Abbott Breakup Could Be Catalyst

Jeremy Glaser: For Morningstar, I'm Jeremy Glaser.

Abbott Labs announced today along with their third-quarter earnings that they'll be splitting into two separate publicly traded companies.

I am here today with Damien Conover. He is an associate director or equity research here at Morningstar. We are going to take a look at what this deal could mean for investors.

Damien, thanks for talking with me today.

Damien Conover: Thanks for having me, Jeremy.

Glaser: So, let's start off just with the basics. What is Abbott planning on doing and what's the timeline for this happening?

Conover: So, it's interesting. Abbott has taken kind of a shift in strategy. Historically, they've been extremely diversified. With today's announcement, they've decided to go down a more focused path by splitting the company into two separate entities. There will be one that will still be relatively diversified with devices, nutritionals, diagnostics. And then there will be another unit that's just strictly branded pharmaceutical products. And this breakup will likely occur at the end of 2012.

Glaser: So, what was the impetus behind this move?

Conover: Well, I think there are two pieces to it. One, and I think the more important piece, is that I think management wanted to unlock some shareholder value. When you look at Abbott, it's a huge company, it's hard to look at all the different pieces and value them correctly. And when you break it into a couple of pieces, I think management's belief is that it's more likely to unlock some of the value. We believe Abbott is undervalued, and we think this move will likely increase the opportunity for investors to see the value there that we see, and will likely be good for the company. So, I think we agree with management's standpoint there.

And then the second point that I think really caused this sort of breakup was that management, I think, wanted to have the two entities having their own strategic focus. I think when you're in a larger firm, it's hard to allocate capital as effectively as you could as separate entities, and to realize each entity's own strategic vision.

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Glaser: So, I know it's going to be some time before shareholders are faced with holding both companies, but does one look like it's going to be much stronger than the other? Is it something that you really are going to want to dump half the company as soon as you can? Or do you think that they're going to be pretty evenly matched?

Conover: That's a great question. I think, from a valuation standpoint, both are going to be relatively equal. I think from a volatility standpoint, the diversified company is probably going to offer a little bit less on the diversified risk front. So, it's going to have a lot of different groups within it--nutritionals, devices, diagnostics, so you are going to have a little bit more steady-growth outlook.

When you look at the pharma group, you are really anchoring on one key product, called Humira, which is an immunology drug, which we anticipate will do quite well over the next several years. However, when you are tied so much to one product, the volatility of earnings, and hence the stock price, are going to be a little bit higher. So, I think, depending on the type of investor that you are, if you want something with a little more volatility, I think you are going to gravitate more towards the pharmaceutical group. If you want something that's a little more of a steady grower, I think you are going to gravitate more to the remaining diversified company.

Glaser: I know that you and also our DividendInvestor editor Josh Peters have recommended Abbott as a good place for investors looking for yield. Do you have a sense of what's going to happen with the dividend going forward?

Conover: Yes. So, management has guided that the dividend in aggregate of the two companies will equal Abbott's dividend at the time of the spin-out of the pharmaceutical company, which we think is very likely. If we take a look at the industry payout ratios, and we take a look at where Abbott is currently, I think it's very likely that the dividend is maintained through this. It's very likely Abbott will probably grow its dividend into 2012, into the split, and that increased dividend will then likely be equal to the dividend that will be for the two firms going forward.

Glaser: So overall, is this going to change your fair value of the firm, or do you think that it's still worth about the same, even if it's split?

Conover: We don't anticipate any significant changes to our fair value. We think that the likelihood of reaching our fair value more quickly could potentially happen as the management has split these two entities up, because it unlocks some of the value there and increases the clarity of the value for Abbott. So, we don't anticipate big changes to our overall valuation, but we do think that the timeline to reaching our fair value may be shortened.

Glaser: Damien, thanks for your thoughts. I will definitely be hearing more about this as we get closer to the breakup.

Conover: Thanks, Jeremy.

Glaser: For Morningstar, I am Jeremy Glaser.