Pfizer (PFE) announced that it plans to sell 20% stake of its animal health unit via an initial public offering. Investors should track this recent IPO filing as it's a rare opportunity for an industry leader to be up for sale. Recall that the big pharmaceutical company announced earlier this year that it decided to spin off its animal health unit. The IPO is targeted for the first half of 2013 and estimated to have proceeds of up to $100 million in Common "A" shares.
The standalone company will be called Zoetis. It is a global provider of diverse portfolio of medicines and vaccines for animal care. Around 65% of its global sales come from livestock healthcare and 35% from healthcare for dogs, cats, and horses. It operates in approximately 70 countries, and employs more than 9,000 employees consisting of technical and veterinary operations specialists and salespeople.
Analysts expect that Zoetis could be worth $15 billion to $18 billion in market valuation. Pfizer could pursue the remaining 80% stake in Zoetis at a later date. If this happens it would definitely sweeten the deal for prospective investors. This signals confidence in the standalone company. It also shows that Zoetis will have enough financial flexibility to support expansion and withstand any stresses in the current environment.
The divestment has been part of Pfizer's plan to refocus on its core businesses. It is also planning to use the proceeds of the sale to fund its planned share repurchase. For example, it decided to sell its infant nutrition business in April for $11.6 billion. These actions could indicate that management is doing its part to improve its shareholder value.
Zoetis - A Massive Cash Cow for Pfizer
The initial public offering of Zoetis will enhance investors' understanding of the animal health industry. Investors have underestimated the value of Pfizer's animal health segment due to its size and the fact that it has not fully disclosed its financial performance. I believe this transparency is the key to fully analyzing the segment, resulting in better valuation for the business. For the next five years, animal health segment is expected to represent 5%-7% of big pharmaceuticals total sales. This will limit the overall decline in group sales from patent losses from human health drugs.
It is safe to assume that the animal health segment has steady revenue source compared to the human health drugs segment. There are reasons for this. These animal healthcare products take lesser time to develop and has minimal investment requirement. It also faces lower regulatory hurdles, and pharmaceutical companies have the ability to leverage its research and development spending.
Sanofi-Aventis (SNY) spent 6% of its total 4.8 billion euros budget in 2011. Companies have power over its clients, as consumers have little bargaining power compared to the large concentrated payers such as the government and managed care companies. Finally, consumers are unaware of generic alternatives for its products and are willing to pay a premium for a brand that they have trusted for years.
Another reason why the industry is often overlooked is that it contributes to less than 10% of the total revenues. Zoetis contributes annual revenues of $3.75 billion, equivalent to 5% of the total revenues. In contrast, Merck's (MRK) Intervet contributes $2.9 billion in revenues, or equivalent to 6% of the total revenues. Sanofi-Aventis' Merial has revenues of 1.9 billion euros, or 6% of the total revenues. Eli Lilly's (LLY) Elanco has revenues of $1.39 billion, also 6% of the total revenues. Another healthcare stock, Novartis' (NVS) animal health unit, contributes $1.2 billion in revenues, or 2% of the total revenues. Given the lack of transparency, it would be difficult to compute the segment results. But I believe a good estimate of operating margins would be in the range of 25%. This is relatively high compared to the other business segments. This is attributed to costs synergies. Most of their operations needed small expenses to maintain compared to other segments. Over time, economies of scale will translate to better profitability.
Valuations for Zoetis and Pfizer
Assuming a 25% margins from the annual revenues of around $3.5 billion, this translates to normalized earnings of $893 million a year. This could translate to market valuation of $17.8 billion, higher than the analysts' initial estimate of $15 billion to $18 billion. If we impute an 80% stake for Pfizer, this would account to 7% of its current market cap.
Valuations could fetch higher than $17.8 billion considering the huge impact it has on both Pfizer and Zoetis. The Zoetis listing will enhance its valuations on improved transparency and visibility. On the other hand, Pfizer will be able to use the proceeds to repurchase its shares and finance its core businesses. This will ultimately enhance shareholder value in the near term.
Meanwhile, Pfizer trades at 9.7 times forward earnings and 2.3 times book value. It also has a dividend yield of 3.6%. It seems that Pfizer does not deserve these valuations given its strong steady revenue growth. For the last 10 years, revenues have grown by 7.65% a year. Operating margins have declined from 36% in 2002 to 22.6% in 2011. This is due to the patent losses through the years.
In contrast, Merck is valued at 11.9 times earnings and 2.4 times book. It carries a dividend yield of 3.7%. But, Merck has lower revenue growth. It has a 10-year annual revenue growth of 0.07%. Its operating margins have also declined from 18% in 2002 to 16% in 2011. Eli Lilly trades at 11.8 times earnings and 3.8 times book. It has a dividend yield of 4.2%. Over the last 10 years, revenues have grown by 7% a year. Its operating margins have also declined from 29% in 2002 to 22% in 2011.
In my view, Pfizer's lower valuations are unwarranted. The discount to its fair value is attributed to uncertainties surrounding future transactions. It's true that future transactions such as divestment and acquisitions for Pfizer will enhance its value. But, regulatory restrictions like the antitrust regulations will limit its future consolidation. Regulators have been inspecting potential mergers ensuring that there will be no monopoly in specific product categories. Pfizer has good track record with acquisitions. The outcome should be favorable and should send Pfizer soaring in the coming months.