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By Christopher M. Oshewolo
The pending separation of consumer care businesses by pharmaceutical companies is understandable and may offer investment opportunities.
Significant portfolio transitions centered around the separation of consumer health care businesses are underway among large pharmaceutical companies: GlaxoSmithKline (GSK) is on track to spin off its consumer health business by mid-2022. Sanofi (SNY) expects to transition its consumer health business to a standalone entity by the end of 2022. And, in November 2021, Johnson & Johnson (JNJ) announced plans to split off its consumer health business over the course of 18-24 months.
What’s going on here? In context, these transitions are simply the current iterations of portfolio reshufflings that become necessary every now and then in the pharmaceutical industry. They are a direct consequence of the growth phases and operating cycles tied to patent exclusivities at the heart of the industry business model. As the pharmaceutical portfolios of large, diversified health care companies mature and consolidated growth slows, the resulting drag on equity performance ultimately prompts reevaluation of the rationales for keeping assets with divergent growth profiles together. In the quest for growth, the case for shedding a lower-margin consumer care business with growth range-bound around the GDP growth rate becomes self-evident, particularly as the relative stability of these businesses allows them to be monetized at higher equity multiples. The proceeds of the resulting separations provide liquidity and flexibility to fund investments in innovative R&D programs and acquisitions of pharmaceutical pipeline assets with high growth potential.
While the pending separations would reduce business diversification for the stub companies, we believe the overall credit implications should be manageable in the near term as historically constructive financial policies indicate that proceeds would be used in a balanced manner-between strengthening the balance sheets of the stub companies and returning capital to shareholders. Related bond issuance out of the new companies to fund potential special dividends to the stub companies may provide investment opportunities. Over the medium term, the emergent companies could become acquirers or targets in M&A transactions as they and/or potential acquirers look to strengthen their market position and enhance longer-term growth prospects. (Unilever’s recent bid for GlaxoSmithKline’s consumer health care business demonstrates the appetite for these assets). These transactions could also provide investment opportunities.
Importantly, consistent with our previous posts on BBB rating risk, the separation of consumer health businesses is occurring among high-quality companies with levers to pull to preserve strong credit quality at the stub companies. Still, investment opportunities could emerge from follow-up transactions involving the new and stub companies.
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