Four large companies are preparing to spin off health-care units over the next year or so.
That could be good news for investors: stocks of newly independent health-care companies tend to outperform the overall market, according to Mike Bailey, director of research at FBB Capital Partners.
FBB Capital Partners is based in Bethesda, Md., and has about $1 billion in assets under management. Bailey joined the firm in 2015, after working as a health-care analyst at Legg Mason in Baltimore. He discussed all four planned separations in an interview on Sept. 13.
Bailey said he did not necessarily advise clients to hold shares of companies before they separated the health-care units. “We would probably keep it simple, for tax reasons, and just buy the spun-off companies,” he said.
Of course, after each spinoff is completed, analysts will have a better feel for each independent company’s growth prospects as well as standard measures of value, including price-to-earnings and price-to-sales.
Here are Bailey’s comments about the four companies and the units they plan to spin off.
Eli Lilly and Elanco
announced plans this month to sell about 20% of its Elanco Animal Health business for between $20 and $23 a share, a deal that could raise up to $1.66 billion. The offering could price late next week.
The life-sciences giant has previously said it plans to sell the entire stake later, and Bailey said he expects that to happen in 2019.
a competitor of Elanco that was spun off by pharma giant Pfizer
in February 2013, initially traded for $31.50 a share. The shares closed at $88.79 on Sept, 12.
Bailey said that when Pfizer announced its plan to spin off Zoetis, he didn’t jump on the opportunity, and “it seems now that Pfizer was lowballing expectations” for the unit.
While saying it was too early to give an investment opinion about Elanco, he called the industry fundamentals for animal health care “attractive” and added: “If they can copy what ZTS has done, with margin expansion and a few deals, you probably have potential upside. There is certainly a case that Elanco can do what Zoetis did.”
Novartis and Alcon
plans to spin off its Alcon eye-care business during the first quarter of 2019. Alcon will be based in Switzerland, like the parent company.
Analysts expect the company to be valued around $20 billion. Novartis spent a total of about $50 billion to acquire the current Alcon unit, including an Ophthalmology pharmaceutical business that won’t be included in the spun-off company.
The new Alcon will be a consumer staples play with stock multiples that are “pretty high,” Bailey said. But the high multiples would be supported by “steady growth,” he said, and Alcon has a good reputation for making high-quality devices.
“High quality, low competition, high barriers to entry and pretty good fundamentals” make for “a pretty good business,” he said.
Danaher and its dental business
Investors were pleased on July 19 when Danaher
announced a plan to spin off its dental business in a tax-free transaction to be completed during the second half of 2019. (A name for the new company hasn’t been announced.) The shares rose 4.5% that day. Here’s how the stock has performed over the past 12 months:
For the second quarter, Danaher reported a 10% increase in revenue from a year earlier, while the dental unit’s sales increased only 4%. Sales in Danaher’s life-sciences unit were up 16%, while sales in the diagnostics unit were up 8% and the company’s environmental and applied solutions segment increased revenue 11%.
Unlike the other three parent companies that Bailey discussed, Danaher is a stock that FBB Capital Partners currently holds for its clients. Bailey said, “We would own Danaher with or without the dental spinoff,” but he added that he has “higher conviction” for Danaher after the spinoff is completed.
While he is “open minded” about analyzing the dental unit for investment after the spinoff, Bailey said the dental business has been a difficult one for Danaher.
“I have been following Danaher closely for a number of years, and dental has always been ‘around the corner’ for improvement, and they have had a tough time making it work,” he said.
General Electric and GE Healthcare
plans to separate its health-care unit through a two-step process beginning with a public offering of about 20% of the company by the end of 2019, after which the remaining 80% “will be distributed tax-free to our shareholders through a spin or split,” GE CEO John Flannery said during a conference call on June 26.
After holding shares of GE for many years, FBB Capital Partners sold late in 2017. “At the time, it seemed health care and aerospace were two of the better-performing divisions,” Bailey said.
He also said he would “probably wait for the spinoff” to consider purchasing shares of an independent GE Healthcare, rather than purchasing shares of GE before the spinoff.
While saying he is keeping an open mind about the four planned health-care company spinoffs, Bailey noted this: “Historically, if you look at any health-care spinoff, there is a pretty high hit rate. You can probably hold your nose and buy all four, and see outperformance if historical patterns hold.”
Meanwhile, here’s how Bailey ranks the attractiveness of all four parent companies as investments right now:
- Danaher, which FBB Capital Partners owns and plans to continue holding after the proposed spinoff.
- Elly Lilly. Bailey said the company is “in the early innings of a very nice margin expansion,” with pricing power and cost-cutting.
- Novartis. Bailey said FBB sold it about a year ago when there were “concerns about competition,” and that he was “less inclined” to consider the company for investment now.
- General Electric.
Here’s how Bailey currently ranks the four expected new companies that will be formed:
- Elli Lilly’s Elanco unit.
- Alcon, to be spun off by Novartis.
- GE Healthcare, which Bailey called “a close third.”
- Danaher’s dental unit.
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