3M's (MMM +1.21%) spin-off announcement last month caught the market by surprise and inevitably raised comparisons with General Electric's (GE +2.29%) impending breakup. Both companies plan to spin off their healthcare businesses in 2023 (with GE also planning to spin off its power and renewable energy businesses together in 2024) to unlock value for shareholders. Let's look at 3M's plans and what they mean for the investment case for the stock.
3M's spinoff plans
Management plans the following:
- A tax-free spinoff of the healthcare business by the end of 2023, creating two new companies, the healthcare business and "New 3M."
- New 3M will retain a 19.9% stake in healthcare, which will be sold over time -- GE has the same plan for GE Healthcare.
- Health care will be spun off with a "net leverage of 3.0x-3.5x adjusted EBITDA and positioned for rapid deleveraging", according to the press release announcing the spin-off.
- The healthcare business will comprise medical solutions (54%), oral care (17%), health information systems (14%), separation and purification sciences (11%), with a food safety business (4%) to be divested before the spinoff takes place.
It's an aggressive move, and the rationale appears obvious: Spin off the healthcare business and release the value locked into a business that's being derated because of the industrial businesses at 3M. As such, 3M shareholders will receive the full value of the business, and it will be better run by more focused management. Moreover, the strength of the healthcare business will enable it to have its own capital structure, and it's likely to find it easier to raise money for investment. It's pretty much the same playbook that GE is running for its healthcare spinoff.
The argument over capital structure is weakened by the fact that the new healthcare business is "positioned for rapid deleveraging," meaning it will be reducing debt, not going to the market for more, and getting more favorable terms as a healthcare company.
Key Data Points
There's a problem
It's a compelling idea, but unfortunately, there's an issue here. Whereas GE is spinning off its most consistent business, and arguably one that would receive the highest market rating, 3M's healthcare business has been a disappointment in recent years. In fact, the healthcare business is one of the big reasons for 3M's dramatic underperformance relative to the market over the last five years.
The numbers tell the story. During the 2016 investor day, then-CEO Inge Thulin told investors the healthcare segment would grow organic local currency sales at 4% to 6% on average between 2016 and 2020. Investors should get used to that number because then-CFO Nick Gangestad told investors to expect 4% to 6% on average from 2019 to 2023 on another investor day in 2019. But here's the thing: 3M's health business hasn't been close to that figure (see table below) consistently over the years. There's the standout year of 2021, but that comes down to a bounce back from the lockdown-affected 2020. There's no way to hide that the segment has underperformed management's guidance.
Of course, that didn't go unnoticed, and management took substantive corporate action. In 2019, it bought wound care and specialty surgical equipment business Acelity for $6.7 billion, and M*Modal's technology business (health information services) for $1 billion. It sold its drug delivery business for $650 million in 2020, and 3M will separate its food safety business and merge it with Neogen later this year.
Unfortunately, it's hard to point to any tangible improvement in a segment that's gone from a 30%-plus operating profit margin in 2016 to just 23.8% in 2021.
|
Metric |
2015 |
2016 |
2017 |
2018 |
2019 |
2020 |
2021 |
2022 Est |
|---|---|---|---|---|---|---|---|---|
|
Organic local currency sales growth |
3.7% |
3.6% |
3.9% |
2.6% |
1.5% |
1% |
8.6% |
"Mid single digits" |
Data source: 3M SEC filings.
3M's healthcare business isn't its strong point
The spinoff may well make sense, but it's hard to argue that 3M's healthcare business is being held back by the rest of 3M. In fact, it's one of the problems, and despite concerted efforts over the years, its performance has been patchy at best. As such, 3M investors shouldn't get too excited about the spinoff. A good comparison is made with GE Healthcare, a business GE is spinning off because it's performing well and highly likely to unlock value. In contrast, 3M's healthcare segment is actually one of its weak points that management has struggled to strengthen in recent years.
