Are the individual business segments that make up Pfizer (PFE) worth more than the current market value of the whole company? If so, it would be beneficial to shareholders for Pfizer to sell or spin off certain parts of its businesses.
Indeed, Pfizer recently announced a review of its businesses to study this issue. If carried out, this would be a titanic change in strategy. Pfizer became the largest pharmaceutical company in the world largely because of its acquisitions, including Warner-Lambert in 2000, Pharmacia in 2003, and Wyeth in 2009. As an investor of Pfizer, this announcement intrigued me: would Pfizer’s business segments be of greater value as independent or divested assets than the company as a whole?
Branded Pharmaceuticals is Pfizer’s largest business segment, responsible for $48.7 billion in 2010 sales – about 72 percent of Pfizer’s total. Competing companies in this segment trade for an average of about 2 times sales, so if Pfizer were an average company we would expect its Branded Pharmaceuticals division to be worth $97 billion. Pfizer does not divulge profits by product segment, but I estimate the profits of this segment at $15-16 billion. I arrived at this estimate by noting that branded pharmaceutical companies tend to be 2.5 – 3 times more profitable than generic pharmaceutical companies, so I used a factor of 2.7. An average P/E for this segment 9.4 applied to these earnings gives a value for the Branded Pharmaceuticals division of $148 billion. Combining the sales and earnings estimates gives a fairly large range of $97-148 billion, which is perhaps why investors have such divergent investment views on Pfizer.
Pfizer’s next largest business segment is actually its generic division (called the Established Products unit). This unit has $10 billion in annual sales, more than Perrigo (PRGO) or Watson Pharmaceuticals (WPI), and only about 40% less than Teva (TEVA), the world’s largest generics pharmaceutical manufacturer. In 2010, when Teva bought Ratiopharm, another generics manufacturer, it paid $5.1 billion for a company with estimated 2011 sales of $2.1 billion, or roughly 2.4 times sales. This aligns with the average 2.2 price / sales ratio of the largest public generics manufacturers Teva (TEVA), Mylan (MYL), and Watson. Applying this 2.2 price / sales ratio values Pfizer’s generics segment at about $22 billion. If Pfizer’s Established Products unit had the same average return on revenue of Teva, Watson, Par Pharmaceuticals, and Perrigo Co, it would have profits of $1.1-1.2 billion (in all cases I’m using adjusted net income). Using the average P/E ratios for these generic pharmaceutical companies would imply a valuation for Pfizer’s Established Products unit of about $13 billion. These two methods give us a range of $13 – 22 billion for the value of Pfizer’s Established Products unit.
Although Pfizer sold its consumer healthcare division to Johnson & Johnson (JNJ) in 2006, Pfizer’s acquisition of Wyeth made consumer healthcare products a significant business line again. When Johnson & Johnson bought Pfizer’s consumer healthcare division it paid $16.6 billion. That division had 2005 (previous year) sales of $3.9 billion, for a price / sales ratio of 4.26. This seems a little expensive to me in the current business environment. In 2005, J&J sold for between 3.56 and 4.17 times sales. So J&J bought Pfizer’s consumer healthcare division for up to a 20% premium. Considering Johnson & Johnson’s current price / sales ratio of 2.6, this would imply a valuation of Pfizer’s current healthcare unit of 2.6 – 3.1 times sales, or $7.2 - 8.6 billion. Now, one could argue that this estimate is low because Johnson & Johnson is currently trading at near-record low valuations, in large part because of numerous recalls and product problems that Pfizer’s healthcare unit has not had. I think that this effect is probably in the neighborhood of 10-20%, which can be verified by looking at the change in JNJ stock price since the first product recall. This widens the range of acquisition prices to $8.0 -10.3 billion.
Pfizer’s other divisions are harder to evaluate because of a lack of good comparables. Eli Lilly (LLY) bought Pfizer’s European division of its Animal Health division in 2010, but the terms of that deal were not disclosed, so I’m unable to estimate a price for the whole Animal Health division from extrapolating from the European portion. The other divisions are nutrition, Capsugel, and “other” business segments. These combined for $6.2 billion in sales in 2010. An organic growth rate is difficult to determine because of the acquisition of Wyeth and its components in these business areas. That makes this the hardest business segment to evaluate, so I have the broadest range. I figure a good minimum using the sales figures is the same minimum price / sales ratio that I used for the consumer healthcare segment. A reasonable high-end estimate is the same maximum price / sales ratio that I used for the consumer health care segment. This gives a range of 2.2-4.3 times sales, or $13 - 27 billion. An estimate using a rough earnings ratio as calculated in the above business segments, other than branded pharmaceuticals, would give about $740 million in earnings. With a P/E of 11.3 (the average of a few large, diversified health care companies) this gives a value of $8.4 billion for this segment. This is significantly smaller than the estimate using sales, giving a combined range of $8.4 - 27 billion.
Adding these 4 segments together gives a total value of all of Pfizer’s business of $126 - 207 billion. This averages to $167 billion, just more than Pfizer’s current market cap of $163 billion. This suggests that there is potential for increased value if Pfizer breaks up into its component pieces, but there’s no driving impetus to break up the company. Management might increase shareholder value by selectively selling business segments for more than the midpoint of these valuations. If successful, the individual components could be valued higher than Pfizer’s current market value by perhaps 25%. Ultimately, Pfizer is not worth significantly more than the sum of its parts. Its parts, however, might significantly help the acquiring business – and I examine who might acquire them in part 2.
Disclosure: I am long PFE, LLY, ABT, TEVA.