Pfizer Inc. (NYSE:PFE) surprised the investment community with the recent announcement that it would attempt to offload the remainder of its stake in veterinary pharmaceutical firm Zoetis Inc (NYSE:ZTS). At minimum, the transaction would be designed to reduce Pfizer’s take in Zoetis to non-majority, non-controlling levels. However, the ultimate goal appears to be the complete liquidation of Pfizer’s interest in its former subsidiary. Although many industry observers expected that this would eventually occur, many have been surprised by the speed and efficacy with which Pfizer appears to be committed to divorcing itself from Zoetis.
This transaction could offer a few key advantages for rank-and-file Pfizer investors. On the other hand, it might temporarily impact the earning power of newly minted Zoetis Inc (NYSE:ZTS) shareholders. However, both of these companies are strong and seem well-prepared to handle temporary volatility. Investors who wish to profit from this special situation should start by comparing Pfizer Inc. (NYSE:PFE), Zoetis and other major drug-makers.
Pfizer, Zoetis and the Competition
Pfizer competes with several major pharmaceutical companies as well as a number of smaller, more narrowly focused outfits. Although it does not enjoy much operational overlap, Zoetis Inc (NYSE:ZTS) also competes with major drug-makers by virtue of its size. One of both firms’ closest competitors is Merck & Co., Inc. (NYSE:MRK) .
Pfizer Inc. (NYSE:PFE) and Merck are far larger than Zoetis. At last count, Pfizer’s market capitalization came in at just over $205 billion. Merck enjoyed a market valuation of around $142 billion. Meanwhile, Zoetis reported a comparatively puny valuation of about $16.7 billion. Despite its enormous size, Pfizer is currently the most profitable of these three firms: At 27%, its profit margin is roughly double that of Merck and (NYSE:MRK) exceeds that of Zoetis by a factor of three. Moreover, Pfizer reported an impressive quarterly earnings growth figure of over 50%. With an earnings increase of 26%, Zoetis also appears to be enjoying some profit momentum. By comparison, Merck recently saw its quarterly earnings shrink by a little over 8 percent.
With just slightly more debt than cash and strongly positive cash flow figures, Pfizer and Merck have similar-looking balance sheets. By comparison, Zoetis Inc (NYSE:ZTS)’s financials look slightly weaker: The company has about $3.7 billion in debt to just $468 million in cash. Fortunately, it has an operating cash flow of around $740 million.
How the Deal Is Structured
According to the terms of the deal, all Pfizer Inc. (NYSE:PFE) shareholders are currently eligible to participate in this secondary offering. The offering will be structured as a one-way share swap. As soon as the program begins, individual Pfizer shareholders will be permitted to exchange their holdings for proportional numbers of Zoetis shares. To increase interest in the offering, Pfizer has indicated that shareholders who participate in the deal will earn a premium of between 7 and 8 percent. Although the exact premium will be based on pre-closing trading averages and will not be announced until June 19, it is currently expected to be near 7.5 percent. In other words, Pfizer shareholders who participate in the swap will receive “extra” Zoetis Inc (NYSE:ZTS) shares valued at 7.5 percent of their previous Pfizer holdings.
Fewer Pfizer Shareholders?
Many industry observers have noted that this deal will produce favorable conditions for Pfizer Inc. (NYSE:PFE)’s shareholders and permit the larger company to divest from a business in which it clearly has little operational interest. Given the amount by which Pfizer’s stock price has increased over the past two years, it is not inconceivable that a significant number of the company’s shareholders would choose to exchange the entirety of their stakes for positions in Zoetis. Were this to occur, it could substantially reduce the number of individual Pfizer shareholders and boost the value of the remaining shareholders’ holdings. As such, current Pfizer shareholders must think long and hard about playing this deal.
What Might Happen After the Spin-off
Pfizer has publicly stated that it wishes to spin off the bulk of its Zoetis holdings through this transaction. However, the possibility exists that this rather large offering will be under-subscribed. Accordingly, Pfizer Inc. (NYSE:PFE) has a number of back-up plans in place to offload the rest of its holdings in a timely fashion. If this current transaction is not wildly successful, the company has indicated that it could mount an additional secondary offering in 2014 or issue a special dividend of Zoetis stock to its shareholders of record. If it is fully subscribed, this deal will result in the exchange of about 400 million Zoetis Inc (NYSE:ZTS) shares.
Long-Term Outlook and Ways to Play
Although the cancellation of a promising cancer drug in the late stages of its approval process represented a major setback for Pfizer, the company appears to have a strong pipeline and plenty of fundamental momentum. Going forward, the company should benefit from growing specialization within the pharmaceutical industry and may leverage its position as the largest North American drug-maker. Likewise, Zoetis may benefit from growing demand for high-tech pet and livestock medications.
In sum, investors who wish to play this deal have two good options. Those who believe in Pfizer’s potential may wish to avoid the offering and count on a post-deal appreciation in the value of their holdings. Alternatively, shareholders who see Zoetis as a better vehicle for growth may wish to pocket this deal’s substantial premium and exchange their Pfizer Inc. (NYSE:PFE) holdings. In either case, this transaction offers exciting opportunities for investors in these two solid companies.
Mike Thiessen has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned.
The article Does Pfizer’s Unwinding of Its Stake in Zoetis Offer Value for Either Company’s Shareholders? originally appeared on Fool.com.
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