Does the Johnson & Johnson split make sense?
Johnson & johnson (NYSE: JNJ) has been in business for over a century. Many were caught off guard when the company announced late last year that it would separate its medical device and pharmaceutical businesses from its consumer health businesses. The split is expected to close within the next two years. In this segment of Backstage pass, recorded on December 17, Fool.com contributors Rachel Warren, Jason Hall, Travis Hoium, Toby Bordelon and Lou Whiteman discuss.
Rachel Warren: The next deal we’re talking about is Johnson & Johnson. It is not an acquisition. We talked about it on the show a few weeks ago. But last month, 135-year-old pharmaceutical giant Johnson & Johnson announced it would split its business in two. It was a huge surprise to I think just about everyone.
The Company’s current business comprises three segments. She owns a fastest-growing pharmaceutical company, a medical device company, and a consumer healthcare company.
Once the split takes effect, Johnson & Johnson will be two publicly traded, dividend-paying entities. One of these entities will contain the pharmaceutical and medical device businesses which will retain the Johnson & Johnson name. The second listed company will be consumer healthcare. We do not yet know what its name will be as well as the management structure and names of this new company.
Jason Hall: Must be better than To block. We know that.
Rachel Warren: It must be. I mean it’s a low bar to start with but [laughs] I have faith that it will go up from there. The split is expected to take between 18 and 24 months. The consumer healthcare sector, I find it interesting that this is the sector that will not retain the Johnson & Johnson name because I think it’s the one most people think of when they think of Johnson & Johnson. Those brands like Tylenol, Motrin, Neutrogena that everyone uses. The pharmaceutical sector offers drugs covering the full range of medical problems.
Everything from those that treat cardiovascular disease to vaccines, and of course, its medical devices are used in a range of procedures. The idea here, according to the company, is to fuel business growth in the words of management to improve operational performance and strategic flexibility, unlock more value for stakeholders, the traditional explanation you expect from them. I think the problem here is that these companies don’t really depend on each other for their growth.
The direction that the consumer healthcare sector is taking is really very different from that of its pharmaceutical and medical devices. I think it makes sense that there might be a time when they would break it up.
There was speculation that it was related to the ongoing litigation that Johnson & Johnson is facing over its talc cancer claims, that it basically created a subsidiary, moved all the claims into that subsidiary, and then filed this subsidiary bankrupt, but they denied this.
We can only speculate there. Finally, the pharmaceuticals and medical devices segments are expected to generate revenues of approximately $77 billion this year alone. The consumer healthcare segment is expected to generate revenues of approximately $15 billion. It’s clear where this high growth area lies and I believe this split will allow both companies to grow at their own pace and succeed.
If you are currently invested in the company like me and remain invested during the split, we now understand that you will remain invested in these two public companies.
The company had previously announced the CEO change to replace its current CEO, Alex Gorsky, who has been leading the companies since 2012. The new CEO will be a man named Joaquin Duato. He takes office on January 3 and will take over as head of Johnson & Johnson. As I mentioned before, we don’t yet know who will lead the new consumer health company. I think it’s a positive agreement.
I think this will allow both of these companies to grow and tap into different consumer bases. I think you have a lot of different clients for each. There is some overlap, but it is clear that these companies have gone in different directions. I think the stock is an excellent dividend payer.
He fell behind S&P500this year’s performance, it is up about 20% compared to the S&P500total yield of about 30%. One to watch, looks like it’s going to be a while before it passes, but I see no reason why it won’t.
Jason Hall: For me Rachel, it reminds me of when Abbott broke up and it was 2013. It wasn’t exactly the same, but Abbott broke up AbbVie it’s the pharmaceutical business of Abbott’s lab, meaning their medical devices and all that. I guess they have a bit of consumer stuff. But I was looking before the show and saw that it went well for investors.
Rachel Warren: Fairly well, yes. [laughs]
Jason Hall: Yeah. Because it’s allowed a bit more focused on different segments by management. I think it’s important because the resource allocation and orientation is a bit better.
Rachel Warren: Absolutely, yeah.
Travis Houm: Well, it’s a theme across the market, GE splitting up I think these conglomerates and that’s just split in two but that’s been a theme over the last quarter and I think that could be for next year as companies like Jason, start focusing on something they do well and don’t half-heartedly try to do a million things.
Toby Bordelon: It will certainly be interesting. I wonder about that, will 2022 be more acquisitions or more spin-offs?
Lou Whiteman: Are there any left?
Toby Bordelon: There are some–
Lou Whiteman: Oh there are?
Toby Bordelon: There are a few on the tech side who I think would rather not part ways. Maybe there will be divisions of strength, we will see.
Jason Hall: Maybe shown the door as they say.
Lou Whiteman: Real quick on that, I think actually Toby and Travis, I think we talked about that on the show, but I think an underrated part of it is that technology makes it possible.
A big part of the old school argument for a conglomerate or a building was the back office. The back office becomes so much cheaper with cloud software. HR as a function can be dispersed more finely now, and that old argument that you just need all those back-office functions under one roof to save money.
That’s just not as true anymore because all of that back office has been automated and allows smaller, more nimble companies to be just as cost competitive as conglomerates on HR finance, accounting, just the non-client -face of it. I think this is a huge trend that is really underrated looking at all the splits.
Travis Houm: At this point, I think maybe the answer to Toby’s question is that I might see more tech acquisitions or mergers next year, as we’ve already talked about on a number of those.
You’re trying to put more software in one package as opposed to consumer durable goods. It may not make as much sense today as it did 20 or 30 years ago.
We can see these old custodial societies breaking up and these new societies merging as they try to grab land in any space.
This article represents the opinion of the author, who may disagree with the “official” recommendation position of a premium Motley Fool consulting service. We are motley! Challenging an investment thesis – even one of our own – helps us all to think critically about investing and make decisions that help us become smarter, happier, and richer.