Yesterday, one of the important market news items was that Nestle (OTCPK:NSRGY) and Pfizer (NYSE:PFE) agreed for Nestle to buy Pfizer's baby food unit for a sum nearing $12 billion. Nestle had been wanting to buy this unit in order to take advantage of the growing demand in Asia as people in this part of the world are having trouble trusting safety of baby formulas, unless they are of well-known brands. Danone (OTCQX:DANOY) was competing with Nestle for this business unit; therefore Nestle had to pay a premium over its earlier offer of $10 billion.
In recent years, the baby formula unit has been Pfizer's fastest growing unit with one of the highest profit margins. Without this unit, Pfizer's growth will definitely slow down and its earnings will take a hit. This is why the company has to use the money from this acquisition wisely in order to keep its investors happy. According to the company's latest quarterly report, Pfizer holds cash of $3.54 billion in addition to short term investments of $23.27 billion. With the latest acquisition, the company's cash and short term investments will total $39 billion. This is a huge sum and it may present plenty of opportunities for Pfizer.
This is particularly important at a time when giant pharmaceutical companies are having trouble expanding their pipelines as fast as they were able to in the past. There is a lot of pressure for these companies to come up with new drugs, and many big drug companies find it easier to save up cash and buy out smaller companies with existing pipelines. Pfizer is one of those companies that has been acquiring smaller companies for part of the growth it wants to accomplish. Two good examples of Pfizer's acquisitions are Wyeth and King Pharma.
Alternatively, the company could use some of this money to buy shares back or raise its dividends. When Pfizer acquired Wyeth, it cut its dividend rate in half and now might be a good time to double the rate. While this would make investors happy in the short term, it would not result in long term growth of any sort. After all, the company can't keep selling its most profitable units and expect to keep growing without investing its money in growth oriented projects. However, the company might still continue to buyback its shares in order to increase its EPS. On a side note, the company is expected to spin off its animal health unit soon. This unit achieved revenue of $4.16 billion in the last year, and it was one of the main drivers of growth for the company as well.
Pfizer currently has a debt of $39 billion. Another option for the company would be to pay off its debt and be debt free. Being debt free is important at a time like this when credit is hard to get. However, I don't know if using all its cash for paying its debt off would be very beneficial for the company. Investors want Pfizer to keep growing, and growth only comes with certain type of investment. Paying off debt may be considered as an investment; however, it is not growth oriented.
The last and most likely option for Pfizer to spend its cash on is a mixture of increased investments of research & development as well as acquisitions of smaller companies. The company still has a strong pipeline going on and this is where most of its growth potential lays. Pfizer will be able to focus all its energy, organizational knowledge and resources to what it is best at making, human medicine. Yes, I agree that diversifying a company's products is important; however, having a focus is just as important. Animal health and baby formula units only accounted for 9% of Pfizer's revenues last year. Also, currently the baby formula units only make up about 3% of the company's earnings.
I am sure that the company will pick the option that is most beneficial for its investors. I am bullish on Pfizer in the long term as I believe in the company's management, strong pipeline and past record of successful products.
Disclosure: I am long PFE.