Interesting Medical Spin-Off for Mid-2013

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Dublin-based medical conglomerate Covidien PLC (NYSE: COV) has confirmed that it plans to complete the spin-off of its pharmaceutical division by the middle of 2013. Although the proposal to create Mallinckrodt Pharmaceuticals was announced more than a year ago, it has been subject to some non-fatal delays along the way. However, these appear to have been resolved. The soon-to-be-independent division has embarked on a major hiring spree and appears poised to begin trading on its own by the end of the second quarter of 2013. Current Covidien shareholders stand to reap the benefits of their patience in the form of an attractive share offering. At this point, it appears unlikely that anything will arise to scuttle or further delay the deal.

About Covidien PLC and Mallinckrodt Pharmaceuticals

Covidien is a highly-diversified drug and medical device manufacturer that makes a wide range of high-end medical products. Originally a wholly-owned division of Swiss conglomerate Tyco (NYSE: TYC), Covidien has been independent for a number of years and has lately mounted an impressive program of organic growth. Tyco today focuses on safety and security solutions in various industries such as energy and shipping.  Covidien, on the other hand, produces a variety of surgical aids and devices, including laproscopic probes, vessel-sealing devices, staples, vascular dilation and contraction aids, and an assortment of dialysis-related products. It also manufactures ventilators, blood-flow aids, vital-signs monitors, and other types of durable hospital equipment. In addition to surgical aids and hospital-room machinery, the company also makes a variety of specialized disposable products for patients who suffer from incontinence, chronic wounds and other ongoing conditions. The company earned about $1.9 billion in revenue of $12 billion in 2012.  This number is now larger than Tyco, its parent company which has revenue just over $10 billion and a loss for the last twelve months. 

Based in the Saint Louis area, Mallinckrodt Pharmaceuticals is Covidien's pharmaceutical division and will soon become a standalone company. The firm is noted for producing various chemotherapy and radiotherapy drugs for cancer patients. It also produces opiate and NSAID painkillers, imaging and contrasting compounds, and diagnostic drugs that play an important role in detecting early signs of cancer and other serious health problems. The company operates a major research and development center in Missouri and employs several thousand others in various parts of the United States and Ireland.

How the deal is structured

Although the terms of this deal have yet to be finalized, its basic outline is clear. Covidien plans to spin off Mallinckrodt through a tax-free share distribution to all of its shareholders of record. The exact ratio by which the new company's shares will be distributed has not yet been announced. It is expected that any fractional shares left over after the distribution will be distributed as cash payments to the appropriate shareholders. Thus far, there has been no talk of a special dividend, preferred stock distribution or other "sweeteners." 

Although it is not yet possible to pinpoint the exact premium that Covidien's shareholders will receive as a result of the spin-off, the company's investors have reacted favorably to news of the deal. Since its late 2011 announcement, Covidien's shares have risen by more than 50%.

Complications and legal issues

At this point, the primary hurdles that stand in the way of this deal's completion are logistical rather than legal. Since no major lawsuits or investigations have arisen to complicate this deal, it appears likely that it will close as planned. Covidien's management team has hinted that it will release specific information about the deal's terms and timing by the end of the first quarter of 2013.

Long-term prospects and outlook

According to the latest figures, Mallinckrodt accounts for just under 20% of Covidien's total sales. As such, the company can expect to earn annual revenue in the neighborhood of $2 to $2.5 billion during the first few years of its existence. In terms of size, this means that it will be one of the smaller newly-formed companies to arise out of the current wave of pharmaceutical spin-offs. For comparison, Abbott Labs's (ABT) AbbVie (NYSE: ABBV) spin-off has annual revenue of about $18 billion. 

However, Abbott Labs is a far less diversified company than Covidien. In addition, Mallinckrodt will have a far more specialized and high-end portfolio of drugs. By contrast, AbbVie's business model relies heavily on the development and sale of blockbuster drugs that have the potential to bring in billions of dollars in revenue on an individual basis. In other words, it may be unfair to compare the two companies.

Regardless, it must be noted that Mallinckrodt is entering a crowded, highly competitive space. While the newly-formed company will be able to rely on a robust portfolio of proven drugs, it will need to invest heavily in research and development in order to remain competitive. The company's current hiring blitz indicates that its management team is aware of this need.

In sum, the Mallinckrodt spin-off looks to provide current Covidien shareholders with a solid opportunity to turn a profit. In the short term, the company is likely to perform well and could provide returns of 20% or more after its release. These returns could be further enhanced by a special dividend. Accordingly, investors would do well to listen to the statements provided by Covidien's management team in the coming weeks.


Mike Thiessen has no position in any stocks mentioned. The Motley Fool recommends Covidien. 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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