Even as the volume of mergers and acquisitions in 2019 reached the highest level in the last 10 years, multiple big pharma companies are looking to get smaller, spinning off units into separate entities.

On Feb. 5, Merck & Co. Inc. announced plans to divest its women’s health, legacy brands and biosimilars businesses into a new company. That same day, Glaxosmithkline plc made definitive plans to spin off its consumer health care joint venture with Pfizer Inc. In addition to letting go of its consumer health care business, Pfizer is also splitting off its generic drug Upjohn unit through a merger with Mylan NV.

On the back of Keytruda

Merck's yet-to-be-named newco will focus on the company's contraceptive and fertility businesses, led by the Nexplanon (etonogestrel implant) franchise. It will also continue working with Samsung Bioepis Co. Ltd. on their biosimilar partnership. And Kenilworth, N.J.-based Merck is throwing in the kitchen sink of legacy brands across dermatology, pain, respiratory and some cardiovascular products, including Zetia (ezetimibe) and Vytorin (ezetimibe/simvastatin).

Sales at the newco, which will be a public company based in New Jersey with 10,000 to 11,000 employees, are expected to decline from 2020 to 2021 as the company loses exclusivity on Zetia in Japan and contraceptive Nuvaring (etonogestrel/ethinyl estradiol vaginal ring) in the U.S. But from there, revenue is expected to grow in the low single digits off a base of $6 billion to $6.5 billion in 2021.

The slimmed-down Merck will focus on oncology, vaccines, hospital and animal health. The spin-off will reduce the company's human health manufacturing footprint by approximately 25% and cut in half the number of human health products it sells. Without the drag of slower growing products, Merck estimated it can achieve $1.5 billion in operating efficiencies by 2024, at which point its adjusted operating margins are projected to exceed 40%. It'll also receive $8 billion to $9 billion through a special tax-free dividend from the newco.

"The reason why we're doing this now is that our fundamental and financial strength, which is being driven by the focus on our best opportunities for growth, allows us now to do what’s strategically correct for the company in the long term," Kenneth Frazier, Merck's chairman and CEO, said on the company's fourth-quarter earnings call. "A few years ago, when we were looking at this, we saw the opportunity but, for example, the cash flow generation of our legacy product was being employed at that time and standing up our oncology business from which we grew from the ground up."

While Merck sees the split as a good move in the long term, initially the spin-off will hurt the company's earnings per share (EPS). "In total, we expect combined EPS of the newco and Merck together to initially be nominally lower than what Merck would have achieved without the spin-off, but as a result of the incremental growth that newco will achieve standalone, combined with the benefit of the operating efficiencies that Merck will realize, we expect that shareholders owning both companies will realize higher EPS within 12 to 24 months," Merck's chief financial offer, Robert Davis, explained on the call.

Analysts seemed shocked by the move and weren't sure what to make of it. "I can't come up with a good explanation as to why this transaction came out of left field," Evercore ISI analyst Umer Raffat wrote in a note to clients.

RBC Capital Markets analyst Randall Stanicky noted that "the decision to spin [off the] legacy business makes strategic sense but also takes an 'easy to own' story and introduces both P&L and valuation debate into a well-owned stock." He also questioned whether the smaller Merck could hit its operating margin goals, what the company will do with the $8 billion to $9 billion dividend and how investors will react to the increased reliance on Keytruda.

Combining to spin out

Pfizer, meanwhile, is splitting itself in three with a little help from some friends.

In late 2018, Pfizer and GSK, of London, announced plans to establish a joint venture to sell their combined consumer health care products. Part of the justification for the combination was to generate an expected $650 million in peak cost synergies, but the combination also made it easier to establish a separate company, allowing both companies to spin off their consumer health care businesses.

New York-based Pfizer owns 32% of the joint venture, giving GSK a majority ownership and the right to initiate a separation and listing on the U.K. equity market for a period of five years from closing of the transaction, at which point Pfizer would also have the right to initiate the separation.

It didn't come to that. As part of its fourth-quarter earnings announcement, GSK confirmed plans to spin off the company in two years. Building up technology infrastructure and corporate functions for the stand-alone company will cost GSK £600 million to £700 million (US$777 million to US$907 million).

"We see the strategic rationale for a UK demerger around mid-22E as an opportunity to crystallise value, plus consumer standalone can support higher debt levels," Jefferies analyst Peter Welford wrote, noting that the remaining company will be able to deleverage, providing capital to invest for growth.

In 2019, Pfizer initiated the other half of its split, combining its generic Upjohn unit with Hertfordshire, U.K.-based Mylan. The deal, which is expected to close in the middle of 2020, will result in Pfizer's shareholders owning 57% of the combined company with Mylan's shareholders owning the rest. The merger brings Mylan's growth products to Upjohn's larger reach in the global markets.

What's left at the remaining Pfizer is a company focused on innovative medicines, which it'll need to shore up as the company heads for another patent cliff in the 2027 time frame.

"We don't want, right now, to do a big M&A," Pfizer CEO Albert Bourla said during a fireside chat at the J.P. Morgan Healthcare Conference in January. "We want to acquire or in-license programs: phase II ready, phase III ready. These programs that can become medicines in 2024, 2025. 2026, 2027 where you indicated that we need to make sure that we sustain the growth."

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