Abbott Laboratories (ABT) announced on Wednesday that it plans to split into two separate companies. The first company, retaining the Abbott name, will be a diversified medical products company. The second will focus on research-based pharmaceuticals. Wall Street clearly liked the move as evidenced by the roughly 6% jump in Abbott stock between the close on Tuesday and open on Wednesday. But will this move unlock shareholder value and be profitable for individual holders of Abbott stock?
Pharmaceutical companies have faced declining P/Es for years as excitement for new products has waned and the looming threat of patent expirations has neared. Companies have responded in one of two ways. First, companies like Eli Lilly (LLY) and Johnson & Johnson (JNJ) have sought to diversify their businesses to mitigate the loss of revenues due to a single product. Second, companies like Pfizer (PFE) have sought to shed off business units to refocus the company one what it perceives as its core strength. Abbott follows this second model, and the fact that the name will remain with the medical products company suggests that it sees its strength there.
Diversified Medical Products
The new Abbott will have about $22 billion in annual revenue, or about 56% of the pre-split amount. About 28% of this revenue will come from nutritional products such as Similac and Isomil infant formulae, the fiber supplement Ensure, and Prosure, a nutritional supplement designed to reverse weight loss associated with cancer. A fourth of the revenue is from Abbott's "Established Pharmaceuticals" division, which markets generic pharmaceutical products internationally. About 19% of revenue will come from a diversified diagnostics product line. Another 16% of the new Abbott will come from Abbott Vascular, which manufacturers or markets coronary stents and catheters. The remainder of revenue comes from Medical Optics Devices (5% of revenue) and Diabetes products (7% of revenue).
The new Abbott is primarily an international company, with about two-thirds of revenues coming from international markets, and 40% from emerging markets. This leads to a high growth profile. Each segment described above had double-digit international revenue growth compared to the third quarter of 2010, and a blended year over year growth rate of 13%.
These divisions also have promising products in the pipeline. The Nutrition division is currently conducting 30 clinical trials across the areas of immunity, cognition, inflammation, lean body mass, metabolism, and tolerances. Recent new products in this division include Ensure® with Revigor, PediaSure SideKicks, ZonePerfect® Sweet & Salty nutrition bars and Glucerna® Hunger Smart shakes and bars. New diagnostic products introduced in 2011 include tests for leukemia, hepatitis C, cytomegalovirus, ovarian cancer, and HIV. Abbott plans to release 20 new vascular products over the next 5 years with a mix of incremental upgrades and brand-new technologies. Recently released or about to be released products include the ABSORB Bioresorbable Vascular Scaffold, MitraClip, and several products in the XIENCE drug-eluting stent line. Abbott's other divisions have similar strong innovation records and growth prospects.
What about Abbott's research-based pharmaceuticals spinoff? This company will have about 45% of the pre-split revenues, but perhaps 60% of profits. About half of the sales of this spinoff will be due to Humira, Abbott's drug to relieve the symptoms (generally pain and swelling) of various autoimmune disorders including rheumatoid arthritis and Crohn's disease. Abbott has been successful in expanding the number of indications that Humira has been approved for, leading to a high growth rate (23% over the past year). Other major products in this new company will be the anti-HIV treatment Kaletra with about 7% of sales and the cholesterol treatments TriCor and Trilipix responsible for a combined 10% of sales.
Analysts differ on the quality and depth of Abbott's pharmaceutical pipeline, but there are a number of treatments currently in Phase 3 clinical trials. Elotuzumab is a monoclonal antibody treatment for multiple myeloma. Bardoxolone is being investigated for treatment of chronic kidney disease. Daclizumab, previously approved in Europe to prevent rejection of organ transplants, is in a Phase 3 trial to examine its efficacy as a multiple sclerosis (MS) treatment. Abbott has three compounds in Phase 2 trials for the treatment of hepatitis C, as well as 11 compounds in clinical trials for cancer and more than a dozen compounds in clinical trials for neurscience and pain indications. The market potential of these compounds is beyond the scope of this article, but Abbott's commitment to research and many compounds in clinical trials suggest continued growth in research-based pharmaceuticals.
Valuing Each Spinoff Company
The diversified medical products company will have a product profile similar to companies such as Johnson & Johnson (JNJ), Medtronic (MDT), and Boston Scientific (BSX). These companies trade at P/Es of 13, 10, and 12, giving us a nice range of P/Es for the new Abbott labs of 10-13, or a stock price range of perhaps $19 - 24 per share. The new Abbott should have significantly stronger growth prospects than any of these competitors, however, and so may have P/E expansion potential. Applying a PEG ratio of 1.5 to this segment would give a stock price of $37.
The drug spinoff will derive nearly half of its revenues from the single product Humira. Although Humira maintains its patent through 2016, the focus on a single product has been a concern for analysts and investors. A worst-case valuation would rank it with other pharmaceutical companies who have steep patent cliffs, such as Pfizer (PFE) and Eli Lilly (LLY), which have recently been trading at P/Es of 8-9. This would suggest a valuation of perhaps $22 - 25. An aggressive valuation would take into account the 26% year over year sales growth of Humira, and 13% of the Proprietary Pharmaceuticals division overall, as well as a promising pipeline, and assign a PEG ratio of 1.5 to give a stock price of $55 per share. A more conservative valuation would assign a PEG ratio of 1.0, for a PE ratio of 13, to give a stock price of $36.
Combining the valuation estimates for the two segments suggest a conservative valuation of $60 per pre-split share, which is a modest increase from the current stock price that shows Abbott stock is already undervalued. The upside potential of each segment is significant, with a long-term 13% growth rate giving a potential near term value of perhaps $90. The downside would be to apply the low P/Es of companies facing severe patent cliffs to Abbott (which does not face a near-term patent cliff) giving a combined valuation of $45. With a current stock price of ~$54, the upside/downside ratio of 4:1, combined with a 13% growth rate and 3.6% yield, makes Abbott a very attractive investment - whether one company or two.
Frankly, the two companies will not appear much different from the parent company. Both spinoffs will be nicely profitable, with significant sales in international markets including emerging markets. Both companies have strong growth rates (including identical 13% year over year revenue growth) with promising products in the pipeline. And Abbott has committed to the total dividend of the two companies equaling the current dividend. Abbott's best hope for this split unlocking shareholder value is changing investor psychology, but both halves are attractive long-term investments.