Friday, May 26, 2023

Healthy return proves worth of Haleon spin-out

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One of consumer health group Haleon’s many claims is it is aiming to make the “world’s mouths healthier” through brands such as Sensodyne toothpaste.

After it was spun out of the pharmaceutical group GSK and listed as a separate company in London in July, Haleon has been trying to prove it is making investors’ returns healthier as well.

Haleon was a joint venture between GSK and Pfizer that included consumer brands acquired from Novartis. Haleon’s shares were knocked this week after US pharmaceutical business Pfizer confirmed it would start selling down its own 32 per cent interest in the business.

The wobble came despite Haleon reiterating at first-quarter results on Wednesday that revenue growth this year would be towards the upper end of its 4-6 per cent guidance range.

Longer term, though, investors should not feel the demerger resulted in any decay.

The joint venture sat within GSK before the spin-off, which created at the time the world’s only pure-play consumer health business available to investors. Haleon now has a direct peer after Johnson & Johnson this week also listed its consumer health business Kenvue in the US.

Lex Populi last week argued that conglomerates, though hard for investors to value, can damp volatility and create economies of scale.

But demergers can also unlock value where the circumstances fit. In GSK’s case, the pharmaceuticals group had been under break-up pressure for years from shareholders, who argued the sum of GSK’s different businesses was greater than its valuation.

They also believed consumer analysts would value the Haleon business more generously, given their understanding of the shorter timescales and smaller budgets for research and development compared with the core pharmaceuticals business.

The success of Haleon’s listing will always be judged against a £50bn offer made for the consumer health business by Unilever. GSK rejected the offer in January 2022, claiming it “fundamentally undervalued” the consumer health unit. Even if GSK had embraced a deal, prominent shareholders in Unilever would have opposed it on grounds of cost and risk.

Today, Haleon has an enterprise value of just over £42.5bn, its market capitalisation plus £9.9bn of net debt. That’s below the offer from Unilever, which also accounted for £10bn of debt. But adjustments need to be made for external factors. In particular the sharp sell-off in pharmaceutical stocks from August when investors fretted about possible legal liabilities related to claims — denied by drugmakers — that the heartburn drug Zantac caused cancer. GSK and Pfizer both previously sold Zantac, as did others.

Haleon’s shares traded well below their 330p IPO price until January. But a victory in a legal case in December helped to ease concerns among drugmakers’ shareholders over possible Zantac liabilities. Shares in Haleon are now up 11 per cent since the listing versus an 8 per cent rise in the FTSE 100 index over the same period.

Factor in several billion pounds for the Zantac effect, as well as corporation tax that GSK would have presumably had to pay on a sale of the consumer health business, and the difference with Unilever’s offer diminishes.

GSK’s and Haleon’s combined enterprise values today total around £119bn, including around £27bn of combined net debt. This compared with an enterprise value for GSK before the merger of about £108.5bn including net debt of £21.5bn.

One of the perks for GSK of the demerger was also a £7bn dividend which helped to reduce net debt of £19.8bn at the end of 2021.

There is always the risk that further external factors could sour the financial benefit from the demerger. But given further time, the spin-off should prove the right form of surgery.

Vodafone: sound practice

Just as GSK felt the need for some financial engineering, telecoms group Vodafone too feels the pressure for some remodelling.

Vodafone and CK Hutchison are close to agreeing a £15bn combination of their UK telecoms businesses, the FT reported this week.

The marriage to create the UK’s biggest mobile operator, with 28mn customers, is expected to be confirmed this month following the appointment of insider Margherita Della Valle as Vodafone chief executive.

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A combination of the two, which would include around £6bn of debt, would add some much-needed fizz to the start of Della Valle’s tenure. But any deal is likely to be snarled in lengthy competition and political fights. In the meantime, Della Valle will have other tough calls to make.

Vodafone faces cut-throat competition in its four key European markets: Germany, the UK, Italy and Spain. With much of mobile telephony now commoditised, getting paid for improved quality is difficult. Meanwhile, the increased penetration of streaming services such as Netflix requires spending increases on bandwidth capacity, while the rollout of 5G will also be costly.

All this is tricky to do when the profitability Vodafone earns from its capital base is only mid single digits, well below the cost of its debt and equity. Della Valle cannot retain sacred cows in Vodafone’s conglomerate-like portfolio. Predators are circling, with e& of the United Arab Emirates recently raising its stake in Vodafone to 14.6 per cent.

She has other options. In Italy, Vodafone is rumoured to be talking again to mobile challenger Iliad, controlled by French tycoon Xavier Niel, who announced his own 2.5 per cent stake in Vodafone in September. Vodafone dismissed an offer from Iliad in early 2022. The Italian market’s hyper-competitive structure is a constant source of concern.

Market share losses in Germany, by far its most important country, and in Spain require more investment in the former and a sale of the latter. Based on peer enterprise value to ebitda ratios, selling off Spain and Italy to private equity or rivals could bring in €13bn to €14bn on current ebitda multiples, thinks Citi.

Vodafone has allowed its brand to wither with both customers and shareholders for years. Della Valle has a chance to reverse this trend by breaking up the unwieldy structure created by her predecessors.

Lex is the FT’s concise daily investment column. Expert writers in four global financial centres provide informed, timely opinions on capital trends and big businesses. Click to explore



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