With Abbott's Spinoff Around the Corner, Should You Buy In?

Jordo is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

The highly publicized Abbott Laboratories (NYSE: ABT) spinoff is coming in roughly one month. The healthcare giant will spin off its proprietary pharmaceutical business segment into a new company, AbbVie.  The remaining segments of the business will remain a part of Abbott Laboratories. Will this turn out to be a good move for investors? Should investors buy into the stock now?  

One of the most attractive aspects of investing in Abbott has been its ability to pay dividends. This stock has paid dividends every year since 1924, a stretch of 354 consecutive quarters. Will this split affect Abbott’s ability to pay out dividends? I believe the likely answer is a definitive no. Abbott paid out over $2.9 billion in dividends in fiscal year 2011.  Assuming the new Abbott will pay out dividends in the future that are proportionate to its part of the current company’s total sales it would need to pay out something in the neighborhood of $1.6 billion to maintain 2011 ratios. Taking the non-proprietary segment of the current Abbott’s earnings we find that the company has earned over $1.9 billion in just the first two quarters of 2012.  This makes it very likely that the company will continue to generate more than enough earnings to continue the generous dividends that Abbott is known.

As far as AbbVie, the business segment that will make up this new company, proprietary pharmaceuticals, generates even more income than the new Abbott segments currently generate.  This segment has generated over $5 billion in earnings through three quarters of 2012. This company will be more than capable of providing shareholders with handsome dividends.

Perhaps the main reason companies will split segments is due to the belief that the stock is grossly undervalued.  If that is correct here then the new Abbott and AbbVie will collectively trade higher than the current share price of Abbott.  I believe this will happen when Abbot splits. The two companies will be more valuable than Abbot is currently.

Using the last full year of operating reports AbbVie would have generated $19 billion in sales during fiscal year 2011.  This means the company will have slightly smaller sales than Eli Lilly (NYSE: LLY) and Bristol-Myers Squibb (NYSE: BMY). Eli Lilly generated a little over $24 billion in sales while Bristol-Myers saw a little over $21 billion in sales.  Taking this information and trying to generate some sort of value for the new company we can use the price to share ratios for these two companies.  Eli Lilly has a current price to sales ratio of 2.36 while Bristol-Myers’ currently stands at 2.86. Using this information, I can roughly value AbbVie at between $43 billion and $53 billion.

The new Abbott's sales based on 2011 results would be around $22 billion. This company will have segments in medical devices, generic pharmaceuticals and consumer nutritional products. Johnson & Johnson (NYSE: JNJ) provides a good comparison to the new Abbott. Using Johnson & Johnson’s current price-to-sales ratio of 2.9, we would find the new Abbott having roughly a $63 billion market cap.

Combing those two figures we find that the potential valuation of the new Abbot and AbbVie at somewhere between $106 billion and $116 billion.  The current market cap of Abbott stands at less than $102 billion.  This leads me to believe that there is still significant value in this stock, even though we are roughly one month away from the split.  Investors should be looking at anywhere between $4 billion and $14 billion worth of value to be gained sometime in early 2013, this is exactly why management decided to pursue this spinoff.

It is worth pointing out that one potential result of this spinoff could be that a pharmaceutical company buys out AbbVie. Recently, Elan (NYSE: ELN) announced that it was spinning off its research arm, and it is widely seen as an effort to make the pharmaceutical company attractive to potential buyers. While Elan will be a much smaller company than AbbVie after both spinoffs, the potential is still there for a buyout of AbbVie, which is another reason for investors to lock in on Abbott while there is still tremendous value and upside.

While the actual outcome of Abbott’s upcoming spinoff is unknown, there are god reasons to believe that investing in Abbott now will produce some nice returns in early 2013. The eventual stocks could very easily see a 15% to 20% return in just the first month or two of 2013. Combine this upside with the tradition of providing solid dividends, and this stock has the look of one of the early winners of the new year.

jordobivona has no positions in the stocks mentioned above. The Motley Fool owns shares of Johnson & Johnson. Motley Fool newsletter services recommend Elan and Johnson & Johnson. 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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