Will Baxter International Inc's Split Unlock Shareholder Value?

If a strategy has worked before, try it again. Baxter (NYSE: BAX  ) has never been shy about identifying businesses that lie outside its core operating focus and being willing to set them free. Edwards Lifesciences, Caremark, and Allegiance Healthcare (now part of Cardinal Health) were all once under the Baxter umbrella, and arguably did better on their own than they would have as parts of Baxter.

Now the company is doing it again, choosing to spin off its biopharmaceuticals business as an independent publicly traded company. Investors cheered the move, as it does remove some issues that were clouding the value of the company's other operations.

The two new entities
Baxter has announced its intention to spin off its biopharmaceuticals business, the part of Baxter that was devoted primarily to blood-derived protein products for hemophilia, immune conditions, and low blood volume. Generating nearly $6 billion in revenue, this business is closely comparable to Grifols (NASDAQ: GRFS  ) and CSL and is one of the three largest plasma protein companies in the world with more than 20% share.

What strikes me as interesting is what Baxter is not spinning off with the new company. Not unlike the Abbott/AbbVie split, not everything is going with the biopharmaceuticals business that readers may assume. The company is keeping the specialty pharmaceuticals ($1.5 billion in 2013 revenue), biopharma solutions ($1 billion in revenue), and biosurgery ($0.7 billion in revenue) within the medical devices and equipment business. On one hand this makes sense as the plasma protein biopharmaceuticals operations are very "discrete" and unified in manufacturing, R&D, and marketing. On the other hand, it leads to some speculation about the real motivation for the deal.

Avoiding perception risk?
One of the most prevalent bear arguments against Baxter had been the oncoming competition to the company's lucrative hemophilia franchise. Biogen Idec (NASDAQ: BIIB  ) is launching its long-acting Factor VIII product Eloctate, and some believe that Baxter will lose half of this $2 billion-plus business (the company's management is arguing the loss will be 20% or less).

Not helping matters any, Novo Nordisk (NYSE: NVO  ) recently announced top-line data from its Phase III Pathfinder 2 study that suggests its long-acting Factor VIII compound will also be a competitive player in the market. Simply put, there was no meaningful difference in efficacy between the long-acting compounds developed by Biogen, Bayer, and Baxter. Baxter's own long-acting Factor VIII product, BAX-855, should go to the FDA later this year, but it seems clear that Baxter is going to have more competition in this space than it has in years past.

The potential loss of $1 billion in revenue is no small matter, but there may be other issues threatening the Baxter biopharmaceuticals business. Grifols has been coming on stronger of late after its acquisition of Talecris and the company is seeking to improve its sourcing, its manufacturing yields, and its marketing prowess.

While the market for products like IVIG is an attractive one (likely to grow around 6% to 8% long term) due in part to more and more patients getting diagnosed and expanded labeling claims, Baxter's business may be running up against capacity constraints in the coming years. This is a fixable problem, but capacity does not come on line overnight and Baxter could lose share in the meantime (or suffer from lower margins if it adds capacity before its needed).

What all of this boils down to is a lot of perception risk around a large business, perception risk that I believe pushed Baxter's valuation down below its fair value. While the biopharmaceuticals business does enjoy more impressive long-term growth prospects than the renal, fluid system, and specialty pharmaceutical operations of the "new Baxter", the short-term worries are real.

The bottom line
It is my opinion that this split does not so much create value as change perceptions. Baxter will be able to focus more attention on gaining share from Fresenius in renal care and CareFusion and Hospira in fluid systems, and also focus more efforts on developing the biopharma solutions and biosurgery businesses – the latter of which could perhaps someday become its own stand-alone company. I did not believe that management was going to have any particular challenges with any of these functions before, though, so I believe this spinoff essentially just removes the cloud of skepticism about the hemophilia market from over the dependable, cash-rich operations on the device/equipment side.

I previously thought that Baxter was worth about $80 per share, and I maintain that view today. Investors can still expect some worthwhile appreciation from this level, but this announcement does move one major catalyst for the shares from "potential" to "realized".

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