Earlier this week, J&J introduced an upcoming inventory trade the place shareholders could have the choice to commerce of their JNJ shares for shares of Kenvue, their client healthcare firm. It is a massive upcoming choice for JNJ buyers as we have to consider which is the higher wager. On this weblog publish, we’ll summarize the trade provide, discover the efficiency of different healthcare spin-offs, and focus on the rationale for and towards exchanging JNJ shares for Kenvue.
Warning: The is an in depth publish overlaying a big quantity of background materials and in-depth analyses. In case you are solely interested by how we plan on dealing with the trade, please skip to the tip.
Disclaimer: I’m at the moment a J&J shareholder and please don’t interpret my views as funding recommendation. Moreover, any numbers shared beneath could also be outdated by the point you learn this publish. Please carry out your personal analysis and evaluation. Seek the advice of your monetary advisor earlier than making any funding choices.
J&J and Kenvue Enterprise Overview
Presently, J&J’s enterprise consists of three enterprise segments which embody client healthcare (Kenvue), prescribed drugs, and MedTech. For FY 2022, the income contribution for every of those companies is as follows:
The buyer well being enterprise represents ~16% of complete J&J gross sales throughout three sub-businesses: self-care, pores and skin well being & magnificence, and important well being. General income is well-diversified throughout every enterprise phase (~29% for Pores and skin Well being, ~30% and Important Well being, and ~41% for Self Care) in addition to geographic footprint (~50% US, ~50% ex-US). Essentially the most iconic family manufacturers embody Benadryl, Tylenol, Band-Support, Neutrogena, Aveeno, Johnson’s, and Listerine.
J&J anticipates the spin-off will enhance strategic execution and enhance working leverage amongst all companies. One other key motivation behind the separation is to handle the liabilities from the talc product-related lawsuits. The litigation facilities on over ~60K lawsuits claiming that the corporate’s talc-based merchandise precipitated ovarian most cancers and mesothelioma.
J&J shaped a separate subsidiary, LTL Administration, and instantly filed for chapter to effectively settle litigation claims. Nonetheless, a US Federal chapter choose denied J&J for the second time and J&J could need to re-appeal once more. This suggests that future liabilities from the talc lawsuits could also be larger for J&J past the most recent $8.9B estimate, probably giving plaintiffs extra leverage. The choose’s chapter choice solely impacts J&J’s liabilities within the US and Canada as a result of Kenvue is accountable for claims in all different geographies.
In analyzing every phase’s income during the last 5 years, the Pharma enterprise has primarily pushed the guardian firm’s gross sales development, with a 5-year CAGR of 5.2%.
Nonetheless, there are a number of challenges dealing with the pharma enterprise. Roughly ~24% of its drug portfolio gross sales has skilled declining operational development in 2022 vs. 2021. Moreover, blockbuster model Stelara will face patent expiry in late 2023. J&J’s technique to convert sufferers from Stelara to Tremfya has had restricted success. Elevated competitors, payer reductions, and the shortage of overlapping indications and formulations stay obstacles to affected person conversion. For its most cancers enterprise, Imbruvica continues to face growing competitors and Medicare rebate pressures.
For J&J’s MedTech enterprise, the expansion has been comparatively flat in the previous few years resulting from sufferers delaying elective procedures due to COVID. Nonetheless, demand has recovered and based on J&J’s newest 2023 2Q earnings report, gross sales from MedTech rose ~12.9% from a 12 months in the past. Moreover, its latest acquisition of Abiomed could assist help future development targets.
We additionally analyzed every phase’s earnings as a proportion of its income as an indicator of profitability. Over the past 5 years, the pharma and MedTech companies have been significantly larger than Shopper Well being:
- Shopper Well being: ~10.8%
- Pharma: ~30.1%
- MedTech: ~18.1%
Proposed Inventory Trade Deal
Based mostly on JNJ’s latest investor announcement, the principle highlights of the proposed trade provide are as follows:
- J&J will allow shareholders to trade some, all, or none of their inventory for widespread shares of KVUE topic to an higher restrict of 8.0549 shares of KVUE for each share of J&J. If the higher restrict is NOT in impact, J&J will present shareholders with roughly $107.53 of KVUE widespread inventory for each $100 of J&J inventory.
- J&J anticipates providing KVUE inventory at a ~7% low cost with the trade provide being a tax-free distribution.
- J&J will decide the costs at which shares shall be exchanged based mostly on the each day volume-weighted common costs of shares on August 14, 15, and 16. The ultimate trade ratio reflecting the variety of shares of KVUE inventory to be obtained for every J&J share shall be on August 18th, 2023 at 9 AM EST
- Traders might want to elect whether or not they wish to take part within the trade by August 16th, 2023.
Moreover, if the trade is undersubscribed by August 18th, J&J plans to make a tax-free distribution of Kenvue shares to current JNJ shareholders as a dividend seven enterprise days following August 18th. For 2023 forward-looking steering, J&J expects ~4.4% income development and Kenvue expects 4.5% to five.5% gross sales development.
The strategic query dealing with buyers is:
Would you commerce some shares of a traditionally larger development, larger profitability enterprise for a modest development, decrease profitability enterprise in client healthcare?
Valuation of J&J and Kenvue
Earlier than evaluating analog case research, we wish to decide the present valuations of J&J and KVUE. These valuations could inform whether or not buyers will obtain good worth on the time of the trade. (Please be aware that there are a number of valuation approaches and it is best to conduct your evaluation.)
For instance: If present inventory costs counsel that J&J is overvalued and Kenvue is undervalued, then J&J shareholders could take into account decreasing some publicity and re-allocate their capital into Kenvue. Kenvue’s present valuation may present a baseline for the way engaging the incremental ~7% low cost incentive is likely to be on the time of the trade.
Utilizing FinViz and analyzing the P/E, Ahead P/E, and PEG ratios, we in contrast JNJ relative to different S&P 500 healthcare drug producers beneath:
With JNJ buying and selling at a 34.6 P/E, 15.29 Ahead P/E, and eight.15 PEG ratio, it’s larger than not solely the phase median but in addition its historic P/E of 17.3 since 2009. If we use J&J’s ahead P/E of 15.29 and the 2023 consensus annual EPS of $10.76, the intrinsic worth of the inventory value must be ~$164.52. Based mostly on the inventory’s earlier shut of $174.48 as of Jul 28th, we imagine J&J is barely over-valued.
We carried out an analogous evaluation for Kenvue relative to different NYSE Shopper Defensive – Family & Private Care corporations beneath:
Kenvue’s present P/E of 21.8 is beneath the phase median and in addition has a decrease ahead P/E of 19.6 than the phase median of 24.7. By making use of its ahead P/E of 19.16 to the projected 2023 consensus forecast of $1.25, the estimated intrinsic worth is $23.95 per share. As of July 28th, the inventory value closed at $24.40 per share, suggesting that Kenvue is priced pretty.
If the inventory continues to hover across the identical value main as much as the trade, J&J’s provide to distribute Kenvue at a 7% low cost to the market value may very well be engaging.
Efficiency Affect of Case Research
Whereas nobody can predict the longer term, we analyze three case research of comparable firm spin-outs to tell doable JNJ-KVUE situations.
Pfizer and Zoetis
Pfizer determined to separate its Human Well being and Animal Well being enterprise (Zoetis) in 2013. Much like J&J and KVUE, they introduced an analogous tax-free inventory trade provide. Pfizer shareholders would be capable to trade 1 PFE share for 0.9898 shares of Zoetis inventory (ZTS) at a 7% low cost to the market value. Very like J&J, Pfizer initially owned ~80% of the widespread inventory of Zoetis, and bought all remaining shares through the trade.
Utilizing Portfolio Visualizer, we back-tested these two corporations, assuming a $10K preliminary funding stability, and evaluated the efficiency following the spin-off from 2014 to 2018 beneath:
The entire return throughout that interval for PFE was 70%, however was 172% for ZTS! Moreover, when analyzing the income development and annual diluted EPS development for each corporations throughout this time interval, we see that ZTS outperformed considerably throughout all metrics.
Following the spin-off, Zoetis outperformed Pfizer on account of a number of components which included:
- Pfizer’s failed try to purchase AstraZeneca in 2014
- Pfizer skilled declines in earnings, decrease gross sales from Lipitor and Viagra on account of patent expiry in addition to decreases in income from different established manufacturers
- Zoetis noticed larger demand for its premium livestock merchandise and launched a number of new merchandise
GSK and Haleon
In July 2022, GSK additionally accomplished the spin-off of its client healthcare enterprise, Haleon. On the time, GSK co-owned Haleon with Pfizer with GSK proudly owning 68% of Haleon and Pfizer proudly owning 32%. As a part of the spin-out, GSK regarded to scale back its 68% holding by 80%.
Whereas there’s restricted historic efficiency information, GSK-Haleon can be a spin-out of the guardian firm’s client healthcare enterprise. GSK shareholders would obtain 1 share of Haleon for every share of GSK. That is totally different from J&J’s proposed trade provide as it’s not an trade. Following the transaction, GSK additionally consolidated shares to stabilize value and earnings by giving 4 new shares of nominal worth at 31.25p for each 5 GSK shares of nominal worth of 25p. Administration advised that the spin-out would drive income and earnings per share development with Haleon rising by 4% to six% yearly and GSK rising by 6% to eight% in 2023.
Moreover, Haleon launched with a big quantity of debt (~£10.9B kilos), round 3.6X of its adjusted EBITDA and an especially excessive debt-to-equity ratio at 64.5% (£10.6B debt / £16.5B fairness). Kenvue, alternatively, has a complete debt of $7.8B, which is ~2.1X its adjusted EBITDA and brings its debt-to-equity ratio to 38.4%. As beforehand talked about, this debt may very well be even larger relying on the excellent talc lawsuits.
Again-testing a portfolio of GSK and Haleon in Portfolio Visualizer, the preliminary outcomes have been underwhelming. This can be because of the restricted time horizon since operational and monetary synergies often require a 3-to-5-year time horizon.
In reviewing the 1-year inventory efficiency from Google Finance, GSK has declined by -16.45% and HLN has risen by 24.14%. Whereas this would possibly look engaging, forward-looking income and annual diluted EPS analyst estimates would possibly counsel a unique interpretation for HLN.
Analysts count on that income will develop by 4% and EPS will decline by -3%. Whereas the spin-out of the patron enterprise is just like J&J, the pharma enterprise of J&J vs. GSK is extraordinarily totally different. J&J has a way more clinically progressive portfolio and has many market leaders of their illness areas, in addition to the MedTech enterprise. GSK’s portfolio has not too long ago had a number of pipeline failures in its oncology enterprise and has principally been anchored by its legacy HIV and respiratory franchise.
For these causes, we have to be cautious about how we interpret the 1-year efficiency of GSK and HLN for J&J and KVUE.
Merck and Organon
In June 2021, Merck introduced the strategic choice to spin off its Girls’s Well being, Biosimilars, and Established manufacturers enterprise known as “Organon”. Merck’s give attention to its oncology, vaccines, and specialty care enterprise diluted its consideration away from Organon, resulting in historic underperformance. In consequence, they felt separating the 2 corporations would result in improved development and shareholder worth creation.
Not like J&J-KVUE, the separation was not an trade provide. Merck shareholders would obtain 1 share of Organon (OGN) for each 10 shares of Merck widespread inventory. In accordance with investor shows, administration estimated low-to-mid single-digit income development from the 2021 base for Organon and ship as much as 1% CAGR enchancment on Merck’s income development.
Again-testing a portfolio of Merk (MRK) and Organon (OGN), we are able to solely consider a 1-year efficiency given the latest timeline of this transaction.
Merck has to date, enormously outperformed Organon in its complete return. Merck’s 1-year return is ~17% whereas OGN has declined -32.6%! Organon’s income has slipped in 2022 in addition to its annual diluted EPS largely attributed to declines in its established manufacturers in addition to the overseas forex trade impression. Over 75% of OGN’s enterprise is exterior the US.
Among the many case research above, solely the Pfizer-Zoetis transaction has an analogous trade provide and presents probably the most complete historic efficiency given a 5-year lookback interval. The GSK-Haleon and Merck-Organon examples weren’t trade affords. Nonetheless, Zoetis’ Animal Well being enterprise may be very totally different in comparison with Shopper Healthcare. A few of these key variations embody:
- Increased profitability for Animal Well being (Zoetis) vs. Human Well being (Pfizer) in comparison with decrease profitability for Shopper Healthcare (Kenvue) vs. Pharma/MedTech (J&J)
- Excessive barrier to entry for Animal Well being resulting from required buyer infrastructure with veterinarians and livestock farmers with devoted discipline gross sales power vs. larger emphasis on digital for Shopper Well being
- Higher safety from competitors and generics entry in Animal Well being vs. Shopper Well being
- Launch of a number of new pipeline merchandise and formulations
Whereas no analogy is ideal, it seems that initially, inventory costs have risen for Zoetis and Haleon following the preliminary IPO. Nonetheless, Kenvue is down ~8 to 10% from its IPO value year-to-date. Nonetheless, Kenvue not too long ago introduced robust Q2 earnings, suggesting a constructive signal for his or her first quarter as an unbiased firm. To what extent do you imagine Kenvue can persistently exceed income and earnings development within the coming quarters?
Causes Supporting A KVUE Trade
Under, we summarize potential causes that may help exchanging a portion of JNJ shares for KVUE shares:
- JNJ is at the moment modestly overvalued and KVUE pretty valued. Take revenue and put money into a high quality firm
- “Hedge” towards future pharma enterprise headwinds (e.g., Stelara LOE, IRA & rebate pressures, elevated competitors / declining manufacturers)
- Unresolved talc product litigation could end in considerably larger settlement necessities for JNJ
- 7% upfront low cost on KVUE and anticipated return could also be engaging if future efficiency is just like Zoetis; higher than anticipated Q2 outcomes helps robust execution because the separation
- Iconic and resilient manufacturers with model fairness and development regardless of financial slowdown
- Manageable debt ranges with KVUE and JNJ extra uncovered to talc product liabilities (assuming eventual LTL chapter approval and no additional enhance to combination settlement)
Causes For No Share Trade
Equally, we summarize potential causes that don’t help exchanging a portion of JNJ shares for KVUE shares beneath:
- Desire to not dilute JNJ returns by changing larger development, larger profitability enterprise with modest development and decrease profitability enterprise
- Increased longer-term valuation multiples for Pharma and MedTech companies given the pharma portfolio focus in oncology and cell & gene-based therapies in addition to its latest MedTech acquisition (Abiomed)
- Shopper Well being enterprise mannequin is extremely commoditized with heavy competitors (e.g., low margin, excessive quantity) requiring important client digital engagement and DTC promoting
- Not sacrificing “diversification” with spin-off as a result of Shopper Well being is simply ~15% complete gross sales and current Pharma and MedTech companies are already extremely various
- Uncertainty for KVUE to attain efficiency targets subsequent 3-5 years based mostly on analog execution
Closing Issues
Remaining Unanswered Questions
There are nonetheless a number of unanswered questions main as much as the trade, a few of which can embody:
- How will the trade and the variety of shareholders that decide in have an effect on the inventory value for each J&J and Kenvue?
- If the trade provide is below or over-subscribed, what’s going to J&J’s method be in the direction of the remaining shares?
- How will the spin-out impression J&J’s reported annual income, EPS estimates, and dividend? (Do the prevailing annual estimates embody or exclude Kenvue operations?)
- How does the latest choice by a US chapter choose to disclaim LTL’s chapter standing impression pending talc-litigation and future debt implications for J&J?
- What’s going to Kenvue’s dividend development coverage be shifting ahead?
Our Choice on Exchanging Shares
Will you be buying and selling a few of your J&J shares for KVUE? Personally, my spouse and I are long-term buyers and can probably maintain on to our J&J shares. We’re unlikely to take part within the trade provide for Kenvue. Our primary causes embody the next:
- Increased compounded development and revenue for its two core companies (pharm and MedTech), probably leading to larger valuation multiples sooner or later
- JNJ Pharma headwinds are largely industry-wide and J&J has a robust observe file of navigating short-term portfolio challenges (e.g., patent expiration, rebate negotiations)
- Not initially planning on promoting JNJ resulting from talc litigation danger
- Not shedding JNJ diversification since Shopper Well being enterprise is simply 15% and Pharma and MedTech portfolios are already very well-diversified
- Restricted efficiency information obtainable for Kenvue, remaining unanswered questions previous to trade choice and the choice to at all times purchase at a later date
Moreover, there’s at all times the choice to purchase Kenvue at a later date if we desired larger client well being publicity past the S&P 500. Thanks for studying this lengthy publish and we hope you discover our evaluation useful! Please tell us your ideas on whether or not you propose on collaborating within the trade on August 18th.
