British pharma giant GlaxoSmithKline (NYSE: GSK) is reportedly exploring a breakup of its consumer healthcare and pharma/vaccine units into separate businesses. The drugmaker's management is under pressure from top shareholders after a decade of disappointing returns on capital. Glaxo's stock, after all, has not only lagged behind the rest of the biopharmaceutical space, but its shares have actually lost investors money to boot.
Even though the drugmaker did swap out a significant chunk of its managerial team in the past year, the company's recent decision to dole out $13 billion for Novartis' (NYSE: NVS) consumer healthcare unit apparently isn't sitting well with shareholders.
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The problem is that consumer healthcare tends to be a far less profitable business than pharmaceuticals and vaccines, and the company leveraged its balance sheet to the max to get this uninspiring deal done with Novartis earlier this year. For example, Glaxo's debt-to-equity ratio now stands at an eye-popping 486 after purchasing Novartis' consumer healthcare unit, giving it arguably zero financial flexibility to consummate other mergers or acquisitions in the high-value pharmaceutical space.
With this background in mind, let's consider whether it's time for this healthcare titan to split up.
What a breakup entails
A breakup is an appealing move for shareholders because there are arguably few, if any, real synergies between consumer healthcare and pharmaceuticals. The only reason to keep the band together, so to speak, is that the combined business obviously generates higher free cash flows than they would separately. In fact, Merck KGaA sold its low-margin consumer healthcare unit to Procter & Gamble not long ago for this very reason, and Pfizer (NYSE: PFE) is closing in on a spinoff of its own consumer healthcare unit to focus more on pharmaceuticals as well. Glaxo would thus be following in the footsteps of its big pharma peers if it did break up.
The problem here, though, is that Glaxo's heavy debt load and middling clinical pipeline make a split a logistical nightmare. The drugmaker, after all, simply can't straddle its consumer healthcare business with the bulk of this long-term debt — that is, unless it wants this business to fail. On the other hand, Glaxo would need to beef up its pharma pipeline via a large acquisition — or series of smaller acquisitions — to make this business viable as a stand-alone. And that would require a healthy balance sheet to accomplish. In other words, Glaxo's debt is a tough hurdle to over come when it comes to exploring a breakup.
A breakup would also be the death knell for the drugmaker's sky-high dividend yield that currently stands at an astronomical 5.29%. Glaxo's management has already stated that they plan on tying the dividend yield to cash flow generation soon, so a significant reduction is almost guaranteed anyways. But the fact is that Glaxo's rich dividend program has long been the only solid reason to buy its stock. The drugmaker thus risks losing the attention of loyal income investors if it splits.
Glaxo's former and new management teams have painted the company into a corner that make a breakup difficult, to put it mildly. The drugmaker's clinical pipeline does have some intriguing assets such as the multiple myeloma candidate GSK2857916 and the HIV medicines dolutegravir and lamivudine that make the idea of a separate pharma business quite attractive. However, Glaxo would undeniably need more clinical assets and perhaps even more revenue from a bolt-on acquisition to transform this business into a healthy independent entity. Unfortunately, Glaxo's sizable debt load may not permit any significant business development moves going forward.
All told, Glaxo has more work to do to assuage the concerns of long-suffering shareholders, but a breakup doesn't appear to be in the cards at this moment. To do so, the drugmaker would have to saddle one of its businesses with way too much debt and that isn't a recipe for success.
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