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.
Split Facts
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.
Conclusion
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.
Henry
I’m for the split, however I wish they announced it 10 years from now. The pharma division has a solid drug pipeline that’s potential worth billions. We’ll see how things go from here.
Dividend Mantra
Matt,
Couldn’t agree more here. I’m upset that not only this wonderful diversified medical company is splitting up, but also that by “unlocking shareholder value” they are, in effect, pricing some of us value-oriented dividend investors out of adding to our ABT holdings. I do know that some dividend growth investors out there are cautiously optimistic about this split, but I’m a bit disappointed as I recently opined. It’s difficult to forecast how this will all turn out, but I’d be happier with the status quo.
Best wishes!
Rock the Casbah
Matt and D. Mantra,
I’m with you guys on this one. Abbott is one of my core holdings and I consider it a cornerstone of my dividend portfolio. If I were a stock “trader” then I think I would be more enthusiatic about this split but as an income investor I am a bit concerned for it’s implications on the dividend growth moving forward. I know you should NOT get emotional about investments but like D. Mantra, I was disappointed and a bit saddened by this announcement.
It seems that splitting up companies to “unlock shareowner value” is a growing trend (I’m tempted to say fad here) that corporate management is embracing. I know there’s been rumors (baseless or not) about Pepisco and JNJ. I’m sure JNJ will be watching the Abbott split closely. I wonder how much more we’ll see of this.
Matt,
My initial inclination on what action to take after the split is the same as yours. Sell the pharma company and re-invest back into “Abbott 2.0”, but as you say it’s much too early. For now, I’ll hold my position and keep my “ear to the ground”.
Thanx for the article.
My Own Advisor
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.”
Agreed, but I think long-term, this is going to work out well for Abbott. I own a few shares, enough to DRIP synthetically, and I’m keeping them all.
Impossible to predict how this might play out, but I’m cautiously optimistic like Mantra. This company has been well-managed and I don’t foresee anything different post-split.
Good post Matt, always enjoy reading your perspectives.
Smeagol
Being an Abbott shareholder I have some reservations about the split in terms of the 2 separate companies being long term weaker than the whole (loss of synergy of cost structure etc.) but my biggest concern is that the diversified company offered steady cash flows that could fund and offset the volatility of the pure pharma play. Conversely the pure pharma play pipeline going forward can help to insure future earnings growth (presuming some of these new drugs are successful). So for these reasons I am concerned.
However, as a current shareholder I am NOT concerned about the unlocking of shareholder value in anything I currently own. One cannot have regret if an investment reaches it’s predicted value earlier than expected for whatever reason…that’s a gift. Take the immediate profits and invest it into something else that matches your investment profile needs (reinvest in the new Abbott diversified division, invest it into JNJ, whatever). I may be precluded from buying more shares now because the price has gone up due to the spinoff unlocking shareholder value, but I would have equally been inhibited if the stock price went up for any other reason as well. In either scenario I would just buy something else…there’s plenty of other fish in the sea.
Barry
I’m not a shareholder of ABT, but the split does worry me…mostly because pure pharma plays are very finicky beasts. They can generate huge profits one year, but once the patents expire it can be disastrous. Plus, there is so much capital that goes into new drugs, and so few get approved, I don’t think they are great dividend plays.
DividendPlayer
I’ll agree with the majority here. I am also not a fan of pure-pharma, although I do hold PFE. I’ll keep an ear to the ground, but at present my plan will be to hopefully realize a pop on the pure pharm company, sell and reinvest into ABT.
DRA
My family has had for decades, what is for us, a significant stake in ABT. We have seen the dividends reliably grow a 1000% over the years.
While in recent years the stock may have been stuck in what you consider “a sweet spot” of low price appreciation and increasing yield, you must realize that there can be no “status quo” in the medical business. The pharma and medical device world of 2011 is quite different than when we acquired our first shares. While, I’m not endorsing the recent announcement, long term holders can look back on the 2004 spinoff of Hospira (1 HSP of each 10 ABT). If you had immediately sold HSP and reinvested in ABT you would have instantly increased your dividend yield by 6%. If you had kept the HSP you would be holding a non-dividend paying stock which has at times shown over 100% appreciation.
As dividend investors, we have to remember that we are not just investing in cash flow and hard assets, we are betting on the smarts of management to keep things growing.