When Johnson & Johnson (JNJ 2.08%) announced that it would be splitting its pharmaceutical and medical device businesses from its consumer health segment last month, investors were stunned. But, could this actually be a genius move on management's part? Fool contributor Rachel Warren explains, in this segment of Backstage Pass, recorded on Nov. 19.
Rachel Warren: If you currently own shares of Johnson & Johnson like I do, when the company splits, you will own shares of both Johnson & Johnson, the new pharmaceutical/medical device entity, as well as the new yet-to-be-named consumer health business. Unlike a stock split where you just own more shares of the company, you will now own two publicly traded businesses that are leaders in their respective markets.
At the same time, if you decide you like one side of the company's business over the other once the split occurs, assuming you stay invested, you could then foreseeably say, hey, well maybe I think the pharmaceutical side has more growth potential and I want to stay invested in that company, but not so much the consumer health side. I've talked about the stock a lot, I've been very clear that I love the stock for one reason because of its nearly six-decade history of raising its dividend payout.
I think one of the questions a lot of investors have had is how will this impact its dividend? If you stay invested in Johnson & Johnson through the split, the dividend payouts of both entities will be lower, but combined, the company said are expected to add up to the same amount investors are currently receiving. Essentially, if you stay invested, the dividends you're receiving based on how much you're invested in the company, that would not change.
This move, I think, really took a lot of investors and analysts by surprise. It definitely took me by surprise. I think one of the most obvious motivations for the split, which the company to be clear has said did not contribute to their decision, are the legal issues that Johnson & Johnson's consumer business is currently facing. The company told the Wall Street Journal that is legal issues which includes lawsuits it's facing for its alleged role in contributing to opioid pandemic, its talc cancer claims: they told The Wall Street Journal this did not factor in the decision, so one can really only speculate there.
To be fair, the company has a ton of cash on its balance sheet and so far, it's been battling these lawsuits for years and it hasn't had a really detrimental impact on its business operations to date. I do tend to think that it's much more of a strategic move in terms of how it can scale business operations for both sides of its business.
I think besides the goals of accelerated growth for both businesses, there's also this train of thought that like this split announcement, some of these other big conglomerates is a sign of the business environment companies are operating in is changing.
I saw this interesting quote in an article in the New York Times by a Professor Eric Gordon who studies business strategy at the University of Michigan. He said, "We're at the point in the cycle where conglomerates are less popular. The pharma companies in general are trying to focus on pharma."
I think in terms of how should shareholders look at this, obviously, everyone is going to have a different take on this. Personally, I think that this is a positive thing for the company. Management said the planned separation is expected to create value for all stakeholders in a variety of ways. They can further focus capital allocation based on the goals of each independent company, allocate resources more effectively, and grow both of these businesses in a more effective way.
I think it's worth noting the pharmaceutical and medical device segments, they're on track to generate revenue of about $77 billion this year alone whereas the consumer health company is expected to bring in revenue of about $15 billion this year. Both companies will be growing, it would seem at a very fast pace, but clearly the pharmaceutical and medical device side, much more so consumer health. The profit margins aren't quite as high.
This is I feel like what consumers know Johnson & Johnson for, but it's clearly something that they are wanting to have as a very separate part from their pharmaceutical entity. Just to wrap up, how likely do I think the deal is to go through? I think it's very likely to go through. As mentioned, the board of directors has the final approval.
The company is going to be waiting on some other factors, including regulatory approvals, but I don't see any reason why this shouldn't go through. I think if you are a long-term investor in this company like I am, maybe you believe in the strength of its businesses that have driven the company to such success over the years, I don't feel personally this should change because the company is splitting.
My outlook on the company hasn't changed. If you think about, for example, the global consumer healthcare market is on track to be a $306 billion industry by 2026, and this is a market that Johnson & Johnson has dominated for a really long time. Having this separate side of its business, I think, will give it a lot of opportunity to grow in that sphere and then continue to grow its pharmaceutical industry presence.
I plan to stay invested in the company through the split. I'm looking forward to see what's ahead. But I actually think that this is a really positive move for Johnson & Johnson and whatever they end up calling [laughs] the consumer health entity, yet to be named. [laughs]
