On Wednesday, British multinational pharmaceutical giant GlaxoSmithKline PLC (GSK, Financial) revealed a sweeping strategic transformation plan aimed towards growing the company’s profits and performance over the next decade, improving its pipeline and unlocking value for shareholders.
The plan, which will result in a “New GSK,” will include the spinoff of its consumer health care business, which it expects to complete by mid-2022. The company plans to use the spinoff to boost its underperforming drugs business by $11 billion, with a focus on investing in the development of vaccines and specialty medicines.
The transformation
By sales, GlaxoSmithKline is the world’s biggest producer of vaccines. However, its core drugs and vaccines business has been lagging in recent years due to a lack of fast-growing products and the expiration of patents.
Thus, the company will be “investing to drive step-change in growth and business mix.” The goal is to have vaccines achieve a high single-digit compound annual growth rate and specialty medicines achieve a double-digit CAGR. The general medicines category is expected to be mostly stable, with the only changes coming from business optimization.
“Immune dysfunction contributes to pathophysiology of many diseases with scientific understanding rapidly evolving,” the company noted in its investor update on Wednesday, explaining why it plans to focus its research and development efforts on the science of the immune system, human genetics and advanced technologies. GlaxoSmithKline aims for more than 70% of its clinical pipeline to consist of immuno-modulators.
The treatment and prevention of immune disfunction has the potential to benefit patients that fall under any of the company’s key therapeutic areas, including infections diseases, HIV, oncology, immunology and respiratory.
On the back of its transformation plan, the company is committing to sales growth of more than 5% and profit growth of more than 10% between now and 2026. The adjusted operating margin would ideally be more than 30% by 2026 as well. It also aims to reach more than 33 billion British pounds ($46 billion) worth of annual sales before the end of the decade, which CEO Emma Walmsley says is very important in terms of seeing the company through the loss of its exclusive patent on HIV drug dolutegravir.
“This growth is all about a quality vaccines and specialty medicines portfolio, and that’s really core to the strategy of New GSK, being focused on prevention of disease as well as treatment,” Walmsley said in an interview on CNBC. “It’s about setting out a New GSK as a growth company with new ambitions for shareholders, but also our chance to impact positively the health of two and a half billion people over the next decade.”
In addition to a New GSK, the company’s transformation plan also includes the spinoff of its consumer health care business, temporarily dubbed as “New Consumer Healthcare.”
“The new Consumer Healthcare company will have a portfolio which generated annual sales of more than 10 billion pounds ($14 billion) in 2020 and is well-positioned for further growth,” said the company.
GlaxoSmithKline also said it would likely slash its dividend by 31% in order to reinvest more of its earnings back into growing its business operations: “New GSK will adopt a progressive dividend policy targeting a dividend payout ratio equivalent to 40% to 60%, starting at 45 pence per share in 2023, the company’s first full year of operation.”
Unlocking value
GlaxoSmithKline expects that its transformation plan will result in growth for New GSK and New Consumer Healthcare, though the focus seems to be on New GSK and its drug pipeline.
The company has made several acquisitions over the years focused on expanding both its drug pipeline and its consumer health care business. The separation of these businesses, along with significant changes to company strategy and a management shake-up, could help both of them accelerate their growth.
However, while the strategic changes could benefit both GSK and its spinoff from a business standpoint, the company has identified the following as the main goals of the separation: 1) Unlock potential in New GSK and New Consumer Healthcare, 2) Strengthen New GSK balance sheet and 3) Maximize shareholder value.
In other words, while the company’s primary focus is beefing up its R&D budget and paying down debt at the expense of the consumer health care business, it expects the separation will result in the market re-evaluating the prospects of both of the new companies and assigning them higher earnings multiples.
This begs the question, is GlaxoSmithKline’s stock undervalued currently? The company seems to think so, and the GuruFocus Value chart seems to agree. As of June 23, shares traded around $39.82 apiece while the GF Value stood at $43.97, making the stock modestly undervalued. The price-earnings ratio of 13.67 is below the industry median and the company’s own 10-year median price-earnings ratio of 18.87.
Will the consumer business be a worthwhile investment?
GlaxoSmithKline’s move to separate itself from its consumer health care business brings with it the question that investors must always ask themselves before an upcoming spinoff: Is this split being made to benefit both the main company and the spinoff, or is the company cutting off a business that it expects to decline in the future?
Given that New GSK will extract an $11 billion special dividend from the New Consumer Healthcare spinoff, it seems possible that it is planning to gain a last benefit from the business before washing its hands of an expected underperformer. However, that assumption is premature given that the company could simply think the drug pipeline will benefit more from the investment dollars than the consumer health care business would.
“This is a tremendous business that we’ve built up over the last few years,” Walmsley said about the consumer health care business, which achieved 4% year-over-year net sales growth in 2020. It is a global leader in its industry, with more than 20 brands (including Advil, Sensodyne and Theraflu) and operations in over 100 markets worldwide.
If the consumer health care business can keep its dominant market position and continue its steady growth trend, it could be worth keeping the shares once it spins off from its parent company, even though it might not reach the more ambitious growth goals that the vaccines and specialized medicines divisions are targeting.
Conclusion
GlaxoSmithKline is far from an unprofitable company. However, its stock has achieved lackluster returns since the 1990s, and its revenue has been fairly stagnant since 1999.
If pharmaceutical giants aren’t consistently developing life-changing treatments that can generate significant revenue growth, it is common for investors’ fervor to cool down, as they expect revenue to begin declining once patents expire without enough growth drivers to replace them. With annual revenue fluctuating in a range of around $35 billion to $45 billion over the past decade, it would also be difficult for investors to get excited about moderate growth numbers.
The spinoff of the consumer health care business could act as a much-needed catalyst to get the markets to re assess the prospects of both New GSK and New Consumer Healthcare. On its own, New GSK also has the potential to report higher growth rates if its efforts to enhance its pipeline are successful.
