GSK PLC (GSK, Financial) completed the long-awaited spinoff of its consumer health care business Haleon (HLN, Financial) on July 18. Shareholders received one Haleon share for each GSK share owned.
By separating the slow but steady consumer health business from the capital-intensive but high-potential pharmaceutical business, the spinoff was expected to drive GSK’s stock valuation multiples higher. The company, which changed its name from GlaxoSmithKline in May, also took a $7 billion payout as part of the deal to fund drug development and acquisitions.
However, the stock market situation has changed dramatically since GSK began planning the spinoff. Now the market is punishing growth stocks and retreating to the safe havens of inflation-resistant businesses.
Moreover, while demand for consumer goods is fairly predictable, the pharma industry is notoriously unpredictable because there is no guarantee a company will be able to continue turning out blockbuster drugs forever.
For investors, this brings up an important question: Will GSK turn out to be the real beneficiary of this separation, or will it end up being Haleon instead?
Missing the ideal timing
In June 2021, when the S&P 500 was still posting new highs every day, GlaxoSmithKline declared its intention to spin off its consumer health business and re-brand itself as the “New GSK.” At the time, it estimated that the spinoff would boost its underperforming drug development business by $11 billion.
By sales, GSK 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 sufficient new products from the pipeline to make up for the expiration of patents.
Unilver PLC (UL, Financial) offered to buy GSK’s consumer health business for $68 billion. However, believing that the price “fundamentally undervalued” the business, GSK decided to reject the bid and stick with the original plan of letting the open market decide the price.
It would appear that by rejecting the Unilever offer, GSK missed its last chance to lock in a favorable price point. As of this writing, Haleon has a market cap of just $34 billion. While its long-term potential may be greater than that, the rejected Unilever offer is a clear signal that the timing of the spinoff was not ideal.
GSK’s pipeline
With its stock price down nearly 4% year to date and not reacting much to the Haleon spinoff, the bad timing of this move may not be doing GSK’s valuation any favors. However, what matters more in the long term is the company’s ability to turn out a solid pipeline of new drugs.
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.
GSK will focus on the treatment and prevention of immune disfunction, which has the potential to benefit patients that fall under any of the company’s key therapeutic areas, including infectious diseases, HIV, oncology, immunology and respiratory.
“Immune dysfunction contributes to pathophysiology of many diseases with scientific understanding rapidly evolving,” the company noted in an investor note last year, explaining it plans to focus its research and development efforts on the science of the immune system, human genetics and advanced technologies. GSK wants 70% of its clinical pipeline to consist of immuno-modulators.
GSK is also open to continued growth through acquisitions. Its most recent addition made earlier this year was Sierra Oncology, a late-stage biopharmaceutical company with a candidate drug for bone marrow cancer that is projected to reach peak demand as high as 1.3 billion pounds ($1.58 billion) a year.
Haleon’s outlook
While Haleon does not have the same growth qualities as the “New GSK” business, it does have some defensive qualities which position it relatively well for a period of economic difficulty.
For example, it has popular brands that inspire strong brand loyalty, including Sensodyne, Advil, Flonase and Voltaren. Consumer health care also tends to hold up well even in periods of recession and high inflation, as customers rely on many of these products as part of their daily routines or to treat minor ailments.
According to estimates from SkyQuest Technology, the consumer health care industry is expected to achieve a CAGR of 6.1% through 2027. For Haleon’s part, analysts are expecting revenue of $13 billion and earnings per share of 44 cents in 2022, which is impressive considering that under GSK’s umbrella, the consumer health segment brought in revenue of 4 billion pounds in 2014, which translated to $6.58 billion given the average currency exchange rates that year.
In the medium-term, GSK estimates that Haleon can achieve a revenue growth rate of 4% to 6% per year.
Haleon does have significant debt to deal with; its cash-debt ratio of 0.42 is nothing to sneeze at, and it is undeniable that GSK intended the spinoff to benefit the pharma business more than the consumer health business.
Takeaway
The mega-trends of global population growth, ageing populations and worsening health outcomes in many nations (including developed countries due to inactivity and poor diet choices) bode well for general growth in the pharma industry, and the same can be said for the consumer health industry as well. Thus, both GSK and Haleon have long-term macro trends going for them.
The current market conditions appear to favor Haleon over GSK due to the defensive nature of Haleon’s business compared to the growth-oriented nature of GSK’s. Haleon has hit the markets at a much lower price than expected given Unilever’s previous bid, though, which has analysts applying heavy scrutiny to the value of the business.
Overall, I think both stocks are fairly valued for the short term and undervalued for the medium term. Short-term growth will likely be stunted by high inflation, but in the medium term, the recession-resistance nature and pricing power of the health care industry should come through. In the long term, a lot depends on how well GSK is able to grow its pipeline. Whereas Haleon can keep chugging along steadily, GSK is a higher-risk, higher-reward situation.
