By Alex Gavrish, Etalon Investment Research; author of “Wall Street Back To Basics”
Prepare for upcoming opportunities
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With equity markets in a seemingly overheated mode, it is harder for value and conservative investors to find bargains. In such an environment we think it is prudent to step back and spend some time researching opportunities that can come up in due course. One of the market niches on which it is always worthwhile to focus is the spin-offs segment. Spin-offs had historically outperformed general market indexes and, in the past, provided investors with unique and profitable investment opportunities.
The Guggenheim Spin-Off ETF, for example, returned 181% over the past 5 years, compared to a 92% return on S&P 500 index. On March 27th, 2014, Baxter announced a plan to spin-off its biopharmaceuticals products division. The spin-off will be effected through a tax-free distribution of 100% of company’s shares to Baxter International Inc. (NYSE:BAX)’s shareholders and is expected to be implemented in the middle of 2015
Spin-off company profile
The biopharmaceuticals business, with 2013 annual revenues of approximately $6 billion, consists of a diverse portfolio of recombinant and plasma-based proteins to treat hemophilia and other bleeding disorders, and plasma-based therapies to treat immune deficiencies, alpha-1 antitrypsin deficiency, burns and shock, and other chronic and acute blood-related conditions. The business’s strategy is aimed at improving diagnosis, treatment and standards of care across a wide range of bleeding disorders and chronic diseases, enhancing capacity to meet growing demand for biotherapeutics, leveraging expertise into new emerging therapeutics through acquisitions and collaborations, and developing a robust new product pipeline focused on new and effective treatments that address unmet medical needs.
According to division’s CEO, Ludwig N. Hantson, Ph.D., the separation will position the company to execute on its future growth prospects, new product pipeline and other opportunities as it enters a new era in the journey to achieve it’s aspiration to be a premier biopharmaceuticals company.
Parent company valuation
Based on a recent share price, Baxter International Inc. (NYSE:BAX) had maket capitalization of $40.6 billion and enterprise value of $47.6 billion. Company is currently valued at a P/E multiple of x20.2 and EV/EBITDA multiple of x17.8 (FY 2013 financials). Company generated $3.2 billion in cash flow from operations and $1.7 billion in free cash flow. Baxter pays a regular quarterly dividend of $0.52 per share which provides an annual dividend yield of 2.8%. Company also allocates substantial amounts of capital to share buybacks: over the last three years it had spent $1.33 billion annually (average) on share repurchases. Based on the current market capitalization this translates into a 3.3% annual buyback yield. Adding the dividend yield, total shareholder’s yield equals 6%.
Baxter’s spin-off insights
Despite the fact that many spin-offs had significantly outperformed the market, they occasionally come with drawbacks, not only benefits. The parent company might be motivated, for example, by the desire to get rid of low or unprofitable operations. Or the parent might be motivated by the desire to dispose of a business segment that consumes too many resources and requires too much management attention compared to revenue and profit that it generates. Or the motive might be to “raise” funds for the parent company through some financial engineering scheme. Such situations can still be positive from the perspective of parent company shareholders, but they do not make an ideal case for potential investor in the new spun-off company. Financial details of the transaction as well as pro-forma financial statements are not available yet, but it seems that the reasons for spin-off as explained by Baxter International Inc. (NYSE:BAX) make a good spin-off case.
The main motive for the spin-off is to separate two businesses that operate in distinct markets. Once separated, greater operating efficiencies could be achieved as each company will allocate and prioritize resources according to its needs and will pursue its own growth strategies. The current valuation of Baxter is not especially attractive, but investors should find it valuable to monitor the company and the upcoming spin-off process.