GlaxoSmithKline Faces Pressure To Split Business Units; A Sum Of Parts Valuation

| About: GlaxoSmithKline (GSK)

Summary

UK fund manager pushing for split of GlaxoSmithKline businesses.

HIV, Vaccine, and Consumer portfolios continue to shine as pharmaceutical revenue declines.

My fair sum of parts valuation shows how undervalued shares are.

Investors win in several ways with a strong dividend yield, possibility of splitting units, or slow but steady growth the company has laid out.

GlaxoSmithKline (NYSE:GSK) was one of my picks at the beginning of the year for my top ten stock picks of 2015. The stock is now up a meager 5.1% with dividends, which embarrassingly enough is one of my top performers. I circle back to this selection as one of my top three reasons given was a potential IPO of the company's ViiV Healthcare unit. That process never came to fruition, but now with meager returns and one noteworthy shareholder leading the charge, the pressure is on the company to begin splitting up its business units.

United Kingdom fund manager Neil Woodford is currently pushing GlaxoSmithKline for a four way split of the business. Under Woodford's plan, GlaxoSmithKline would end up looking like this:

· Prescription drugs/vaccines

· Viiv Healthcare

· Consumer Health

· Dermatology

Woodford's name probably won't ring a bell to most reading this, but he is a prominent name in the pharmaceutical space, especially in the UK. He recently helped AstraZeneca fight off a takeover attempt by Pfizer. Woodford started his own business last year after a long term stint of picking stocks at Invesco Perpetual.

According to Sky News, Woodford has met privately with the new Chairman of GSK Phillip Hampton. A follow-up meeting is also scheduled. Woodford has also met with other top GSK shareholders, according to that same article. Woodford recently added to his GlaxoSmithKline stake, but is still said to own less than 5% of the entire company.

The spinoff of GlaxoSmithKline business units could come now, as the company is struggling. Despite the overall struggles, the company reminds investors that 2016 is a "return to significant earnings growth". Also, several areas are performing well, as evidenced on last week's earnings call.

In the third quarter, vaccine sales grew 12%, led by the new Meningitis franchise acquired through the Novartis asset swap. Meningitis vaccines like Menveo and Bexsero were up 34% in the quarter. Flu vaccines also saw growth of 59% in the quarter. A look back at the company's investor presentation in May shows how committed the company is to its new market leading vaccine portfolio. Even though three million deaths are prevented annually with vaccines, more than 22 million infants are still missing basic vaccines. There are also major diseases without vaccines including: RSV, Group B Strep, TB, and HIV, all areas GlaxoSmithKline is working in.

The global pharmaceuticals segment continued to lag. Sales of Advair has declined 19% in the first nine months of the year. Despite this decline, GlaxoSmithKline does still have 30 products that gross more than 100 million pounds (~$155 million U.S.) annually.

Consumer health sales were also up 7%, led by Flonase OTC and several other key brands. As a reminder, with the Novartis asset swap, the company's consumer health joint venture has a market leading position in pain relief, respiratory, and a second place position in gastro-intestinal treatment.

The gem of the Pharmaceuticals segment continues to be ViiV Healthcare and its HIV assets. HIV sales hit $914 million in the third quarter. Trivicay has now launched in 51 markets, while Triumeq is available in 26 markets. The HIV segment has performed great in all territories throughout the first nine months, with sales up 83% in the U.S., +45% in Europe, and +18% in other international territories.

Despite the slow moving growth, GlaxoSmithKline seems perfectly content with their operations. In fact on the conference call they said they were, "pleased with the progress of the momentum in all the businesses". GlaxoSmithKline has responded by saying it doesn't need a breakup or a large merger with a company like Pfizer to continue on its path. After all, despite the talk of spinning off ViiV Healthcare, the company decided "that just wasn't a good economic transaction to do" and even cited shareholders being against the deal.

I'm not sure why the emphasis on dermatology from Woodford, but I do see the need to separate business units. In fact, the very idea of spinning off Viiv was one of the biggest factors in picking GlaxoSmithKline as a stock selection for 2015.

In fiscal 2014, the company's revenue split looked like this:

· Pharmaceuticals (with ViiV): 59%

· Consumer Health: 25%

· Vaccines: 16%

Through the first nine months of the current fiscal year, revenue has been:

· Pharmaceuticals (with ViiV): 59%

· Consumer Health: 26%

· Vaccines: 15%

The Pharmaceuticals category can also be split between ViiV and the Global Pharmaceuticals as 9% and 50% which would make the overall split look like this through nine months:

· Pharmaceuticals: 50%

· Consumer Health: 26%

· Vaccines: 15%

· ViiV Healthcare: 9%

Here is the financial figures for the segments through the first nine months:

 

Revenue

Operating Profit

Operating Margin

Pharmaceuticals

$16.1 bil, -1%

$5.0 bil

30.6%

Vaccines

$4.2 bil, +4%

$1.2 bil

29.8%

Consumer

$7.0 bil, +7%

$772.9 mil

11.2%

While Woodford has argued for four business units, and I would personally be happy to see just ViiV get set on its own, we will use a split of three as today's business model. Since GlaxoSmithKline already utilizes three business segments, they will be used with one slight change. I will strip out the ViiV Healthcare from Pharmaceuticals and instead replace it with the Vaccines business. The new GlaxoSmithKline would look like this (nine month revenue):

· Pharmaceuticals and Vaccines: 65%

· Consumer Health: 26%

· ViiV Healthcare: 9%

By the end of the year, I would guess that the Viiv Healthcare segment rises to double digits and perhaps the consumer health segment also gains a percent or two from pharmaceuticals/vaccines. My full year model would be:

· Pharmaceuticals and Vaccines: 60%

· Consumer Health: 28%

· ViiV Healthcare: 12%

For the full 2015 fiscal year, analysts are currently projecting sales of $36.7 billion, a 3.1% decline from the prior year. In 2016, analysts see this figure rising 3.6% to $38.0 billion. By operating segment, this would translate to:

 

Fiscal 2015 Sales est.

Fiscal 2016 Sales est.

Pharmaceuticals/Vac.

$22.0 billion

$22.8 billion

Consumer Health

$10.3 billion

$10.6 billion

ViiV Healthcare

$4.4 billion

$4.6 billion

By utilizing peer companies, we can start to come up with good valuations for these segments on an individual basis. I will be using price to sales, as price to earnings is tougher without the operating profit of ViiV Healthcare stripped out from the Pharmaceuticals segment.

For ViiV Healthcare, I use peers Gilead (NASDAQ:GILD) and Abbvie (NYSE:ABBV), who both have competing HIV operating businesses. For the Pharmaceutical/Vaccine business, I used Sanofi (NYSE:SNY), Pfizer (NYSE:PFE), and Merck (NYSE:MRK). For the consumer segment I used Johnson and Johnson (NYSE:JNJ). The results were this:

· Pharmaceuticals/Vaccines average price to sales 3.8 for 2015 and 3.6 for 2016

· Consumer Health average price to sales of 4.0 for 2015 and 3.9 for 2016

· ViiV Healthcare average price to sales for HIV was 4.7 for 2015 and 4.5 for 2016

This translates to prices of:

· Pharma/Vac 2015: $83.6 billion, 2016: $82.1 billion

· Consumer 2015: $41.2 billion, 2016: $41.3 billion

· ViiV Healthcare 2015: $20.7 billion, 2016: $20.7 billion

This would give GlaxoSmithKline a combined market capitalization of:

· 2015 model: $145.5 billion

· 2016 model: $144.1 billion

· Today: $104 billion

That translates to share prices of:

· 2015 model: $60.12

· 2016 model: $59.54

· Today: $43.06

Shares have traded as high as $49.08 over the last 52 weeks, nowhere near the sum of parts price I laid out today. Also keep in mind that the valuation of ViiV Healthcare could prove to be the most conservative. Estimates call for the unit to see annual sales of $6.1 billion by the year 2020.

Remember that GlaxoSmithKline is undervalued however you look at it. On a price to sales ratio, shares trade under 3, which is lower than all the companies used in comparison figures. The company also trades with price to earnings ratios of 18.8 and 17.0 on a current and forward basis, below most of the companies used in comparisons. Investors also get a healthy 5.3% dividend yield along the way.

The downside and risk here is GlaxoSmithKline continuing to operate as normal. The company believes on its own it can achieve mid to high single digit growth in vaccines, low single digit growth in pharmaceuticals, and mid single digit growth in consumer health. The companies sees earnings per share growing at a double digit rate in 2016 and continuing higher in years to come.

I'm a believer here in GlaxoSmithKline either way. I think the company will lose some luster if it continues to silence the possibility of splits or IPOs of units like ViiV Healthcare. Shares might also lose a little bit if Pfizer is able to successfully swallow Amgen, taking out one of the companies that could actually acquire GlaxoSmithKline as it stands today. With that said, imagine the M&A possibilities if the company split into those three units. I have to believe at least one of the three would be acquired within a year.

Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in GSK over the next 72 hours.

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

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