Which Half of Abbott’s Split Should You Own?
10/25/2011 4:02 pm EST
Got a better place to park your money for 14 months?
The plan, announced on October 19, envisions splitting Abbott into two companies, with the separation to be complete by December 2012.
One, with $18 billion in sales, would be a focused drug company with ownership of the current Abbott blockbuster Humira. That drug for rheumatoid arthritis is projected to account for $8 billion in sales in 2011. That would be more than 40% of the sales of the new drug company after the split.
The second, with $22 billion in sales, has been described in most stories as a medical device and diagnostics company. That’s rather misleading. This post-split company would actually get the biggest part of its sales from nutritionals—28% to the 27% of sales from medical devices.
Nutritionals for infants and adults is, I argued when I added the stock to Jubak’s Picks in September 2010, the jewel among Abbott’s units. The business is growing at double-digit rates and expanding margins at the same time—Abbott projects that operating margins for nutritionals will expand by a full 7 percentage points from current levels by 2015.
Not that the rest of the device-diagnostics-nutritionals company is made up of dogs, either. The medical device unit, for example, is No. 1 in drug-eluting stents and No. 1 in coronary stents. The fastest growing part of the device unit, though, is its diabetes division.
The further you dig down into the two proposed companies, the more you’re likely to be convinced that you’d much rather own the device-diagnostics-nutritionals company than the drug company. The growth in the former is likely to be much higher, thanks in no small part to its focus on developing economies as opposed to the focus of the drug company on developed markets.
Add in the greater risk for the drug company—Humira, 40% of post-split sales, will face generic competition beginning in 2016—and that preference just gets more pronounced.
The deal is indeed intended to unlock value in the current Abbott Laboratories that isn’t recognized by the stock market. But—and this is kind of shocking if you’ve been an investor since the days when drug stocks were the gold standard for safe growth—the value that the deal is intended to unlock is in the device-diagnostics-nutritionals company.
Wall Street analysts who have done a sum-of-the-parts calculation get a total value for the two parts of Abbott of $60 to $65. That’s a gain from the current price of $53.49 of 12.2% to 21.5%. Add in a dividend yield of 3.4%, and that’s none too shabby.
The problem, unfortunately, is that investors can’t expect that gain to materialize smoothly over time. It is likely, in fact, to be lumped mostly in the months near the split up.
In the nearer term, the deal—whatever the soundness of its logic—will actually act as a damper on the share price. Some number of investors will shy away from buying Abbott Laboratories because they have heard about the split up, haven’t bothered to digest the plan, and are just put off by its novelty.
My suggestion is to hold Abbott Laboratories right now, until safe stocks rotate back into favor when the current rally shows signs of flagging in a month or two. See how much of the projected gain you get in that rotation. And then see how the math of selling then in order to rebuy in the fall of 2012, closer to the split up itself, works out.
I think owning the stock pre-split up is likely to get you the best price on the part of Abbott Laboratories you want to own, the device-diagnostics-nutritionals business.
Full disclosure: I don’t own shares of any of the companies mentioned in this post in my personal portfolio. The mutual fund I manage, Jubak Global Equity Fund, may or may not now own positions in any stock mentioned in this post. The fund did not own shares of Abbott Laboratories as of the end of June. For a full list of the stocks in the fund as of the end of June see the fund’s portfolio at http://jubakfund.com/about-the-fund/holdings/