Abbott announced in mid October that the company will be splitting into two companies. It is expected to be completed at the end of next year.
I’m a shareholder of Abbott, and my 2011 analysis can be found here. It’s several months old, but it provides a solid overview of the company.
The company plans to split into two companies with a tax-free distribution. The sum of the dividends of the two companies is expected to equal the dividend of the combined company at the time of the split.
The first company, which will retain the Abbott name, will be a diversified medical products company with approximately $22 billion in annual sales. It will include the medical devices segment, diagnostics, nutritionals, and generic pharmaceuticals. Significantly more than half of the sales will be international, and the company will have strong emerging market exposure.
The second company, which is yet to be named, will be a researched-based pharmaceutical company with approximately $18 billion in sales. The business will invest in R&D to come up with new drugs. Abbott’s current blockbuster drug, Humira, will make up a considerable portion of the sales and will present much of the immediate growth, while other drugs will have to fill in for Humira’s success when it begins to go off patent in 5-6 years.
Advantages from Splitting
Splitting the company does offer some advantages.
-Smaller companies often have better growth opportunities. More opportunities are available to them that wouldn’t be large enough to matter for a larger company.
-Investors can invest in exactly what they want- diversified medical or pure pharma.
-The diversified medical company with the Abbott name should maintain very strong free cash flows since there will be no expenditure on leading edge pharmaceutical R&D. This should be good for dividends, and the risk overall may be reduced.
-The pharmaceutical company will be medium-sized. Although earnings will be more volatile than the diversified business over the long term, there is the opportunity for outsized returns if some of the pipeline drugs do well, and if Humira continues to grow as well as it has. Based on the medium size of the business, it’s not out of the question that this segment could be acquired by a larger rival, which would result in a premium for shareholders.
Why I don’t want to “Unlock Shareholder Value”
Apart from some downsides of the split, like the costs of duplicating operations and the cost of restructuring the debt, I believe a potential downside is what many are referring to as an upside.
One of the reasons given by investors for liking this spit is that it may unlock shareholder value. In other words, the combined stock valuation may increase due to the split. Segments can be more accurately valued for what they are, and many argue that Abbott is currently undervalued. Abbott’s flat stock price for more than a decade could see a boost.
As a long term investor, I’m not interested in an increased valuation, and in fact I’d rather it stay undervalued. An increased valuation may be beneficial to stock traders, but for long term dividend investors, it’s just an increase in paper value. Some of the best historical investments, such as Altria, were so great specifically because they remained undervalued. When a company trades for a low valuation, dividend payments can purchase a greater number of shares than if the valuation were higher, and this results in faster accumulation of dividend income and long-term total returns. On the other hand, increased paper valuation does noting for me if I were not intending to sell any time soon. It just lowers the dividend yield of fresh capital that I put into the company, and makes it so I can buy fewer shares and therefore smaller dividend payments.
While I can see some reasons for the split, as an intended long term shareholder, I’d rather hold the company as a unified whole. It’s too early to be sure, but my thoughts at this time is that I’ll likely keep my position in Abbott, and sell my position in the researched based pharmaceutical business. I’ll either reinvest that capital back into the Abbott half, or put it elsewhere. I’m not too interested in investing in pure pharma plays, and instead prefer diversified health care companies. This doesn’t necessarily mean I think the diversified medical company will have superior returns; it’s simply that I feel the diversified medical company more suitably fits my investor profile. I expect that the diversified company, Abbott, will continue to perform well, should stay at a reasonable valuation, and should have solid dividend growth prospects based on EPS growth and strong free cash flows.