It’s funny how fashion changes in the corporate world.
Back in the 70s, the sexiest companies were conglomerates that operated in lots of different industries. So a conglomerate might have separate divisions selling, say, tobacco, frozen food and hotel rooms.
In the 90s, fashion changed. Focus became trendy. Many conglomerates were broken up into separate companies operating in just one industry. That was a sensible change. If the directors of a company focus on just on one industry, they’re more likely to build up specialist knowledge and not get distracted by ephemera.
That said, even though this change in fashion started 25 years ago, there are still some conglomerates with break-up potential. And there’s one which I think is well worth buying.
This company could slim down
So which company am I talking about?
GlaxoSmithKline (LSE: GSK), the pharmaceutical giant.
I know, the words, ‘pharmaceutical giant’ suggest that Glaxo is a company that operates in one industry – medical drugs. But actually, that’s not true.
Granted, the main part of Glaxo’s business is developing patent-protected pharmaceutical drugs. But Glaxo also has a consumer healthcare business that sells products you can buy in your local convenience store – things such as toothpaste and vitamin tablets.
Admittedly, there is some overlap between pharma drugs and consumer healthcare, but not that much, and I think it would be better for shareholders if consumer health was spun off into a separate company. Senior management in both companies would then be fully focused on either pharma drugs or consumer products. And that should lead to improved performance.
What’s more, a break-up gives more choice to investors. Currently, if you buy shares in Glaxo, you’re investing in the main pharma drugs division as well as the consumer health division. The consumer division generates around 20% of sales and roughly 10% of the profits. So on a ‘back of the envelope’ basis, perhaps 15% of your investment is going into consumer health with the rest in pharma drugs.
But you might think that consumer health is a rubbish business, and you really want to invest all your cash into pharma drugs, or vice versa. But you don’t have that option. You’re stuck with Glaxo as it is. It’s a simple binary decision – you invest in Glaxo as it is now, or not at all.
But if Glaxo was split up into two companies with separate stock market listings, you could invest 60% of your money in ‘Glaxo Consumer’ and 40% in ‘Glaxo Pharma’. Or whatever proportions you fancied. The choice would be yours.
I think that extra choice could bring in more investors.
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We could also see some ‘multiple expansion’. Basically, large consumer product companies tend to trade on higher price/earnings (P/E) ratios than pharmaceutical companies. For example, Glaxo currently trades on a price/earnings ratio of 12, whereas Unilever’s ratio is 19. So ‘Glaxo Consumer’ might well trade on a higher multiple than 12, and that would deliver a financial boost to existing shareholders.
If you’re wondering why consumer companies tend to have higher price/earnings ratios, I think it’s mainly because they’re less risky. The likes of Unilever (LSE: ULVR) and Reckitt Benckiser (LSE: RB) don’t have to worry too much about their products losing ‘patent protection’. But patent expiries are a huge issue for large pharma companies.
I’m writing about this now because Glaxo’s boss, Sir Andrew Witty, hinted in an FT interview yesterday that he might be willing to spin off the consumer health division. What’s more, I think a corporate deal with Novartis earlier this year makes a spin-off even more attractive and more likely too.
You see, Glaxo and Novartis are about to merge their consumer divisions into a joint venture where Glaxo will have a 63.5% stake. As a larger business, it should be all the more attractive as an independent entity.
It’s also worth noting that Reckitt Benckiser announced yesterday that it was selling off its pharma division so that it can focus purely on its 19 consumer ‘power brands’. So I think Glaxo should follow Reckitt’s lead.
So should you buy shares?
Well, I own shares in Glaxo, so you’d expect me to be positive. But at the current price of £14.12, with a price/earnings ratio of 13, I think the company is in bargain territory. Admittedly, bears are concerned that the company’s new respiratory drugs have got off to a disappointing start in the US, but I think that’s probably a short-term problem and the shares have fallen too far.
In fact, I think the shares are a bargain even if Glaxo never does spin off the consumer division. But if the spin-off does happen it will be a nice catalyst for some share price growth. Go on, Sir Andrew. Spin off consumer health!
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On this day in history
Dubbed the ‘Austerity Games’, the XIV Olympiad opened in London to 85,000 spectators in Wembley Stadium on this day in 1948.