Industries (TEVA) have turned into major threats to leading pharmaceutical companies because they have used business models based on lower margins but higher volumes. They have benefited from generic versions of Pfizer's treatments such as Viagra in nine important European markets where patent protection expired this year. Plenty of other manufacturers have announced plans to launch a generic version of Viagra which generated over $2 billion in revenue for Pfizer last year, most of it from the United States where it is protected until 2020. Spinning off the generics business will allow it to focus on growth at its own pace.
The investment thesis
The company says it does not intend to spin off or sell the three new business units until 2017 but this does not preclude other large companies offering to buy the generics business. I cannot see the company not selling especially if the price is attractive. The split will take time to accomplish and add value to the stock price. You should not expect much short term capital appreciation but console yourself with a stable stock price and the 3.3% dividend yield. Keep an eye on the performance of the three separate businesses with a view to future investment.