Trading Baxalta For Visa

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Includes: BAX, SHPG, V
by: The Dividend Bro

Summary

Why we took profits in Baxalta after Shire agreed to buy the company.

We used proceeds from sale to purchase shares in Visa.

Buying Visa increases our portfolio's dividend growth while adding a quality company to our holdings.

In March 2014, Baxter (NYSE:BAX) announced it would split into two companies, a medical supply company and Baxalta (NYSE:BXLT), a pharmaceutical company. After we experienced a 127% gain in AbbVie shares (NYSE:ABBV) after it split from Abbott Laboratories (NYSE:ABT), my wife and I were very interested in the possibility of a similar occurrence with Baxter. We purchased a small amount of shares and looked forward to the eventual split. This is not the usual way we purchase shares in companies (our selection criteria can be seen here), but Baxter had a history of paying and raising dividends, so we were happy to initiate a position.

The one issue we should have looked more into was what Baxter planned to do with their dividend once they split. Prior to the split, Baxter paid a quarterly dividend of $0.52 per share. Post-split, Baxter and Baxalta paid a combined $0.19 per share. Ouch, that is quite the dividend cut. Luckily, the Baxter position was our smallest position and as we are not yet ready to live on dividends, it was not a huge hit to our income stream. In early October, we sold Baxter to initiate a position in Verizon (NYSE:VZ). We held onto Baxalta because Shire (NASDAQ:SHPG) was attempting to purchase the company. Their first attempt to purchase the company in early August 2015 was for $45.23. The offer sent the stock soaring 12% in one day, but ultimately Baxalta rejected the bid. On January 11th, Shire agreed to purchase the company for $45.57 in a cash and stock deal that, if approved, would be scheduled to close in mid-2016.

On January 15th, we sold out position for $40.61. Why didn't we wait until the deal closed later this year? A few reasons. First, Baxalta was by far our smallest position. By selling now and not waiting until the deal closed later this year, we actually only left about $50 on the table. We didn't feel it was worth it to have that position in the portfolio for another few months for that little extra return. Second, the rules that we follow state that a cut in dividend is a reason for possible sale of the position. Because we bought shares in Baxter for the potential pop in the stock price and the combined companies cut the dividend, we decided the company no longer met our objectives. On the sale of both positions, we had a combined 14% gain. Not bad at all.

Now what to do with that money. In a previous series of articles, we discussed several dividend paying stocks we don't own but would like to purchase as well as positions we'd like to add to. One stock we included in this shopping list was Visa (NYSE:V). We already own MasterCard (NYSE:MA) but have eyed Visa for some time. While the world's largest credit company card isn't exactly a high yielding Dividend Champion, it does have some impressive dividend growth. This is what we wrote about the company on 1/12/2016:

"While we are primarily interested in increasing our dividend income, there is a place for companies that are more growth orientated in our portfolio. The dividend is less than 1.0%, but Visa's average five-year dividend growth is almost 31%. While that is probably not sustainable forever, that is an incredible number. The company has also raised their dividend each year for the past eight years."

That type of dividend growth really caught our attention. Most of the companies in our portfolio are of the Altria (NYSE:MO) and Johnson & Johnson (NYSE:JNJ) variety, meaning they are mature companies paying healthy dividends and rewarding shareholders with mid-single digit annual dividend growth. We don't own too many positions that offer 30%+ annual dividend growth over the past five years.

In addition to these metrics, Visa is taking market share in the card space. The following is a list of companies that are switching to Visa's cards:

  1. In April of this year, Costco (NASDAQ:COST) will stop accepting American Express (NYSE:AXP) and only accept Visa credit and debit cards at stores and gas stations.
  2. USAA, one of the country's largest issuers of credit and debit cards, will be switching from MasterCard to Visa. USAA members made $26 billion in purchases on their cards last year.
  3. At the beginning of the year, Fidelity announced it was dropping American Express in favor of Visa. Fidelity has almost 24 million customers.

At the same time the company is making the dividend a priority, Visa is taking business from its largest competitors. This is exactly the type of company we want to own. The issue has always been valuation with Visa. According to our rules, Visa falls somewhere between a supporting holding (5+ years of dividend growth) and a speculative holding (less than 1.0% yield). Therefore, we tend to view it as more of a speculative holding. Due to this, we were looking for an average of 10% of Morningstar's fair value, S&P Capital's fair value and twelve-month price target. Here were the numbers as of 1/22/2016.

S&P Capital 12 month price target

S&P Capital Fair Value

Morningstar Fair Value

Our Price Target

$80

$68

$104

$72

Click to enlarge

The fair value and price target comes to an average of $84 per share. Because we're viewing Visa as a speculative position, we were looking for at least 10% under this number. Due to a broad market sell off to start the year, we taking our own advice from a previous article and purchasing shares. On Friday, we initiated a position in Visa at a price of $72.57. This is roughly 16% under our metrics.

In conclusion, we have may have left a small amount of money on the table by selling Baxalta at a price below Shire's bid, but we traded a stock whose dividend had been cut and no longer fit our investment objectives for one that was rapidly increasing both its dividend and market share. All and all, we'll take that trade every single day. The good news for us is that this purchase was made with money from selling a position. We still have money from our monthly contributions available for another purchase in January. Hopefully, this market turmoil will continue and we'll get another stock on our shopping list at a very reasonable price.

Disclosure: I am/we are long V.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: We are not investment professionals. Please do your own research prior to making any financial decision.