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Pfizer Breakup Talk Stoked by Discount to Drug Stocks

Thursday, 07 February 2013 12:25 PM

Pfizer Inc.’s industry-leading profit margins and disposal of non-drug businesses still haven’t closed the valuation gap with rival drugmakers. No wonder its chief executive officer is contemplating a full breakup.

CEO Ian Read said last week that he may consider separating Pfizer’s branded medicines from its generic products businesses as part of his strategy to slim down the world’s largest drugmaker. Despite already divesting animal health and infant nutrition units from one of the most profitable pharmaceutical companies, Read still is faced with a stock that trades for a lower price relative to earnings than almost 80 percent of similar-sized peers, according to data compiled by Bloomberg.

Splitting New York-based Pfizer in half may help investors better gauge the true value of its two businesses, which Goldman Sachs Group Inc. estimates to be about $35 billion more than its market capitalization of $201 billion. A breakup would follow similar moves by companies such as Bristol-Myers Squibb Co., which fetches a valuation that’s two-thirds higher than Pfizer’s as a pure-play drugmaker after having spun off baby formula maker Mead Johnson Nutrition Co. four years ago.

“If you’re on Pfizer’s board of directors, you’re scratching your head and thinking, ‘Why is this happening? We’re a great operator,’” Peter Sorrentino, a senior fund manager at Huntington Asset Advisors Inc. in Cincinnati, said in a telephone interview. “Investors play it cautious and put less of a premium on businesses when there are too many things to understand and analyze. Pulling them apart, you can probably do the shareholders better.”

Huntington oversees $14.7 billion and owns Pfizer shares.

Evolving Business

Speculation of a full Pfizer breakup was renewed when Geno Germano, president of the company’s specialty care and oncology businesses, told Bloomberg News in a Jan. 8 interview that Pfizer’s four drug units are “probably going to evolve to two, where there’s the innovative business and the value business.”

Pfizer’s units cover oncology, primary care, specialty drugs, and so-called established products, which are medicines that have lost patent protection and face competition from generic versions. The possible structure Germano described would separate the branded drugs, considered the innovative business, from the generic, or value, division.

Read echoed Germano’s comments last week on an earnings conference call.

“We will look at it,” Read said, when asked about the possibility of a bigger breakup of the company. “We will move towards a separate management, and at that point we’ll be able to evaluate whether shareholders would prefer to have the option to invest in two distinct companies or not.”

For now, Read said, “there’s not really a lot of point” in speculating on a split.

Already Separate

Read said Pfizer’s operations in developed markets such as the U.S. and Europe already are structured into separate units for brand-name drugs and generics. The company may move toward a similar structure in emerging markets, which in most places organize operations by country or region instead of by type of drug.

Joan Campion, a spokeswoman for Pfizer, declined this week to comment further.

Pfizer agreed in April to sell its baby-food unit to Nestle SA, the world’s biggest food maker, for $11.9 billion in the first of two major divestitures that Read oversaw to shrink Pfizer and concentrate on producing new drugs. It was the company’s largest divestiture since the $16.6 billion sale of consumer-health brands including Sudafed cold medicine and Bengay pain cream to Johnson & Johnson in 2006, data compiled by Bloomberg show.

Testing Waters

Pfizer then filed in August to take its animal health unit public. Shares of the new company, called Zoetis Inc., have risen 19 percent since they began trading Feb. 1.

“Pfizer is really steering the course to enhance shareholder value,” Herman Saftlas, a New York-based equity analyst for Standard & Poor’s, said in a phone interview. Read’s remarks about a potential split are “a very simple way of testing the waters. Once there’s clarity in terms of actually achieving enhanced value, then at that point you go ahead,” he said.

Since Pfizer announced it was exploring alternatives for its baby-food and animal-health units in July 2011, the shares have risen 31 percent. While the gain is more than double the advance of the Standard & Poor’s 500 Index during that time, Pfizer still hasn’t been able to fetch a valuation as high as its peers.

Lower Multiple

Pfizer earned more than 31 cents in operating profit for every dollar of sales in the last 12 months -- more than all of its rivals except AstraZeneca Plc and Novo Nordisk A/S, according to data compiled by Bloomberg.

Still, the stock trades for about 12 times analysts’ earnings estimates for this year, lagging behind 79 percent of pharmaceutical companies larger than $10 billion, data compiled by Bloomberg show. The median multiple for the group, which includes Merck & Co. and Novartis AG, is 14, the data show.

Even similar-sized generic drugmakers, including Mylan Inc. and Actavis Inc., fetch 13 times this year’s estimated earnings on average, the data show.

Goldman Sachs analyst Jami Rubin estimates that by valuing Pfizer’s innovation and generic businesses separately and applying trading multiples based on peers to her 2013 earnings forecast for each unit, the company is worth $32 a share. That implies an equity value of about $236 billion, a 17 percent premium to its market capitalization yesterday.

Dragged Down

Pfizer’s “value business is dragging down the value of its drug business, which would be better recognized if the businesses were fully separated,” New York-based Rubin wrote in a note to clients last week.

Bristol-Myers Squibb’s decision to become a pure-play drugmaker has paid off for its investors. The stock has risen 64 percent since it took Mead Johnson public in February 2009, and Mead Johnson’s shares have more than tripled.

While Pfizer climbed 94 percent over that span, Bristol- Myers still trades for 20 times this year’s estimated earnings, topping Pfizer’s valuation by 67 percent, the data show.

Breakups create “a much cleaner business model and you don’t have these sort of cross-overs and areas of gray,” Huntington’s Sorrentino said. “You basically let those businesses that are no longer core focuses go, and they obtain a better valuation than what’s given to them while they’re buried inside a conglomerate.”

Strategy Reversal

A Pfizer breakup would stray from its past strategy of growing and diversifying through large acquisitions, said Les Funtleyder, a health-industry analyst at New York-based Poliwogg LLC, an investment fund. Since 2002, Pfizer has made two $64 billion takeovers -- Pharmacia Corp. and Wyeth.

“This is actually a reversal for them,” Funtleyder said in a phone interview. “In general, Pfizer has been bulking up.”

John Eade, a New York-based analyst for Argus Research Co., said that should Pfizer pursue a full breakup, he doesn’t see it happening “in the next couple of years.”

“I don’t see any real rush for management right now to take a lot more steps than they’ve already taken,” he said in a phone interview. “I think they’ll focus on bringing new drugs to market, keeping costs under control and maybe look to some kind of acquisition.”

Splitting Pfizer’s businesses -- including the management, operations and manufacturing -- may prove too difficult, according to Marshall Gordon, a New York-based health-care analyst at ClearBridge Investments LLC, which oversees about $57 billion, including Pfizer shares.

Tricky Split

“I don’t think you can really separate the two assets,” Gordon said in a phone interview. “The most important part is the manufacturing. I think that’s really hard to separate out.”

Still, Pfizer wouldn’t be the first large pharmaceutical company to break apart and narrow its focus. In addition to the Bristol-Myers breakup, Abbott Laboratories split off AbbVie Inc. at the start of the year to get its other businesses out from under the shadow of its best-selling arthritis drug Humira. Abbott kept the medical devices, diagnostic tools and infant nutrition.

While demand is growing for generics, it’s a lower-margin business than brand-name medicines, so spinning off or selling that piece may boost Pfizer’s valuation, said S&P’s Saftlas.

“It’s definitely a likely outcome, to shed off the generics and focus on the growth areas,” Saftlas said. “This would allow them to attain a higher multiple, which would certainly be great for the stock.”

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Pfizer Inc.'s industry-leading profit margins and disposal of non-drug businesses still haven t closed the valuation gap with rival drugmakers. No wonder its chief executive officer is contemplating a full breakup.CEO Ian Read said last week that he may consider separating...
Thursday, 07 February 2013 12:25 PM
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