Pfizer (NYSE:PFE) filed an amendment Jan. 17 for its IPO that will sell 20% of its animal health business to the investing public. Expected to begin trading Feb. 1 on the New York Stock Exchange under the symbol ZTS, Zoetis will begin its new life as an independent company. Should you own its shares? I'll have a look.
Pricing its shares between $22 and $25, Zoetis will have a market cap between $11 billion and $12.5 billion, making it a smallish large-cap or a large mid-cap, depending on your terminology. Either way, it's a decent-sized business. After doing a little back-of-the-napkin number crunching, I estimate its enterprise value will be $14.5 billion based on a mid-point share price of $23.50. Its estimated EBITDA based on no revenue growth in 2012 and a 16% operating margin is $833 million. Based on these assumptions, Zoetis' enterprise value when it goes public will be approximately 17.4 times EBITDA, 2.2 times higher than its parent.
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In terms of revenues, Zoetis is the largest business operating in the animal health medicines and vaccines industry. Its immediate peers include the animal health divisions of Merck & Co. (NYSE:MRK), Sanofi (NYSE:SNY), Eli Lilly and Company (NYSE:LLY) and others. With a commanding 19% market share, its competitiveness was a big reason Pfizer chose to spin off Zoetis rather than sell it to one of its human pharmaceutical competitors. Comparing Zoetis' valuation to its large-cap peers makes little sense. because most of them have significantly larger, mature human pharmaceutical businesses that are more conservatively valued, just like Pfizer.
The closest publicly traded comparison to Zoetis is U.K.-based Dechra Pharmaceuticals (OTCBB:DPHAF), which trades on the London Stock Exchange but is available over-the-counter in America. Dechra's revenues have grown 8.8% annually over the past four years to $660 million, while its operating income in the same four-year period has grown 17.7% to $56.7 million, an operating margin of 8.6%. On an EBITDA basis, its profit margin is 12%, 770 basis points less than Zoetis. Therefore, given that Dechra has an EBITDA margin 36% less than Zoetis, you could extrapolate that its enterprise value as a multiple of EBITDA would be similarly valued. On that basis, Dechra should have an enterprise value 11.1 times EBITDA, rather than its current 12.4 times. Either Dechra is overvalued or, more likely, Pfizer has slightly undervalued its animal health division.
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Should You Own?
Zoetis is a premiere player in the $100-billion animal health industry. Its main area of vaccines and medicines is a $22-billion market growing at 6% annually over the past five years. As I mentioned earlier, it is the global leader in animal vaccines and medicines with a billion-dollar gap in terms of annual revenue over Merck, its next biggest competitor. Operating in over 120 countries around the world, this is definitely an investment to consider if you're an animal owner.
A big difference between investing in Pfizer and Zoetis is the way in which the drugs are paid for. Most of Zoetis' revenues are self-pay in nature whereas most of Pfizer's involve some type of insurance or government agency. Pet owners paying out-of-pocket generally results in less pricing pressure, which translates into more consistent revenue and profitability. Zoetis' top 10 products account for just 38% of its revenue with no single brand able to bring down the company. Geographically, its revenues are spread globally with the U.S. accounting for 39% and emerging markets such as Brazil, China and India accounting for another 27%. Interestingly, the only region where it isn't No.1 is in Western Europe, a prime market for Dechra Pharmaceuticals. Now that Zoetis is independent, a company such as Dechra would seem to make an ideal acquisition.
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The Bottom Line
Spin-offs often outperform the parent in the first 18 months following an initial public offering (IPO). Generally, the parent undervalues its subsidiary fearing investors won't pay top dollar to own the pure-play business. You can bet, however, that other major drug companies like Merck that compete with Pfizer's animal health business are watching this IPO closely. If it goes off without a hitch, which it should, you'll likely see similar IPOs in 2013 and beyond.
Zoetis expects to pay an annual dividend of 26 cents per share, providing investors with a 1% yield on its $25 share price. Its payout based on $595 million in net income in 2012 is 22%, suggesting it will have plenty of free cash flow to double its dividend in no time. I'm usually not a fan of IPOs, but I think this one's a winner. If you're a current Pfizer shareholder, you'll want to own some shares in Zoetis; if not, the same sentiment applies.
At the time of writing, Will Ashworth did not own any shares in any company mentioned in this article.