In AMM Dividend Letter Vol. 23 we mentioned that Johnson & Johnson (JNJ) could be a target for activists. Size is no longer an impediment to initiating change. An activist investor has taken a stake in JNJ. We also mentioned that JNJ could split up into 3 companies to unlock value and this is the activist’s plan.
Artisan, a global investment firm that manages nearly $100 billion in assets, announced last week that it’s urging other activists to push for Johnson & Johnson (NYSE:JNJ), a $289 billion healthcare conglomerate, to break up into three separate companies: a consumer health company, a medical device maker, and a pharmaceuticals company. Based on Artisan’s numbers, doing so could unlock nearly $90 billion in enterprise value for shareholders.
As the article goes on to state, Artisan only owns 0.2% of shares outstanding. They won’t be able to push for changes on their own. Most likely they will get other large shareholders on board, try to get a seat or seats on the board, and push for change from the inside.
ExxonMobil (XOM) announced yesterday that they are suspending share buybacks. This may look like a company conserving cash during a difficult operating environment but it is probably a sign that ExxonMobil’s management has found something even better to buy.
A more plausible reason Exxon is ending buybacks: it’s preparing to acquire another company whose shares are even more deeply discounted than Exxon’s. And with “just” $3.7 billion in cash on hand at the end of the fourth quarter, its likely that Exxon would use its shares as currency for a buyout.
Who would they buy? The options abound for a company still sporting an equity market cap of $318 billion. Anadarko Petroleum (APC) has long been rumored to be a prime Exxon target; its shares are down about 65% to a market cap of $19 billion. Occidental Petroleum (OXY) float is $51 billion, ConocoPhillips (COP) $47 billion and Apache APA Corp. (APA) is at $15 billion. Deeper in the discount bin, Marathon Oil (MRO) shares could be had for $6.5 billion, or Devon Energy (DVN) for $11 billion.
Of course Exxon would also need to assume any debt carried by an acquisition target. But that wouldn’t be a problem — compared with the averaged overleveraged oil company, Exxon has modest gearing with $38 billion in debt outstanding.
Buying other energy companies during periods of distress is what ExxonMobil does. In 1998 when oil prices crashed Exxon bought Mobil. ExxonMobil has the balance sheet and the ability to buy more assets during this period of distress. It’s not a matter if they’ll buy, it is a matter of when.
There is a common misconception with AbbVie (ABBV) in regards to its blockbuster drug Humira. Sure Dividend outlines this misconception below.
That’s where the risk with AbbVClie comes in.
The company’s composition-of-matter patent for Humira expires at the end of 2016 in the United States. It expires in 2018 in Europe.
When these patents expire, Humira will lose its competitive advantage. Amgen (AMGN) has already submitted a biosimilar version AbbVie to the FDA (they did so in November of 2015). It is likely that other pharmaceutical companies will follow.
It’s difficult to know exactly how far revenue and profit will slide for Humira once it experiences competition.
The image below shows the effects of generic drug competition on Claritin to give an idea of what happens when a drug loses market exclusivity:
Humira is going off patent and will experience a dramatic drop-off in sales once generic drugs get the green light just like Claritin did. For AbbVie it could be even worse because so much of its current revenue and profits come from Humira.
And it would be very scary if not for the fact that Claritin and Humira are two drastically different drug compounds.
Small Molecule Drugs
Claritin is a small chemically synthesized drug whose structure is well defined. When a small molecule drug loses its patent a generic drug maker only has to prove that their generic drug is the same drug structurally. The generic drug maker does not have to run new efficacy and safety trials. For good reason, the generic and the branded drug are exactly the same.
Making generic small molecule drugs is relatively cheap. This is why generic drug makers can charge such low prices in relation to the branded drug and take market share away.
Large Molecule Biologics
Humira is a biologic. It is a very large molecule that is made through the use of microorganisms. The entire process of making a biologic, from creating the genetically engineered cells to the isolation of the finished product, is the drug. A change in any step can produce a different molecule.
Because different biologic making processes can produce different drugs, any company that wants to make a generic biologic, a biosimilar, has to undergo new efficacy and safety trials for its drug. Bringing a biosimilar to market is about the same as bringing a new branded drug to market. It is costly. A biosimilar’s discount to the branded drug is not as great as a generic small molecule’s discount is to its branded drug. Novartis’ Neupogen biosimilar sells at a 15% discount.
Higher Legal Hurdles
The legal hurdle for bringing biosimilar’s to market will be high too. As Amgen just found out with U.S. patent officials refusing to review two of their Humira patent challenges. The patent challenge mentioned by Sure Dividend above. Amgen was thought to be the first company able to bring a Humira biosimilar to market. That timetable has been pushed back.
Biologics are a little more protected than chemical small molecule drugs to generic competition. It doesn’t mean biosimilars can’t come to market and compete with Humira. However, if biosimilars only offer a 15% discount it will be tough to take significant market share away from the branded drug. If Humira is working well for a patient with little side effects then it will be hard for the prescribing doctor to switch from a medication that works to an unproven biosimilar.
We’re always big fans of confirmation bias. Today’s confirmation bias comes from Barron’s. They ran a screen for companies with dividend yields greater than the S&P 500’s current yield and with increasing earnings estimates. Barron’s came up with 4 and one of them, Pfizer, is a current holding.
Pfizer ( PFE ) has topped earnings estimated for 10 consecutive quarters. It’s slated to report fourth quarter results on Feb. 2. Barron’s recommended Pfizer last October, citing a modest valuation and potential for double-digit annual earnings growth through the end of the decade. The stock price since then has come down by 9%, in line with the market, but earnings estimates have been creeping higher while those for the market have been falling. Shares trade at 13 times the 2016 earnings forecast and yield 3.9%.