Pfizer (NYSE: PFE) reported first quarter profit of $0.51 per share on $10.86 billion of revenue Tuesday —beating estimates of $0.49 per share. The performance was largely driven by strong demand for its vaccine and cancer drugs.
However, the drugs giant was forced to cut its 2015 revenue forecast to by half a million dollars to between $44 and $46 billion, blaming the strengthening dollar for the shortfall. Pfizer generates 60% of its revenue from overseas so is particularly vulnerable to currency swings.
Overall it was a positive quarter for the drugs giant which has been underperforming the broader market for several years due to the expiry of patents on some of its best performing drugs, such as the anti-inflammatory drug Celebrex and the cholesterol controler Lipitor.
The problem with Pfizer is not that it’s unable to produce new drugs to replace global established products with expiring patents. They have a range of promising new drugs, such as Prevnar-13 a vaccine for pneumonia and meningitis. The problem is these new drugs are not generating enough revenue for the market to get excited about.
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Pfizer has a market cap of around $200 billion, making it difficult for any single drug to have a major impact on the share price. The result is Pfizer’s stock has been flatlining for years now, forcing the board to announce an aggressive share buyback program in order to provide better value to shareholders.
Pfizer has also jettisoned some low growth businesses, such as its animal health care business Zoetis. However, many shareholders say this is not enough, arguing they would be better served by splitting the company in two.
How would a split work?
Splitting a company like Pfizer is no easy task, you can’t simply hive off the global established products business containing patent expired drugs like Celebrex. Global established products revenue fell by 7% in the first quarter alone for example. Who would want to own a company that loses revenue each year.
Nor can you simply slice the company in half, mixing the global established products business and global innovative drugs together. Falls in revenue from the global established products division would continue to cancel out any growth from innovative drugs no matter which way you cut it. They would simply be recreating the current problem, albeit on a smaller scale.
So the task facing Pfizer management is how to split the company in such a way that its global established products business can grow and form a viable business for shareholders going forward.
To that end Pfizer appears to have partially solved the problem by agreeing to pay $17 billion dollars for the intravenous drugs specialist Hospira, a deal which should be completed in the second quarter of 2015. In Hospira, Pfizer has what appears to be the perfect mate to pair with its global established products business.
Hospira produces generic injectable pharmaceuticals, along with integrated infusion therapy, which is used by hospitals and other healthcare professionals such as domiciliary care providers across the world.
But it’s their Biosimilars product line which most caught Pfizer’s eye. Biosimilars are a new type of biological pharma which are based on similar biological drugs from other manufacturers whose patents are about to expire.
Traditionally chemical based drugs have been easy for generic manufacturers to replicate once their patents expire. But biological drugs are much more difficult to replicate. Biosimilars aim to solve that problem by creating a drug which is similar if not identical to the original, while having the same therapeutic benefits.
Biosimilars are a new and exciting technology with a huge untapped market, they should bring increased competition while offering lower-cost alternatives to healthcare providers who are coming under increased pressure to reduce costs.
Hospira, Inc (NYSE: HSP) also reported earnings on Tuesday, posting first quarter profits of $0.43 per share on revenue of $1.17 billion up from $0.40 per share a year-ago. Excluding r&d and other superficial charges, earnings came in at $0.97 per share, way ahead of analysts predictions of $0.53 per share on revenue of $1.08 billion.
Most encouraging was the performance of its key injectables business which climbed by 12.9%, while other pharma sales including Biosimilars increased by 26.7% for the quarter. However a poor performance from its medication management unit, which fell 1.2%, took the shine of Tuesday’s results.
In Hospira, Pfizer has a company which aligns perfectly with its global established products business. Pfizer already has a large generic injectables business so by combining it with Hospira they should be able to achieve significant economies of scale.
While the exciting new Biosimilars business should provide strong growth going forward. We need to see the deal go through, possibly in the second quarter, but once complete it paves the way for a split.
That being said, Pfizer still has around $20 billion in cash which the firm may want to use to strengthen its global innovative products business first. Currently global innovative products, which include new biopharmaceutical drugs, make up less than half of Pfizer’s total revenue. Making a one share in each company split impossible.
Is Pfizer worth buying ahead of a split?
If a split comes it is not likely to occur until the first quarter of 2016. Management made no mention of a split in its first quarter conference call suggesting a split is some way off.
My own hunch is that Pfizer will want to make another large acquisition before instigating a split. I suspect that will be in the biopharmaceutical sector to boost bio revenue. There are many potential suitors, with Actavis and Bristol-Myers Squibb being mooted as possible candidates.
Pfizer is clearly going to offer greater value to shareholders as two separate companies. The only potential roadblock to a split was the handling of their global established products business. With the Hospira purchase Pfizer has solved that particular problem.
Hospira’s innovative biosimilars products should be able to provide strong growth in the global established products business long term. However, right now I don’t think that business is strong enough to compensate for declining established product revenues.
The next few quarters, after the Hospira purchase has been completed, should give us a better idea of how the financials in the global established products business stack up.
So is it worth buying Pfizer now, or should you wait until after the split and pick whichever company you think offers the better prospects?
The answer of course depends on your own personal circumstances. What is clear is that Pfizer is worth more than the sum of its parts. If you do buy the stock it should be on the premise that Pfizer splits in two. Owning equal shares in both companies after a split is going to provide you with more growth going forward.
My own feeling is that you should wait until Pfizer makes another big biopharmaceutical acquisition. If they do it will be clear a split is on the cards sooner rather than later.