Billionaire Steve Cohen Bets Big On This Spinoff

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SAC Capital Advisors, the hedge fund managed by billionaire Steve Cohen and his team, has filed a 13G with the SEC to report that it owns 7.6 million shares of Zoetis (NYSE: ZTS), an animal pharmaceuticals company that was spun off from Pfizer in February (the stock is about flat from its levels in early February). According to the filing, this gives the fund control of 7.7% of the company's total outstanding shares. We track quarterly 13F filings from hundreds of hedge funds, including SAC, as part of our work researching investment strategies (we have found, for example, that the most popular small cap stocks among hedge funds earn an average excess return of 18 percentage points per year). We can see from our database that Cohen had owned about 730,000 shares as of the end of March (find SAC's favorite stocks), so most of the fund’s purchases have come in the last few months rather than immediately after the spin-off.

Zoetis has released a 10-Q for the first quarter of 2013, though investors should of course be aware that as a recent spin-off the company is in a period of transition, and that any comparison to a year ago will not be completely perfect. In any case, the report shows Zoetis’s revenue grew by 4% during the quarter compared to Q1 2012, and earnings were up even if we add back higher restructuring charges in the prior year period. The 10-Q showed net income of $140 million for the quarter--28 cents per share--and about $280 million in cash flow from operations, with little capital expenditures required.

If we annualize last quarter’s earnings per share figure we get a P/E multiple of 28. Wall Street analysts are expecting $1.62 in EPS for 2014, which would require improvements on the bottom line. We’d note that many hedge funds and value investors like to invest in spin-offs on the theory that management of the new company is better able to focus on operations without having to concern themselves with the needs and initiatives of the parent company. Read more about investing in spin-offs. However, many market players are bearish, as shown by the fact that 19% of the float is held short.

VCA Antech (NASDAQ: WOOF) and IDEXX Laboratories (NASDAQ: IDXX) are two other animal health companies, though they tend to focus more on pets and on laboratory and hospital services (as opposed to pharmaceutical products) than Zoetis does. VCA Antech carries a high trailing earnings multiple, but the sell-side expects the company to improve over the next year and a half, and so the forward P/E comes in at only 15. However, earnings were down in the first quarter of 2013 versus a year earlier and so we think that we’d avoid it at least for now. Recent reports show a rise in both sales and net income at IDEXX, but investors have already incorporated expectations of high future growth in the stock price and so the trailing and forward P/Es are 27 and 23, respectively, which seems a bit high for us to get involved.

Merck (NYSE: MRK) and Sanofi (NYSE: SNY) are two large pharmaceutical companies which maintain animal health units of their own, and these segments may be closer competitors for Zoetis. Each of these peers has been struggling recently, recording a 9% decline in revenue in their most recent quarter compared to the same period in the previous year; earnings were down in each case as well. However, analysts are also optimistic for these businesses. While Merck and Sanofi feature trailing P/Es of more than 20, they both trade at only 12 times forward earnings estimates. Merck may also be of interest to income or defensive investors, with a dividend yield of 3.7% and a beta of 0.4.

We’d consider Merck on that basis, but would be a bit concerned about the degree to which its valuation depends on future earnings growth. In fact, right now analysts seem to be expecting significant earnings growth at a number of these companies, including Zoetis itself, and with financial performance not looking good in a number of cases we’d be wary of treating any of these stocks as value plays.

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This article is written by Matt Doiron and edited by Meena Krishnamsetty. They don't own shares in any of the stocks mentioned in this article. The Motley Fool recommends VCA Antech. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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