The first day of trading in 2013 started with a bang thanks to the fiscal cliff deal Congress was able to cobble together and pass through both the Senate and the House of Representatives. Hidden amongst the excitement was Abbott Laboratories' (NYSE:ABT) spinoff of its pharmaceutical business into a separate publicly traded company. AbbVie Inc. (NYSE:ABBV) is expected to be the growth vehicle of the two companies. I'll look at which stock is the better investment.
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In the planning stages since October 2011, Abbott Lab shareholders received one share of AbbVie for every share held in the former parent. Abbott Labs will have revenues of approximately $22 billion after the spin-off with 40% in emerging markets, 30% in developed markets outside of the United States and the remaining 30% at home in the U.S. Its sales mix is extremely balanced with all four divisions each generating between 20 and 28% of overall revenues. With just $2.5 billion in net debt, it expects approximately $4 billion in operating cash flow in 2013, which will make it very easy to meet its dividend payout. Although Abbott retains the lower margin businesses, they are very stable while still providing growth opportunities in emerging markets.
Part of AbbVie's estimated $18 billion in revenue will come from Humira, its multi-purpose drug used for conditions like rheumatoid arthritis and Crohn's disease. Unfortunately, the drug's patent expires in 2016 in the U.S. and in mid-2017 in Europe. If it's unable to build a replacement pipeline between now and then, its business could be seriously affected. Unlike its former parent, a majority of its revenue is generated in the U.S. That's something that will have to be improved upon. Acquisitions overseas would seem to make sense now that it's independent. In addition, it will step up the number of uses for its star drug as well as expanding its research and development program for bringing new drugs to market. AbbVie's two biggest problems are that it has a pro forma debt of $15.7 billion, and many speculate that its separation from Abbott Labs makes it easier for larger pharmaceutical companies like Bristol-Myers Squibb (NYSE:BMY) to swoop in for the kill. Fortunately, AbbVie has an initial cash balance of $7.2 billion, leaving it with approximately $4.6 billion to reduce debt after paying a projected annual dividend of $1.60 per share. If business continues to grow, it could be in a net cash position by the end of 2015.
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AbbVie closed its first day of trading at $35.12, $3.07 higher than Abbott Labs. AbbVie's free cash flow (FCF) yield is 10.3%, 440 basis points higher than Abbott Labs. In terms of revenue, AbbVie closed its first day of trading valued at 3.1 times sales compared to 2.3 times for Abbott Labs. I would gladly pay a little more for revenue when it means the delivery of FCF is almost 75% higher. Long term, the additional cash flow is going to be very beneficial to its growth.
The Bottom Line
I wrote an article about spin-offs in August 2010 that revealed that spin-offs generally outperform the market in the first 18 months of trading. Furthermore, they often make better investments than the former parent. Perhaps that's why the Guggenheim Spin-Off ETF (ARCA:CSD) has outperformed the S&P 500 over the past five years by 269 basis points annually. The numbers don't lie. Spin-off's make great investments.
While the new Abbott Labs doesn't appear to have as much risk as AbbVie, the FCF of the pharmaceutical business combined with the historically strong performance of spin-offs, makes AbbVie the better candidate in my opinion. However, if you owned Abbott prior to the split, I see no reason why you shouldn't hang on to both.
At the time of writing, Will Ashworth did not own any shares in any company mentioned in this article.