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Summary

  • Abbott Laboratories announces the second deal in as many months.
  • This should boost growth and improve its growth profile as it expands even more into emerging markets.
  • Despite the improved growth appeal, diversification and strong financial position, I am cautious given the quality of adjusted earnings.

Abbott Laboratories (NYSE:ABT) managed to close a modest deal on Monday by acquiring Veropharm, a Russian pharmaceutical producer. The deal marks the second acquisition of the company in as many months, as the company aims to boost growth and its growth profile, thereby further expanding its presence in emerging markets.

The strong balance sheet, improved growth profile and diversification are key attractions. The valuation, driven by the huge gap between GAAP and non-GAAP earnings, is holding me off making an investment at current level. I am a buyer on more pronounced drops.

The Deal Highlights

Abbott Laboratories has entered into a definitive agreement to acquire Company Garden Hills, a holding company which owns a controlling interest in Veropharm.

The company will pay anything between $395 and $495 million, depending on the ownership stake of Company Garden Hills in Veropharm at the time of closing of the deal. Currently, Garden Hills holds an 80% stake in the company, which is anticipated to increase towards 95% at the time of the expected closure of the deal.

Abbott will furthermore assume net debt of $136 million, putting the total deal tag at $530 to $630 million. Closure of the deal is anticipated to occur in the fourth quarter of this year.

Strategic And Financial Rationale

Abbott will increase its presence in Russia after operating in the country for nearly 40 years. With the deal, Abbott will obtain a portfolio of medicines which focus on women's health, the central nervous systems, cardiovascular diseases and gastroenterology.

Currently, Veropharm is in the process of building a new manufacturing facility, which can be used by Abbott's Russian activities as well. The company produces over a 100 pharmaceutical products at three plants, while employing a total of 2,000 workers.

The deal will add about $150 million in annual revenues, valuing the deal at roughly 4 times annual sales at the midpoint of the reported deal tag.

Russia's pharmaceutical sector is expected to see growth given the growing middle class, in combination with the aging population. The deal fits within the company's strategy to focus on generic business in about 15 emerging markets.

Valuation

Back in April, Abbott released its first-quarter results. The company holds $7.05 billion in cash, equivalents and short-term investments, while operating with $7.25 billion in debt. This results in quite some liquidity, of course, and a negligible net debt position.

The company posted a 2.5% drop in first-quarter sales to $5.24 billion. Lower sales and increased costs triggered a 31% drop in earnings, which fell to $375 million. Note that earnings in the year before have been "inflated" on the back of very low effective tax rates. The company has posted trailing revenues of $21.7 billion and earnings of $2.4 billion.

For the current year, Abbott guides for adjusted earnings of $2.16 to $2.26 per share. The company has, however, already identified amortization and cost reduction initiatives, which result in total expenditures of $1.03 per share.

Trading around $41 per share, equity in Abbott is valued at roughly $61 billion. This values equity in the business at 2.8 times annual sales and 25 times trailing earnings. The company trades at roughly 18-19 times adjusted earnings for this year, which, on a GAAP basis, will be roughly cut in half.

The quarterly dividend of $0.22 per share provides investors with a 2.2% dividend yield.

Some Background

The deal seems remarkable given the increased tensions, to put it mildly, between Russia and the US. That being said, Abbott is definitely not putting all of its eggs in one basket, with Veropharm adding just 0.7% in annual revenues.

Yet, Abbott is on an acquisition path, after it already announced a sizable deal last month.

For $3.3 billion, it acquired CFR Pharmaceuticals, a Latin American pharmaceutical company. The deal adds $900 million in anticipated revenues, while the company is anticipated to grow at double-digit rates in the coming years. The deal has no real impact on 2014's earnings, although accretion is expected in 2015. The deal with CFR is much more substantial, adding about 4.1% in annual revenues.

With this deal and the smaller deal of Veropharm, the company is increasing its exposure to emerging markets even more. Following quicker growth in emerging and developing markets, it would not be unthinkable to see Abbott generate half of its revenues from these markets by 2016.

The increase in deal activity follows the split from AbbVie (NYSE:ABBV), which became effective in January of 2013. The company has focused the most of last year on its own operations, but under command of CEO Miles White, is now entering the M&A market.

Takeaway For Investors

Following the split of AbbVie and Abbott about one and a half year ago, shares of Abbott have seen solid returns, increasing from roughly $32 to $41 at the moment.

The company has a solid balance sheet and great product, as well as geographic diversification. The company has operations in 150 countries, and actually derives 40% of its sales from emerging countries. About 30% of revenues are generated in the US, with a similar percentage of revenues derived from the activities in the rest of the world. As mentioned earlier, the increased focus and recent deal-making might push the revenue percentage of emerging countries towards 50%.

In terms of products sales, Abbott has solid diversification as well. The company generates 30% of sales in nutritionals, a quarter in medical devices, and slightly lower percentages in established pharmaceuticals and diagnostics.

Despite the excellent diversification and exposure to emerging markets, Abbott reported a 2.5% drop in first-quarter revenues. In all fairness, adverse currency movement shaved off 3% in reported revenues. Even then, growth is anything but impressive, especially given the huge exposure to "growing" emerging markets.

With the latest two deals, Abbott will, however, add more than a billion in sales, thereby increasing revenues by 4%-5% next year. The deals furthermore improve the growth profile a lot, thereby boosting appeal to investors. The guidance of double-digit growth for CFR alone should boost overall revenue growth by 0.5% per annum on top of the one-time jump in reported revenues.

The improved growth profile, solid balance sheet and diversified operations are key attractions for Abbott. The valuation is a bit demanding given the gap between GAAP and non-GAAP earnings. While I don't mind an occasional amortization charge hitting GAAP earnings, I am less tolerant to structural discrepancies between both metrics, especially if it is explained by stock-based compensation.

I like a little bigger margin of safety before jumping on the bandwagon. As such, I don't think that shares offer compelling value for me at current levels.

Source: Abbott Laboratories: Recent Emerging Market Acquisitions Boost Growth Profile