By Gene Marcial

 

Pfizer (PFE +0.09%) isn't just developing more innovative drugs to stay on top of the global health care business. The world's biggest research-based pharmaceutical company also continues to look for ways to enhance shareholder value.

Spinning off its animal health care division, which generated sales of $4.2 billion in 2011, is its latest investor-incentive brainstorm.

Pfizer announced on June 7 that it would spin off to shareholders its animal health unit and turn it into an independent, publicly traded company. Pfizer will shortly file a registration statement for an initial public offering for the new company, to be called Zoetis, in which it will hold a minority stake.

That should be welcome news to Pfizer shareholders, who will have the opportunity to own shares in a thriving new company in an expanding industry. Global demand for products and services for animals has been strong.

More details about the planned spin-off will be revealed in Pfizer's second-quarter announcement. In the meantime, the animal health unit will be treated as a continuing operation for financial reporting purposes. The animal division has been a positive contributor to Pfizer's bottom line, but the company believes the unit will perform better as an independent company and, at the same time, further improve shareholder value.

"Pfizer animal health unit is a dynamic business with strong fundamentals, an expanding and loyal direct consumer base and a proven management team," said Pfizer chairman and CEO Ian Read. "Our focus continues to be on taking the action that will generate the greatest after-tax value for our shareholders," he added.

Zoetis plans to build on Pfizer's leadership in providing a diverse portfolio of animal vaccines, medicines, biopharmaceuticals, diagnostics and genetic tests to prevent and treat diseases in livestock and companion animals, according to Read.

The animal unit has more than 9,000 employees and markets its products in more than 120 countries, including the emerging nations. It has its own extensive research operations and holds leading market positions in North America, Europe, Africa, the Middle East, Latin America and Australia.

The spin-off is expected to be completed before July 2013. "We think Pfizer could entertain a split-off transaction where investors choose stock in either Pfizer or the new company," says Joseph Cornell, the president of Spin-Off Research.

In a split-off, holders of Pfizer shares must choose to continue owning the stock or exchange some or all of the parent's stock for shares in the spin-off company. Typically in a spin-off the parent offers its existing shareholders stock in the subsidiary in exchange for shares in the parent.

Cornell notes that to induce enough shareholders to swap stock, investors are offered shares in the unit that are worth more than the shares being returned to the parent company. This offered premium explains why split-offs are often oversubscribed. Some successful split-offs have been those of Sara Lee (SLE -0.95%)/Coach (COH -0.70%), Du Pont (DD +0.16%)/Conoco (COP -0.62%) and Bristol-Myers Squibb (BMY +1.14%)/Mead Johnson Nutrition (MJN +2.03%).

Shares of Pfizer have leaped from $16 a share in April 2011 to a 52-week high of $23.08 on April 27, 2012. Currently trading at $22, the stock is expected to continue rising.

Analyst Herman Saftlas of S&P Capital IQ, who rates Pfizer as a "buy," expects improving bottom-line trends, "helped by growth in emerging markets, cost restructurings and share buybacks." Generic competition for its blockbuster cholesterol drug Lipitor, which produced sales of $9.6 billion in 2011, is expected to drive down sales in 2012. Lipitor's patent expired in November 2011. But Saftlas says he likes Pfizer's R&D pipeline, with key catalysts on three potential breakthrough drugs expected over the near term.

Saftlas says Pfizer's animal health division offers one of the largest-selling and broadest product lines in the field, including feed additives, antibiotics and other veterinary products. Pfizer's bottom line is expected to be helped by more buybacks with its ample cash stash. Operating cash flow for 2012 is projected at about $19 billion. In April 1012, Pfizer agreed to sell its nutrition unit to Nestle for $11.8 billion. That should give the company more ammo for more share repurchases.

For 2013, Saftlas expects Pfizer to post earnings of $2.33 a share, up from an estimated $2.24 a share in 2012. In 2010, Pfizer earned $1.11 a share.

While Hillshire's frozen desserts business, including its cheesecakes, seems to have little to do with sausage, Connolly argued that the business is extremely popular in commercial food service and gives Hillshire a chance to sell those clients on its meat products.

He added that the bakery expertise helps Hillshire make better-quality frozen breakfast sandwiches, which have been a growth engine for Jimmy Dean in recent years.

By January, Hillshire plans to move 500 to 600 employees back to Chicago, on the Near West Side, which Connolly sees as fitting because of the company's roots in the city.

Like the company's history, the mechanics of its separation are a little complicated.

Company shareholders will receive one share in DE Master Blenders for every share owned in Sara Lee. The company stock will also go through a one-for-five reverse split, meaning shareholders will receive one share in Hillshire for every five shares held in Sara Lee. This relatively unusual division prevents the new Chicago-based company from debuting as a $5 stock.

"It's more of a marketing or appearance sort of thing," said Joe Cornell, managing principal of Spin-Off Advisors and author of "Spin-off to Pay-off." "They'd rather not have a sub-$10 stock, but cutting the pie differently doesn't change the value."

Shareholders will also receive a $3 special dividend.

James Schrager, a clinical professor of entrepreneurship and strategic management at the University of Chicago's Booth School of Business, explained, "it became very, very profitable to be in a conglomerate and the stock market welcomed and rewarded executives who went out and bought other companies."

However, "by the mid-'80s everyone figured out it was a temporary gain," he said. "In fact, it's much harder to manage a company than it seems when they're just buying a good brand when you don't know what's going on inside them." But Sara Lee kept buying.

Brands like Jimmy Dean, Kiwi shoe polish, and Champion sportswear joined the portfolio in the 1980s. Sara Lee Corp. became the company's official name in 1985.

Sara Lee bought Playtex in the 1990s, along with other apparel, meat and coffee brands, reaching the $20 billion sales mark in 1998. Then growth plateaued. Sara Lee began scaling back in 2000, spinning off Coach and selling other businesses.

After years of lackluster earnings, Sara Lee announced plans to spin off or sell 40 percent of its businesses in 2005, including its apparel division led by Hanes, European packaged meats and U.S. retail coffee. PepsiCo alum Brenda Barnes was named CEO and credited with accelerating the company's divestitures.

"They've tried to say for years now, 'We've gotten to a manageable collection of businesses,'" said Tim Calkins, a clinical professor of marketing at Northwestern University's Kellogg School of Management. "Then a few years later they would say, 'Now we've gotten to a manageable collection of businesses,' but each time the company really struggled and ended up splitting up some more."

Sara Lee announced major sell-offs in 2009 and 2010: its household and body care business to Unilever, followed by its North American bakery business to Grupo Bimbo. Barnes stepped down in 2010, after suffering a stroke. She was succeeded by Marcel Smits, who announced the intention to break up the company in early 2011.

After the split, the question for a number of industry analysts is whether a smaller company can stay independent, or if it's likely to be absorbed by a larger one. After all, Hillshire's first-year sales are expected to be about half those of meat-industry competitor Hormel and a fraction of those of Tyson Foods.

"There tends to be a lot more merger activity with these companies post-separation or spinoff," said Cornell, estimating that companies are three to four times more likely to be bought by a larger company within six to 12 months following separation.

As for Sara Lee in particular, Cornell added, "We think both pieces could be good takeover targets by a strategic buyer, for a bigger competitor to pay up for them."

For his part, Connolly believes meat consumption in the United States will only grow.

"The vast majority of consumers love meat in the foods they eat," Connolly said. "Consumers are just eating meat differently, which is why we're so committed to innovation and following consumer trends to give them meat in the products they want."