It's coming soon. Within the next four months, Abbott Labs (NYSE: ABT) will split into two separate companies. The health-care giant plans to spin off its proprietary pharmaceutical business segment into a new company, AbbVie. All other business segments will remain part of Abbott Labs.
When the split was first announced back in October 2011, analysts cheered the move. With the date getting closer, are there any reasons for investors to reconsider? Let's take a look.
Imperiled aristocracy?
Abbott Labs is a member of an exclusive club: the Dividend Aristocrats. To qualify for this group, a stock must have at least 25 years of consecutive dividend payment increases. Abbott has paid dividends every year since 1924 -- 354 consecutive quarters.
Is the aristocracy imperiled with the split? I doubt it.
Granted, AbbVie won't be a Dividend Aristocrat. As a new company, it won't have the dividend track record to qualify. As long as the "new" Abbott continues to pay and increase dividends, though, it can remain part of the elite group.
Abbott paid out $2.9 billion in dividends in 2011. If we assume that the new Abbott needs to pay out dividends going forward proportionate to its part of the current company's total sales, it would need to pay out roughly $1.6 billion to maintain 2011 levels.
The business segments that will be part of the new Abbott reported operating earnings of $1.9 billion in just the first half of this year. It seems likely that the company will generate sufficient earnings to keep its dividend momentum going.
The business segments that will comprise AbbVie reported even higher operating earnings of nearly $3.5 billion during the first six months of 2012. It too seems capable of rewarding shareholders with solid dividends.
Divide and conquer?
Abbott CEO Miles White stated that the two companies will be "valued more accurately" or "appreciated more by investors" as separate entities. In other words, he expects stock in the two companies to trade higher when added together than Abbott's current share price.
Will that happen? Some analysts think so.
According to Bloomberg, Jan David Wald with Morgan Keegan believes that the two companies will be more valuable than Abbott is today. Wald thinks that the medical device business is undervalued because of its ties to Abbott's proprietary pharmaceutical business.
Others speculate that AbbVie might be worth $45 billion to $54 billion when it trades separately from Abbott. Several analysts think that the new entity could become a prime acquisition target for other pharmaceutical companies. If so, that would likely be good news for shareholders.
Based on 2011 figures, AbbVie would have annual sales of $18 billion. The new company will be similar in size to Bristol-Myers Squibb (NYSE: BMY) and Eli Lilly (NYSE: LLY). Bristol's price-to-sales ratio currently stands at 2.60 while Eli Lilly's ratio is 2.04. Using those ratios would value AbbVie at $37 billion to $47 billion using 2011 sales.
The new Abbott's sales based on 2011 results would be around $22 billion. The company's products will include nutritionals, branded generic pharmaceuticals, core laboratory diagnostics, and medical devices. Johnson & Johnson (NYSE: JNJ) is a reasonable comparison company in terms of product mix, although there are several product line differences. Using J&J's price-to-sales ratio of 2.92 would give the new Abbott a market cap of $64 billion based on 2011 sales.
Our rough potential valuation numbers for AbbVie and the new Abbott total $101 billion on the low end and $111 billion on the high end. Abbott's current market cap is $104 billion. That level reflects a 24% run-up in the stock price since the announcement of the company's plans in 2011. The market appears to have already priced in much of the anticipated impact of the spin-off strategy. However, there should still be some upside potential for investors after the split.
New math
The strategy of splitting to grow more is gaining some traction. Covidien (NYSE: COV) announced plans to spin off its pharmaceutical business not long after Abbott's announcement was made. Like Abbott, Covidien is counting on a boost in valuation.
It is still too early to know how Abbott's separation into two companies will pay off for investors. However, my hunch is that this move will prove advantageous even for those who buy the stock now. It might sound like some sort of new math, but division could quite possibly equal multiplication for investors in this Dividend Aristocrat.
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