Every once in a while a find a comment in one of my articles that deserves further investigation. There were a couple of comments mentioning that Johnson&Johnson (NYSE:JNJ) should be broken up. So, I thought I would give it a whirl. It does seem like a worthwhile endeavor to really see if the company could unlock shareholder value by splitting up.
For starters, a key takeaway from the Management objectives is the decentralized management approach, which I believe would be central to the company if it were to split up. However, the company would not be able to leverage resources of the current company for certain segments to grow.
Given that JNJ's 10-k only gives each segments' revenues and EBIT, we are limited in the variety of multiples that can be used. For revenues, I used the Price-to-Sales ratio and for EBIT, I used the Enterprise Value-to-EBIT multiple.
These multiples will come from the industry of each of JNJ's segments to arrive at the Sum-of-the-parts (SOTP) valuation.
I begin with the Consumer segment of JNJ. Given that this segment is focused on the daily, broad needs of consumers, I used the top 4 holdings in the XLP (S&P Consumer Staples ETF) which contained the needed information. For the Pharmaceutical segment, I used the top 4 holdings in the XPH (S&P Pharmaceuticals ETF). Lastly, I used the top 4 holdings in the XHE ( S&P Healthcare Equipment ETF) for the Medical Device segment. Below are tables that contain the information for reference. The relevant ratio data was obtained via Gurufocus.com.
I took the average of these 4 companies because that will be the mid-point/average value for my valuation of the segments.
I multiplied these ratios by the latest 10-k data segments given above in order to obtain a range of equity and enterprise values.
Below are the range of values for each of JNJ's segments based on the respective ratios. The hi values are the highest P/S or EV/EBIT ratios in the given samples, and the low values are the lowest values in the given samples. For example, in the Consumer segment, the hi equity value based on the P/S ratio is obtained by multiplying 14,496 by 4.84.
Summing the range of segment values together, we obtain the high, average, and low equity value of the firm. When these numbers are divided by the total number shares outstanding, 2807 million, we get a range of share prices. Now I like to pay attention to the average as that seems a bit more realistic to me. The high and low share prices help to put some perspective on where the average is located.
In the table below, the range of values obtained from the EV/EBIT ratio had a huge dispersion driven mainly by the Pharmaceutical segment. By multiplying JNJ's segment EBIT by the respective EV/EBIT ratios, we obtain a range of enterprise values. However, we need the equity value to calculate the potential stock price.
The following formula is used to obtain the equity value:
EV = market value of common stock + market value of preferred equity + market value of debt + minority interest - cash and investments
Minority interest and preferred equity were zero. For debt, I used the total liabilities as that is money the JNJ owes to its claimants. The cash and investment value is the topline on the balance sheet label as cash and cash equivalents. Therefore, enterprise value minus net liabilities equals equity. Dividing these equity values, gives share prices that are twice as high as the equity values obtained from the P/S.
Now, some of you may be wondering why I kept the analysis using the EV/EBIT, when it does not appear to provide useful information. Because, going through this process helped to identify what numbers appeared realistic and stable. There was no way of knowing beforehand. Although the values are very high, the proportion of each segments contribution is similar to those of the P/S ratio. It does confirm which segments are adding value.
So, it appears that most of the value generation is coming from the Pharmaceutical and Medical Device division. Those two divisions combined would form the healthcare division. Thus, we can perform a similar analysis to see the potential ranges for the company. The shares outstanding will be assumed to be unchanged. However, I am only going to look at the equity value obtained from the P/S ratio as the dispersion in equity values is much smaller than the dispersion in values using the EV/EBIT ratio.
Assuming that JNJ contained these two segments, as of right now the stock is heavily undervalued. JNJ does seem to have close to 40 dollars of upside as of the end of Jan.15 2016.
For those curious, I performed the above analysis grouping the Pharmaceutical segment with the Consumer segment and grouping the Medical Devices segment with the Consumer segment.
In both cases it seems that the Consumer segment adds marginal value and there does not appear to be any upside left using the average values of the share prices. Thus, the stock at its current levels appears overvalued based on the average value. This is a stark contrast compared to the former where the Pharmaceutical segment and the Medical Devices segment remained a part of JNJ.
Therefore based on the financials, I believe that JNJ could be more valuable to shareholders if it removed itself from the consumer division and concentrated itself on its healthcare segment.
Disclosure: All tables were self-created using data from their respective sources.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within 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.