Like many value-oriented investors, I tend to take a dim view of companies that resort to financial gymnastics to make their reported numbers look better or to get a better valuation from investors. With that said, I'm curious, and more than a little skeptical, as to whether Pfizer's (NYSE: PFE) long-term plan to potentially break itself up into three separate companies will really generate any long-term value for investors.
To be fair, Pfizer has already done a little bit of this already. The company spun off Zoetis -- the world's largest animal health company with almost 20% share -- earlier this year, and Pfizer's shares have outperformed the S&P 500 by about 5% since then while Zoetis has lagged (though Zoetis is up more than 20% if you take the IPO price as the starting point). Time will tell regarding the ultimate value created by this transaction, but freeing Zoetis to invest in R&D and market development as it sees fit ought to be a win-win for both parties.
Along with Pfizer's second-quarter earnings, management announced that it was going to separate its operations into three business units. The "value unit" (Value Products Group, or VPG) will include mature products (those whose exclusivity ends in 2015 or before), JV products, and biosimilars. Vaccines, Oncology, and Consumer Healthcare -- or VOC -- is pretty straightforward, as it will include Pfizer's vaccines, oncology, and consumer health operations, while the Innovative Product Group, or IPG, includes immunology, metabolic, cardiovascular, neurology, pain, and women's health.
At this point, it is only an internal reshuffling of resources. Pfizer management believes that it would be too difficult to extricate the financials looking backwards, and so the company wants to operate this way long enough to generate three years' worth of audited financials before considering a more formal break-up plan.
Where's the logic?
On first blush, there's a lot to dislike about this plan. If run as separate entities, these three businesses will all need their own management and operational infrastructures (including legal, compliance, and accounting units), and that costs money. Likewise, there could be some conflicts in terms of basic R&D, though most drug companies run highly "siloed" R&D operations organized by disease.
I'm also not entirely sold on the idea of stripping out mature drugs from the more innovative growth-oriented operations. While it's true that the decline of major contributors like Lipitor has weighed heavily on Pfizer's growth rate recently, it would be a mistake to think that the company isn't still booking good margins and generating good cash flow from the drug. Lipitor still generated more than $500 million in sales in the second quarter, and that's with considerably less marketing spend to support it.
Last and not least, I'm somewhat concerned about the impact of such a split on foreign sales and profitability. Emerging markets like China, Brazil, and Turkey are becoming more and more of a priority for drug giants, but establishing a marketing and distribution presence takes time and money -- having to basically do that multiple times seems wasteful to me.
On the other hand...
Looking at the other side of this potential move, I can see some arguments for how it could help the business. The IPG and VOC businesses will have some potentially meaningful differences owing to their different component parts -- IPG is likely to require a more sustained, intensive sales force effort and more clinical R&D spending, while VOC will require less sales force intensity, different R&D spending, and offer longer-tale value.
Why? IPG's target areas of immunology, metabolic disease, and cardiovascular generally require very large clinical trials and each person in a phase 3 study can cost upwards of $50,000. Likewise, a lot of these diseases are treated at the family practice level, require more bodies, more effort (detailing, sampling), and more resources in marketing. On the other hand, it typically requires less R&D spending to develop vaccines and cancer drugs trials tend to be smaller. What's more, vaccines and consumer health products tend to have long productive lives in terms of cash flow and profits.
Moreover, there are many cases out there of break-ups creating more valuable, better-performing pieces. While the AT&T/Baby Bells example is probably the best-known, Tyco, ITT, and Altria are all arguably success stories -- the key difference in those cases, though was that the split-up businesses were not nearly as similar as Pfizer's potential offshoots. Even so, the argument can be made that these individual units will be more nimble and better able to take advantage of strategic licensing or acquisition opportunities that wouldn't be as value-added to a combined entity.
There is also the example of Abbott Labs (NYSE: ABT) and AbbVie (NYSE: ABBV) to consider. While some have cast the decision to separate these two businesses as being solely about reducing Abbott's risk to Humira biosimilars, there's more to it than that. A large percentage of Abbott's business is made up of "long tail" revenue-generating assets that require less marketing and R&D support to maintain like diagnostics, vision care, and nutrition (which is probably why Abbott kept the branded generics business). With the split, AbbVie and Abbott can better align their R&D and marketing spending relative to the revenue and cash flow-generating realities of these businesses.
For now, Pfizer's potential "split" is more about giving analysts and investors something to talk about than any real change in the business. At a minimum, the company can ponder the idea over the next three years before coming to a final decision. I don't see all that much value in Pfizer at present; while I liked the stock a while back, it has matched the S&P 500 over the past year, and valuation seems more in the range of "OK" rather than "intriguing." Absent a real value-altering move like an underrated/overlooked phase 1/2 drug showing exciting clinical results, I guess it will take moves like this to keep investors interested.
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