Does Johnson & Johnson's Split Make Sense?

Johnson & Johnson (JNJ -0.19%) has been in business for well over a century. Many were blindsided when the company announced late last year that it would be splitting its medical device and pharmaceutical businesses from its consumer health business. The split is set to close sometime in the next two years. In this segment of Backstage Pass, recorded on Dec. 17, Fool.com contributors Rachel Warren, Jason Hall, Travis Hoium, Toby Bordelon, and Lou Whiteman discuss. 

Rachel Warren: The next deal we're talking about is Johnson & Johnson. This isn't an acquisition. We talked about this on the show a few weeks back. But last month, the 135-year-old pharmaceutical giant Johnson & Johnson, announced that it would be splitting its business in two. This came as a huge surprise to I think just about everyone.

The company's current business contains three segments. It has a pharmaceutical business which has been its fastest growing, a medical device business, and a consumer health business.

Once the split goes into effect, Johnson & Johnson will be two publicly traded dividend paying entities. One of these entities will contain the pharmaceutical and medical devices businesses that will retain the Johnson & Johnson name. The second publicly traded business will be the consumer health business. We don't know yet what the name of that will be and the management structure and names for that new company.

Jason Hall: Has got to be better than Block. We know that.

Rachel Warren: It have to be. I mean, that's a low bar to start with but [laughs] I have faith that it's going to go up from there. The split is expected to take anywhere from 18-24 months to complete. The consumer health business, I find it interesting that this is the business that's not going to retain the name of Johnson & Johnson because I think that this is the one that most people think of when they think of Johnson & Johnson. Those brands like Tylenol, Motrin, Neutrogena that everyone uses. The pharmaceutical business features drugs across the range of medical concerns.

Everything from ones that treat cardiovascular ailments to vaccines and then of course, it's medical devices are used in a range of procedures. The idea here the company said is to fuel business growth in the words of management to enhance operational performance and strategic flexibility, unlock more value for stakeholders, the traditional explanation you would expect them to give. I think the thing here is that these businesses, they don't really rely on each other for growth.

The direction the consumer health business is going is really very different than where its pharmaceutical and medical devices are. I think it makes sense that maybe there would come a point where they would split it off.

There was some speculation that it was related to the ongoing litigation that Johnson & Johnson is facing regarding its talc cancer claims, which it essentially created a subsidiary, moved all the claims into that subsidiary and then filed that subsidiary for bankruptcy, but they have denied that.

We can only speculate there. Just as a final few points here, the pharmaceutical and medical devices segments are expected to generate revenue of about $77 billion this year alone. The consumer health segment is expected to generate revenue of about $15 billion. It's clear where that high area of growth lies and I think this split will enable both of the companies to grow at their own pace and succeed.

If you're currently invested in the company like I am and you stay invested through the split, the understanding we have now is you'll remain invested in both of those public companies.

The company had already announced the CEO change to replace its current CEO, Alex Gorsky, who's headed up the companies since 2012. The new CEO will be a man named Joaquin Duato. He takes over on January 3rd and he will head up the Johnson & Johnson company. As I mentioned before, we don't know yet who is going to head up the new consumer health business. I think this is a positive deal.

I think that it will enable both of those businesses to grow and to tap into different consumer bases. I think you have a lot of different customers for each. There's some overlap, but it's clear that these businesses have been going in different directions. I think the stock is a great dividend payer.

It has lagged the S&P 500's performance this year, it's up about 20% compared to the S&P 500's total return of about 30%. One to watch, it sounds like it's going to be a bit before it goes through, but I don't see any reason why it won't.

Jason Hall: To me Rachel, this reminds me of when Abbott split up back and it was 2013. It wasn't exactly the same, but Abbott split off AbbVie which is it's pharma business from Abbott's lab which is their medical devices and that stuff. I guess they have some little bit of consumer stuff. But I was looking before the show and I saw that's gone swimmingly for investors.

Rachel Warren: Quite well, yes. [laughs]

Jason Hall: Yeah. Because it's allowed a little bit more focused on different segments by management. I think that's important because the resource allocation and focus is a little better.

Rachel Warren: Absolutely, yeah.

Travis Hoium: Well, this is a theme across the market, GE splitting up, I think these conglomerates and this is just only split into two, but this has been a theme in the last quarter and I think could be for the next year as companies like Jason said, start to focus on something that they do well and not trying to do a million things halfheartedly.

Toby Bordelon: It's certainly going to be interesting. I wonder about that, is 2022 going to be more acquisitions or more split-ups?

Lou Whiteman: Are there any left?

Toby Bordelon: There's a few--

Lou Whiteman: Oh there are?

Toby Bordelon: There's a few that on the tech side that I think would prefer not to split out. Maybe there will be some force split ups we'll see.

Jason Hall: Maybe shown the door as they say.

Lou Whiteman: Real quick on this, I think actually Toby and Travis, I think we talked about it on the show, but I think an under-appreciated part of this is the tech is making this possible.

A lot of the old-school argument for conglomerate or building was the back-office. The back-office is becoming so much cheaper with cloud software. HR as a function can be spread thinner now, and that old argument that you just need all of this back-office functions under one roof to save money.

It just doesn't hold as true anymore because that whole back-office has been automated and it is allowing for smaller, more nimble companies to be just as cost-competitive as the conglomerates on that HR finance, accounting, just the non-customer-facing side of it. I think that is a huge trend that's really under-appreciated in looking at all the splits.

Travis Hoium: To that point, I think that maybe the answer to Toby's question that I could see more tech acquisitions or mergers next year as we've talked about on a number of these already.

You try to put more software under one bundle as opposed to the hard goods in consumer products. Those maybe don't make as much sense together today as they did 20 or 30 years ago.

We may be seeing these old guard companies splitting up and these newer companies merging as they're trying to have a land grab in whatever space there in.