Is Warren Buffett Wrong About This Health Care Giant?

As always, many investors watched closely as Berkshire Hathaway (NYSE: BRK-B  ) revealed its holdings from the last quarter. One stock that Warren Buffett and company decided to unload in large fashion was British drugmaker GlaxoSmithKline (NYSE: GSK  ) , selling 75% of the previous position. Did Mr. Buffett make the right move, as he so often does -- or is he wrong about this health care giant?

Time to jump ship?
Glaxo isn't exactly blowing anyone away with its financial performance of late. The company badly missed consensus estimates for third-quarter earnings. It expects full-year 2013 revenue to grow by a paltry 1% year over year and earnings to climb by only 3-4%. 

The big pharmaceutical firm has also taken on a lot more debt compared to its peers when stacking up their debt-to-equity ratios. Loading up with debt typically isn't a plus in the eyes of Warren Buffett.

Buffett banks heavily on management that he can trust. It's in this area that Glaxo perhaps messed up the most. The company continues to reel from allegations of bribing Chinese doctors. This scandal hurt Glaxo's financial results last quarter -- with a 61% drop of sales in China.

Serious mistakes by management have led Buffett to cut positions in companies before. In 2012, he sold a large portion of Berkshire's stake in Johnson & Johnson (NYSE: JNJ  ) after a series of missteps. Buffett stated at the time, "It's still got a lot of wonderful products and it's got a wonderful balance sheet and all of that, but there have been too many mistakes."

...But what about investing for the long term?
Glaxo's China problems, weak financial results, and debt might have caused Buffett and Berkshire to jump ship to a large degree. But Warren Buffett believes in investing for the long term. Aren't there reasons to think that Glaxo could move past the current China issues and achieve better financial performance in the days ahead? Yes on both counts.

Over the long run, the effects of the current Chinese scandal should diminish. And Glaxo boasts several products with potential to become winners, particularly with some of its partnerships.

One such drug is Breo Ellipta, developed in partnership with Theravance (NASDAQ: THRX  ) . The drug just gained regulatory approval in Europe, where it will be marketed under the name Revlar, for treating asthma and COPD. Regulatory approval is expected soon for another drug from the partnership with Theravance -- Anoro -- that could be an even bigger winner.

Glaxo also hopes to gain market share in the HIV/AIDS arena through its ViiV Healthcare joint venture with Pfizer (NYSE: PFE  ) and Japanese drugmaker Shionogi. ViiV counts 11 drugs in its portfolio and recently gained FDA approval for another HIV drug -- dolutegravir.

There are also quite a few products that Glaxo is developing solo. The company's pipeline includes eight drugs for which phase 3 clinical results are expected to be announced by the end of next year. 

Foolish take
In light of the company's potential, is Buffett wrong to sell Glaxo? I don't think so.

I don't doubt that Glaxo will eventually overcome the problems related to the scandal in China. Glaxo's partnerships and pipeline could very well deliver in the not-too-distant future. Even a wealthy investor like Warren Buffett, though, can only successfully maintain a finite number of stock positions. You have to know when to prune a stock that could do well over the long run to reinvest in a stock that could do even better.

My hunch is that's what Buffett and Berkshire are doing in this case. Sometimes those decisions are good ones -- and sometimes they're not so good. J&J, for example, has soared since Berkshire cut back on its position in the company last year.

You have to make those hard decisions, though. In this case, Buffett's probably right. He usually is.

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