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Breaking up. It’s all the rage. Just days after industrial conglomerate General Electric (GE) announced that firm’s future de-conglomerization, and less recently after fellow pharmaceutical giants Pfizer (PFE) and Merck (MRK) had spun out their respective consumer businesses, comes the next shoe to drop. Johnson & Johnson (JNJ) , the world’s largest health products company by sales and employer of more than 136K human beings, announced that the longstanding member of the Dow Jones Industrial Average will be separating into two distinct firms, but not right away. More like in a year and a half to two years, which makes this equity trader/investor wonder if this news came out only because it was coming out and not because the time was right.
What gives? A push to simplify business direction in order to improve focus during complex times? Sure. Oh, it might be about unlocking value as well. Perhaps the sum of the parts might be greater than the whole, especially if the slowest growing, lowest margin portion of the broader business is set free.
The Story
The S&P 500 is up 24% year to date. PFE is up 35%. Johnson & Johnson reported the firm’s third quarter performance about three weeks ago. The firm beat on the adjusted bottom line, missed on the GAAP bottom line, and missed on the top line, albeit on 10.7% annual growth. Sales of the firm’s COVID vaccine badly missed expectations. The firm did boost guidance for current quarter revenue, but still not quite to where Wall Street was on that metric. However, JNJ did also increase current quarter guidance for adjusted EPS above Wall Street’s consensus. No mention of a breakup.
This week, Johnson & Johnson won a court ruling on their request to halt tens of thousands of talc related lawsuits. The firm also agrees to provide its COVID vaccine to some of the most vulnerable people in the world through the COVAX Humanitarian Buffer. No mention in either case of a breakup.
The firm currently operates through three business lines… Pharmaceuticals, which provided 55% of the firm’s revenue in 2020, Medical Devices, which drove 28% of revenue last year, and Consumer Health, the legacy business that you all know that drove only 17% of total revenues. This last business is the one being spun off. The larger two businesses will retain the Johnson & Johnson name. The smaller business, including brands such as Listerine, Tylenol, Band-Aid, Neutrogena, and Rogaine will most likely be spun off in less than two years in a tax-free transaction that will include a stock offering.
This action has nothing to do with the lawsuits alleging that the firm’s famous baby powder caused cancer, according to outgoing CEO Alex Gorsky. Gorsky will be replaced by Joaquin Duato who will run the pharmaceutical and medical devices business. There has not yet been any announced leadership for the consumer-focused spin off.
The Chart
I have to admit that I don’t like this chart. I don’t like that the shares have given up the majority of their pre-opening surge and have now retreated all the way to their 200 day SMA. What happens next is truly crucial. While I see good reason to be in this name ahead of the split, I really think that you have at least a year to make that decision. While this is a solid firm that pays investors $4.24 (2.6% yield) just to hang out, I see better value elsewhere in the pharma space. That’s why I have been in Pfizer and AbbVie (ABBV) (ABBV is +9% ytd, div yield of 4.84%) all year, and have traded in and out of both Merck (MRK) and Bristol-Myers Squibb (BMY) on opportunity.
Keep in mind that next year is another election year, and both houses of Congress will be in play. One thing both the left and the right agree on? Beating up the drug companies.
If one is long the shares or decides to get long here… one can write January 2023 $210 calls against the position for about $1.50. Might as well get paid something for a long dated way out of the money calls. Not much risk outside of capping a profit that one would readily agree to right now, there.
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