How to Play the Pfizer Breakup (If It Happens)

The breakup of Pfizer (NYSE: PFE  ) is looking more possible by the week.

Two weeks ago, Sanford Bernstein analyst Tim Anderson issued a report stating that after talking with CEO Ian Read, he felt Pfizer was taking a serious look at the potential.

And last week Bill Steere stepped down from Pfizer's board of directors. Having served as CEO from 1991 to 2000 and chairman of the board from 1992 until 2001, Steere was the father of the bigger-is-better philosophy that seems to have plagued the drug giant.

With Steere gone and a new CEO that appears interested in maximizing value, could a breakup be imminent? Investors can only hope so.

Sum of the parts
If the breakup does occur, it'll likely happen as spin offs. Some smaller units might be sold; Pfizer has already said it's looking to sell Capsugel, an operating unit that develops drug formulations, like capsules, for Pfizer and other drugmakers. But a majority of the businesses -- animal-health, over-the-counter products, generics, and the like -- will probably be spun out into separate companies that will be owned by current shareholders.

The theory here is simple: Faster-growing parts of a business are often undervalued when thrown in with the rest of the business. When drugmakers spin off their non-pharma assets, investors usually assign higher values to the faster-growing assets than they did when they were a part of the larger company.

It's worked for other drugmakers. Bristol-Myers Squibb spun out Mead Johnson Nutrition (NYSE: MJN  ) and Zimmer Holdings (NYSE: ZMH  ) . Medco Health Solutions (NYSE: MHS  ) has been on a tear since Merck (NYSE: MRK  ) released its grip on the company. Ditto for Abbott Labs (NYSE: ABT  ) and its stepchild Hospira (NYSE: HSP  ) .

What's left?
Once the company has broken up and investors have sold shares of the spin offs or kept the ones they wanted to continue owning, the only thing left will be the pharmaceutical business.

We're still years away, if it happens at all, but investors need to be prepared to run screaming and not look back once Pfizer is left with just its drugs.

Pfizer hasn't historically been very good at developing new drugs. None of its top-selling drugs were homegrown.

Drug

2010 Sales (in billions)

Origins

Lipitor $10.7 Warner-Lambert
Enbrel $3.3 Wyeth
Lyrica $3.1 Northwestern University
Prevnar $2.4 Wyeth
Celebrex $2.4 Monsanto via Pharmacia

Source: Company press release.

There's nothing wrong with licensing or acquiring drugs from other companies, especially if a drugmaker can pick winners that become multi-billion drugs. Grabbing rights to blockbusters has been a strength of Pfizer's, although we can argue whether it overpaid for Warner-Lambert, Pharmacia, and Wyeth.

The big unknown is how much cash and debt will be shed in the spin offs and how much will be retained. Pfizer currently has a war chest of $28 billion and long-term debt totaling a whopping $38.4 billion. If the company sticks all the debt with the spinoffs and keeps the cash with the pharma, then it might be worth taking a look at. Maybe.

There's also the issue of Pfizer having vast amounts of its cash stored in offshore subsidiaries, avoiding U.S. taxation. If it wants to license the drugs stateside, it may have to pay taxes to repatriate the cash.

Buy, sell, hold?
Without knowing exactly what Pfizer is going to do, it's a little hard to know whether it's worth owning. My gut says that management will realize that the sum of the parts is worth more than the value investors are currently bestowing.

But my gut also said that Pfizer wouldn't make a major purchase when I picked the company as my best stock for 2009, and look how that turned out. Proceed with caution, Fools.

See what's up the analysts sleeve in "The Motley Fool's Top Stock for 2011." Grab a free copy of the report by clicking here.

Pfizer is a Motley Fool Inside Value recommendation. MedcoHealth Solutions is a Motley Fool Stock Advisor choice. Motley Fool Options has recommended a synthetic long position on Monsanto. The Fool owns shares of Abbott Laboratories and Zimmer Holdings. Motley Fool Alpha LLC owns shares of Abbott Laboratories. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.

Fool contributor Brian Orelli, Ph.D., doesn't own shares of any company mentioned in this article. The Fool has a disclosure policy.


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  • Report this Comment On March 31, 2011, at 2:19 PM, FarmaBiz wrote:

    All the talk of a massive breakup was for Wall Street consumption - hence why Read gave it to Anderson. The reality will be somewhere in between. Steere, Lorch, and Read will continue to be one in the same. From the Warner-Lambert purchase press release, the 3 core focuses are human RX, OTC, and Animal Health. They will get rid of Capsugel and Nutritionals, but keep the rest. There is no point in doing Emerging Markets and not feed Established Products the same drugs to get lower costs. A much better idea is to get rid of the manufacturing by spinning it out with CentreSource (why is PFE a contract manufacturer?), keep 40% ownership to force lower costs yet not have to consolidate the financials.

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