Is Another Big Transformation on the Way for GlaxoSmithKline?

Image source: Flickr user Nguyen Hung Vu.

Although 2015 wasn't a particularly strong year for U.K.-based pharmaceutical giant GlaxoSmithKline (GSK -1.11%), with its stock dipping by a tad over 5%, it was nonetheless a transformative year for the company.

GlaxoSmithKline changed in a big way in 2015
Last year saw the completion of a three part asset swap that will likely reshape the futures of GlaxoSmithKline and Swiss-based Novartis (NVS -1.41%). Under the terms of the deal, GlaxoSmithKline wound up selling its Food and Drug Administration-approved oncology products and small-molecule oncology pipeline to Novartis for as much as $16 billion; Novartis wound up selling GSK its vaccines franchise, sans influenza, for about $7 billion; and the two companies formed a joint-venture for their consumer health products. GSK also wound up clearing a substantial amount of cash from Novartis based on the difference in price between the oncology and vaccine franchises.

The idea here was pretty simple. For Novartis, acquiring GSK's oncology products pretty much secures its spot among the to oncology drug developers in the world. In GSK's case, purchasing Novartis' vaccine line helped diversify its own vaccine portfolio, and it may also help boost pricing power and margins of the franchise over the long run. Both companies benefit from the consumer health joint-venture as the combination should help with pricing power and create cost synergies that ultimately lead to higher margins.

Image source: GlaxoSmithKline.

In GSK's third-quarter report we already began witnessing some of the fruits of this transformation. Vaccines revenue soared 32% year-over-year, and consumer healthcare sales jumped 55%. GSK also reported results on a pro forma basis, which excludes the acquisition and looks at things on an apples-to-apples basis. Here we still observed marked improvement, with vaccine sales up 13% and consumer health product revenue up 7% from the prior-year period. 

But could another major transformation be in GlaxoSmithKline's future? It's always a possibility.

GlaxoSmithKline's CEO hints at another possible transformation
With the World Economic Forum ongoing in Switzerland, GlaxoSmithKline's CEO Andrew Witty sat down with Bloomberg Television to answer a few pressing questions. One point raised during the interview concerned what Witty might do given the pressure coming from certain investors calling for the company to split or spin off certain components. What Witty said might surprise you.

If you thought vaccines had a chance to be a stand-alone company, you should think again. Witty was pretty clear that there's no reason for vaccines and pharmaceuticals to be spun-off from GSK. Instead, Witty opined that at some point in the future it might be worthwhile to spin off its consumer health segment into its very own entity.

CEO Andrew Witty. Image source: GlaxoSmithKline.

As of Q3 2015, GSK's consumer health segment was pacing around $9 billion annually. Witty, during his interview, suggested that consumer health products -- which include brands like Sensodyne and Aquafresh toothpastes, Tums, and Theraflu -- could deliver 10 billion pounds, or $14.2 billion, in the coming years. He also suggested that profit margins for consumer health products could double, likely as a result of better pricing power and lowered expenses.

To be clear, Witty also suggested that this is just one possible course that GSK is considering, and it does not guarantee that GSK will make a move anytime soon. In fact, Witty pretty much denied considering a consumer health spinoff anytime over the next 18 months. Still the point is that at no previous time was a consumer health spinoff even on the radar, and now it is. This is certainly a development worth eyeing very closely, one that I suspect Witty and his team will develop further if they believe it'll unlock shareholder value.

What are GSK's other nuts and bolts?
But it's also important that investors aren't simply buying GSK, or holding GSK shares, because they believe a spinoff is upcoming. All of GSK's nuts and bolts should be taken into account.

Its remaining businesses consist of vaccines, pharmaceuticals, and HIV therapies via its majority stake in ViiV Healthcare. Pfizer and Shionogi also own minority stakes in ViiV.

Vaccines have obviously been a strong performer thus far, but relying more on vaccines also means near-term pressure on GSK's margins. Vaccines come with relatively low price points compared to branded pharmaceuticals, meaning GSK makes the bulk of its profit from the volume side of the equation. It could take a good year or two before Wall Street and investors are acclimated to GSK's new lower margins as a result of higher vaccine reliance.

Image source: GlaxoSmithKline.

ViiV Healthcare, though, is firing on all cylinders with Tivicay and Triumeq. Triumeq's unique formulation and high efficacy are believed to give it an edge over most available HIV therapies, and it's a big reason why HIV sales for GSK rose by 65% in the third quarter. It's looking plausible that GSK's HIV business could handily top $4 billion in sales in 2016 if this growth rate keeps up. 

Unfortunately, the laggard remains respiratory, an indication where GSK is still dominant. Advair's patent loss and the subsequent pricing pressures GSK has felt in the U.S. and EU are expected to push sales lower for the COPD and asthma blockbuster throughout the remainder of the decade.

New long-lasting respiratory products such as Breo Ellipta, Anoro Ellipta, and Incruse Ellipta were expected to pick up the slack in the near-term, but the launches of Breo and Anoro have come with unanticipated speed bumps. Breo initially struggled with insurer coverage, but has since overcome that obstacle after a little more than a year of sluggish sales. Anoro, though, has had difficulty breaching the mind-set of physicians who have been prescribing Spiriva or Advair for a decade or longer. Righting the respiratory ship is going to take time.

A promising but long road ahead
Ultimately, GSK looks to be on track for a better 2016 than 2015, and the transformations undertaken in 2015 are on pace to be a big help. Still, without major improvement in respiratory it's difficult to envision GSK's valuation galloping substantially higher. If you're looking at GSK as at least a five-year hold, then there could be some serious value here, particularly considering its juicy dividend. If, however, you're betting on a quick rebound, this may not be the investment for you.