Johnson & Johnson is the biggest pharmaceutical company in the US
based on its market cap. It was named number 36 on the 2021
Fortune 500 list of the largest United States corporations by
total revenue. Johnson and Johnson has experienced dividend
growth for nearly 60 years and has consistently outperformed
the S&P 500 over the past 25 years.
The analyst community has been talking about splitting up J&J
for years - as long as I've known the company.
Johnson & Johnson announcing that is going to be splitting
into two publicly traded companies.
The pharma and medical device company, which will be called
Johnson and Johnson, and then the Tylenol, Listerine, Band-Aid
company.
They're now separating the consumer business away from
pharmaceutical and the medical device division. And I think
that's going to create significant shareholder value.
But some investors question why J&J would choose to break up
now. The company is embroiled in a series of lawsuits regarding
its talcum powder, as well as its role in the opioid crisis.
J&J also took a hit when the CDC recommended Americans receive
one of the mRNA Covid vaccines from either Pfizer or Moderna,
rather than J&J due to "the risk of serious adverse events."
The timing situation is critical, just because people
have been very intrigued as to why now
Johnson & Johnson is one of the most influential companies in
the pharmaceutical industry. It's really seen as a bellwether
for the space.
Why is the largest pharmaceutical company in the US
breaking itself up and what does it mean for investors?
Johnson & Johnson is made up of three unique business segments:
Consumer, medical devices - which is also called Med Tech -
and pharmaceuticals.
The consumer business sells everything from Tylenol to
Neutrogena. The pharmaceutical and medical device side of the
company develops vaccines, like its single dose Covid vaccine
cancer treatments, joint replacement materials and other
biomedical technology.
Separation right now makes a lot of sense. You're going to have
two companies with good financial strength and cash
flows in order to pursue the objectives that they need to to
have normal growth for the foreseeable future.
Analysts say the split allows J&J to bring in a management
team to specifically focus on the consumer division, while
also giving that segment new branding and marketing
The strategy of running these consumer businesses is very,
very dissimilar to a medical device or a pharmaceutical
business. There's a lot more direct to consumer, obviously,
the sales and marketing effort, the social media effort is very
pronounced in consumer, it's much less so for the other
businesses. So allowing a management team just to focus on
what has to be done in order to resume growth or drive better
revenue growth over the next couple of years, I think is very
smart on their part.
Our pharma and our medical device business tends to be much
more of a business to business relationship in the way that we
work through other intermediaries, you know,
compared to the consumer business. And most importantly,
where we see things going into the future, we feel it now is
the right time to make this kind of a move. And again,
ultimately, it's going to allow us to reach more patients, more
consumers have more innovation, and execute in a much more
focused way.
It's a somewhat common practice for companies with diverse
segments to break apart. Pfizer, Eli Lilly and Merck all
reorganize their business structures within the last five
years by spinning off segments into separate companies.
What the market is saying is that companies should focus on
their core competencies and let us diversify. We've already seen
several examples of large pharma separating out non core assets.
I think they finally came to terms with the fact that they
weren't really seeing value in the share price from having that
consumer business.
When you're a conglomerate, you never get credit for the various
different pieces. And quite frankly, you probably shouldn't,
because some other parts of the company are not investing the
way they should. They're not focus the way they should. And
so when you separate out various different businesses, we now as
analysts and portfolio managers can appreciate what the each of
the businesses are. And they do over time, there have been
studies that have been done, both Remain Co. and New Co. can
outperform because they are on their own.
So far, investors reaction to the divide has been mild with
the stock only moving modestly higher on the news. The stock
went on to underperform the week following the announcement.
The market hasn't really reacted to the news. There are some
risks to this execution from separating out the consumer
business. And I think investors aren't fully convinced yet of
the standalone earnings potential of both companies. So
from a consumer perspective, I think people wonder how the
consumer business can compete with companies such as Procter &
Gamble, and some of these larger, more established players
in the space.
J&J's business move may also help attract a different type of
investor.
You're going to get people that are consumer staples and
consumer oriented. You'll get them focused on the consumer
piece. And of course, you're now more of a pure play healthcare.
And so you'll get more health care analysts.
You finally get a situation in J&J, where the balance of the
business is not impacted by what's going on, good or bad,
with the consumer business. But unfortunately, there's been more
bad than good for J&J over the past call it five to 10 years,
probably.
Johnson & Johnson coming out with the statement saying that
due to a product review resulting from the Covid-19
pandemic, they have decided to cut about 100 different products
from their assessment, including all of their talc based
Johnson's Baby products.
Let's not forget that the talc litigation is with consumer
product right and the talc litigation has been horrendous.
Johnson & Johnson has experienced a number of legal
battles and liability issues regarding all three segments of
its business. In July 2021, Johnson & Johnson reached a
settlement that requires the company to pay $5 billion over
the next nine years due to its involvement in the opioid
crisis. But it's the legal challenges on the consumer side
of the company that has grabbed the most media attention.
More than 20,000 lawsuits have been filed alleging Johnson &
Johnson's baby powder resulted in mesothelioma and ovarian
cancer. These legal challenges have been ongoing for years,
with a slew of headlines coming out about juries awarding
plaintiffs millions of dollars Johnson and Johnson discontinued
selling its talc-based baby powder in the US and Canada in
May 2020 as demand for the product fell.
In June 2020. The courts ordered j&j to pay a $2.1 billion fine
in the Baby Powder cancer case. There may be more settlements
and fines to come as the lawsuits make their way through
the courts state by state.
I think one of the main reasons that this stock trades where it
does which is discount to the market overall. It's the
unknown. Once we get the resolution, I honestly think
it's going to be kind of almost liberating. Okay, we got it, we
figured it out. Whatever the dollar amount is, now we can
move it along and focus again on the pharma business and the med
tech business.
These may seem like big numbers. But to put it in perspective,
J&J reported a profit of more than $15 billion in 2019, and
$14.7 billion in 2020. The company reported $19.9 billion
in free cash flow in 2019. And that number went up to $20. 2
billion in 2020.
I don't think the legal issues will be an impediment to the
company's growth going forward. I do think there's some headline
risk to it. We often get questions as to if that's the
reason J&J is separating out its consumer business. And I don't
think that's the case. I think they separated out the consumer
business because the business model has changed and the
synergies that they used to have with pharma med device are now
different.
Johnson & Johnson declined CNBC requests for comment on its
decision to separate as well as the on-going litigation. The
company told The Wall Street Journal in November 2021 that
the lawsuits alleging the use of Johnson's baby powder cause
cancer didn't play a role in the decision to break up the
company.
In October 2021, J&J put the talcum claims into a separate
company, which filed for bankruptcy protection. That
means it's going to be considered a separate entity
from the consumer business.
What they're trying to do is increase the attention on what's
actually happening with the business at the remaining J&J,
having a liability shell absorb the pain related to talc and the
painkiller situation, and then the consumer business hang on to
the rest.
So it is something that we have seen other companies do before I
think that J&J will be able to prevail and basically having an
efficient way to deal with all these liabilities and then
remove it, I think, from the headline risk.
If they can create these liability shells in order to not
protect the company so much, but just to limit the effect it's
having, I don't think investors care as long as they're the
company responsible for paying out any claims.
Johnson & Johnson's different segments tend to offset one
another.
The risk to J&J longer term is that there are issues that are
more pervasive within either pharma or med tech. And the
consumer business no longer provides an offset in the event
that the fundamentals around that unit improve.
When you think about the future of consumer if that business
model is evolving, and the synergies that were historically
there are not there anymore, and you require greater investment
in order to grow that business, then I think the offset to cash
flow, if there's any hiccup in pharma med device won't be
there, the way that it used to be.
They're gonna obviously have to do a very good job of making
sure the growth rates with the balance of the business continue
to be robust or improve from here.
Wall Street has also expressed concerns about how smoothly the
process of spinning off will go.
Some of the things that people have asked about that the
company hasn't given a ton of color on is the stand up costs
associated with separating out this consumer business. Any
potential synergies and the tax implications and exactly how
they're going to affect this.
There are a few other potential risks such as the possibility of
health-care reform or patent expiration.
That's why they're so excited about their pipeline, because
while a few of their drugs are going to go off-patent in a few
years, and that's your near-term risk, your longer-term story as
well wait, we've got a big pipeline and now we're kind of
more of a streamlined company, where we can take our cash flows
and reinvest and do even more and do even better and grow even
stronger.
Some analysts were questioning why Johnson and Johnson didn't
split into three companies by separating its pharmaceutical
and medical device units.
It's a topic of debate. And it's not clear that over the longer
term if that might not be something they could pursue. But
I think today, the board and the company feel that pharma and med
devices still has a lot of synergies. They talk about but a
lot of opportunities that are shared from a market perspective
between the two businesses. And the way that products are
developed and commercialized are still similar enough where they
can actually work together to get it done. But I would say
that over the longer term that would potentially make sense.
And I think one of the things when I talk to investors about
J&J, what's really tough is, it's hard to find an investor
that has a broad enough perspective to really get their
arms around. All three businesses being pharma, med
device, a consumer people are usually focused on one of those
three segments.
I would say that when you have a business that we're most of the
analyst community doesn't really pay attention to and you siphon
that off, it's probably gonna be a positive.
I think I'm gonna continue to add to this position. They're
trying to create shareholder value any way that they can.
This is one you kind of put away and I think just gonna let it
ride and let them figure out how the whole thing evolves. I think
it's very exciting though.