There's no such thing as afree lunch , but spinoff companies
are as close to free as you can get.
When a company is spun off, there's a high level of forced
selling. One of the best ways to think about spinoffs: "There's a
natural constituency of sellers and not a natural constituency of
buyers," according to "Margin of Safety " author andhedge fund
manager Seth Klarman.
Simply, many shareholders who ownshares of theparent company
are not interested in owning the spinoff. This can be for a
variety of reasons, such as different business fundamentals, weak
management, or negativecash flow . In most cases, investors are
selling the company for no good reason. While on the other side,
the buyers are limited, as themarket is inefficient in digesting
data on new spinoff companies.
Spinoffs Versus The Market
Yet, over the longterm , spinoffinvesting tends to outperform the
This is not new information. A 1993 study titled
"Restructuring Through Spinoffs" found that spinoff companies
outperformed the S&P 500index by 30% on average during their
first three years. A similar study by Lehman Brothers concluded
that between 2000 and 2005, spinoff companies outperformed the
market by a whopping 45% during their first two years.
JPMorgan Chase (
came to similar conclusions, finding that spinoffs outpaced the
market by 20% during their firstyear and a half between 1985 and
So far this year, spinoff companies have maintained that
Guggenheim Spin-Off (
exchange-tradedfund is up 30% this year, compared with the
S&P 500's 16.5%.
Earlier this year,
Abbott Laboratories (
completed a split after realizing the company had grown into two
now trades as the former pharma business of Abbott Labs, while
Abbott continues as a health care products and medical devices
The idea of breaking up the health care and pharma businesses
was to make the companies easier to value. However, it appears
the market has gotten this one wrong. Spinoffs are great ways to
fix mistakes. As a result, spinoffs generally have weak
management, lower margins, lower returns onequity , or
negativeearnings . This is not the case with AbbVie. Thestock had
a nice run out of the gate, but interest and tradingvolume have
since cooled off.
But investors should give AbbVie another look. Sometimes the
market fundamentally misunderstands spinoffs. In this case, the
market is treating AbbVie like a typical problematic spinoff --
but in reality, AbbVie appears more fundamentally sound than
Breaking Down The Numbers
AbbVie is trading with a price-to-earnings (P/E ) ratio of 13,
which is well below Abbott's 60. AbbVie has an impressive
33%operating margin for the past 12 months, compared with
Abbott's 20%. Abbvie is also churning out areturn on capital
employed (ROCE, equal tooperating income divided bycapital
employed) of 43.5%, compared with Abbott's 21.6%.
While the companies' business models are debatable, there's no
denying the strength of AbbVie'scash position anddividend yield .
AbbVie has $5.50 in cash per share, which covers 12% of the share
price, and the company generated $4 per share in cash flow from
operations over the trailing 12 months.
AbbVie has a solid 3.6% dividend yield, which is in line with
(and in most cases above) other major pharma companies and dwarfs
the 1.6%yield of Abbott, its former parent. Yet unlike some of
its peers, AbbVie'sdividend payout (as a percentage of earnings)
is below 50%. AbbVie's board has also authorized a $1.5 billion
share buyback program, representing just over 2% ofshares
What About The Business?
AbbVie's key drug is Humira, an anti-inflammatory product used
primarily for rheumatoid arthritis. In 2012, Humira accounted for
around half of AbbVie's $18.4 billion pro formarevenues . Last
year, the drug accounted for about 50% of the market for
rheumatoid arthritis drugs, which is expected grow to more than
$25 billion in 2017, up nearly 40% from 2012.
One concern is the fact that Humirawill losepatent protection
in 2016 in the United States and in 2018 in Europe. However,
AbbVie's total research and development (R&D) pipeline has
more than 20compounds in Phase II or Phase III development,
including five key products planned for launch before
Humira is also approved for a number of other uses, which
includes HIV, Crohn's disease, psoriatic arthritis and several
other ailments. These uses and the drugs in AbbVie's pipeline
should help AbbVieoffset any fall-off in Humira revenues.
AbbVie, which gets more than half itsrevenue from outside
North America, has a number of growth opportunities in the U.S.
and internationally.Emerging markets should see tailwinds from
increased spending on health care, and in the U.S., theAffordable
Care Act (akaObamacare ) is expected to provide coverage for more
than 30 million uninsured Americans next year. All in all, the
company has company- and industry-specific tailwinds for which
the market appears to be mispricing ABBV.
Risks to consider:
As with any pharma company, there are risks thatpatents will
be challenged or the company will fail to produce new
revenue-generating products. AbbVie faces patent expirations for
its top drug Humira in the next several years, which could be a
negative if its other products fail to come to market in a timely
Action to take -->
Consider buying shares of AbbVie, which has a well-developed
R&D pipeline and a cheap valuation. With just a modest 20
times P/Emultiple on AbbVie management's 2013EPS forecast of
$3.10, the stock should trade north of $60. Its solid cash
position and robust dividend also give the stock somedownside
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