Pfizer's $11.85B Deal a Baby Step in Drugs Refocusing (Update 1)

Updated to reflect analyst comments and additional data throughout

NEW YORK ( TheStreet) -- Pfizer ( PFE) has sold its baby nutrition unit to Nestle for $11.85 billion, slightly more than previous reports indicated, as continued divestitures including an initial public offering of its animal health business loom.

For Pfizer, the world's largest drug maker, and Nestle, the leading maker of baby foods, the deal represents an increasing focus by both companies on their core businesses. The sale also represents one of Pfizer's biggest-ever divestitures and its largest step in rationalizing its non-pharmaceuticals businesses in a plan to focus on its drugs unit as some blockbusters, like Lipitor, go generic.

For Pfizer CEO Ian Read, Monday's deal marks his biggest step since taking over as CEO and announcing a plan to shrink the drugs and health products giant. After previous reports that Danone or Mead Johnson ( MJN) would be interested in Pfizer's baby foods unit, Monday's sale price of $11.85 billion in cash also exceeds those reports by roughly $2 billion.

For Switzerland-based Nestle, the move may help the leading baby foods seller add to its China-based revenue, while raising its infant formula sales to roughly $7 billion from $5 billion. Although Nestle tops overall baby nutrition sales, it's in eighth place in China, according to Euromonitor data. That data shows that the Pfizer business its acquiring have a stronger presence in Asia, the Middle East and Aftica, providing what could be an inroad for Nestle into fast growing markets.

In reaction to the deal, analysts keyed in on the higher than expected price of the sale. At a price of 5.5 times expected 2012 sales, "this multiple is at the upper range of the bids recently quoted in the press and in our view reflects the quality and scarcity value of the asset," wrote Bank of America Merrill Lynch analyst Gregg Gilbert in a Monday note to clients. Gilbert estimates that Pfizer can use the cash from the sale to increase buybacks, in a move that will add roughly 4% to the company's 2013 earnings per share. He rates shares a "buy" with a $25 price target.

"The sale of the Nutrition business to Nestlé is consistent with Pfizer's intention to generate the greatest value for shareholders by maximizing the value-creation potential of our businesses and prudently managing our capital allocation," said Read in a statement. "We remain focused on enhancing shareholder value and, following the completion of this divestiture, we expect to allocate the after-tax proceeds to further share repurchases, or invest in other business-development opportunities, with the return on share repurchases remaining our case to beat."

Gilbert of Bank of America noted that if the animal health unit were to be divested at a similar price-to-sales multiple, it could add a further 7% upside to Pfizer's 2013 EPS -- higher than his previous estimates in the 3% to 4% range if a divestiture were valued at $16 billion. " Pfizer has a number of catalysts in 2012 that have the potential to significantly influence its valuation," wrote Gilbert, citing the animal health unit sale, FDA action on a stroke prevention drug called Eliquis and the possible approval of tofacitinib for rheumatoid arthritis.

Earlier in April, The Wall Street Journal reported that Pfizer may hire JPMorgan, Bank of America and Morgan Stanley to lead an initial public offering of its animal vaccine and drug unit as early as this summer.

In response to an April query from the TheStreet following the Journal reports of possible baby formula and animal health deals, a Pfizer spokesperson said, "With respect to the Animal Health business, we believe that a public transaction is most likely. That said, no decisions have been made at this point."

The spokesperson added in the emailed statement, "We view the future of Pfizer as a company with 2 distinct biopharma businesses along with a Consumer products businesses: 1. The Innovative Core and 2. Established Products."

The asset sale and IPO -- Bloomberg data show they took in $6.3 billion in revenue -- could mark a wider breakup effort by Read, who has spoken about Pfizer's re-commitment to its drug research and development as some of the company's key drugs, led by Lipitor, go generic.

Pfizer shares were down less than 1% to $22.56 in pre-market trading. While a year-to-date share rise of just over 4% has underperformed the S&P 500, Pfizer's 18%-plus gain in the last six months has outperformed markets, fueled by the divestiture plans.

In a March meeting, Goldman Sachs analyst Jami Rubin wrote in a report that Read hinted at a multi-year breakup of Pfizer far beyond his previously announced divestiture plans. Health care giants Abbott Laboratories ( ABT) and Covidien ( COV) have been pursuing multi-billion spinoff plans since last year.

"We recently met with PFE's CEO Ian Read, who expressed an openness to going further with separations beyond Animal Health and Nutrition if the conditions make sense... This, coupled with the CEO's openness to consider unlocking further value, could create an attractive situation with significant upside," wrote Rubin of the meeting in a March 27 note to clients.

If Pfizer were to undergo a full breakup, Rubin expects it to occur in three parts, with the sale of the company's animal health and nutrition units as just the first step. In a split, Pfizer would be more focused on its growth-oriented pharmaceuticals business and a stable generics business, argued Rubin, who sees the moves netting Pfizer 18 cents a share in EPS.

After those divestitures, a second step would then be a rationalization of Pfizer's organizational structure after the disposals, with efficiency efforts likely to wrench out a $26 a share stock value that puts Pfizer on Goldman Sachs' "America's conviction buy list."

The final step, a full split of Pfizer's drugs businesses, could come in two to three years' time, with the possibility that the moves drive $5.7 billion in additional sales, adding 93 cents to earnings per share, according to Rubin.

"In our view, Pfizer has emerged a new company, with significant execution still ahead but the important groundwork laid down. While 2011 was clearly a transformative year for Pfizer with sweeping catalysts that unlocked shareholder value, we continue to see significant and stock-moving catalysts ahead," wrote Rubin.

In December 2010, Read took over as CEO of Pfizer after the retirement of Jeffrey Kindler, and has led sweeping change. The company has revamped its drug R&D processes, launched dividend and share buyback increases and announced multi-billion dollar sale and spinoff efforts.

Still, Monday's deal could put Pfizer back in the acquisitions game, where it's been a prolific spender. That's especially the case as Pfizer tries to revamp its drugs R&D pipeline after years of underinvestment relative to some competitors.

"We continue to believe that Pfizer needs to make more significant acquisitions in the future to offset industry-wide price pressures as well as to build a stronger R&D platform for the long term," wrote Jefferies analyst Jeffrey Holford in a Monday note reacting to the baby health unit sale. Because of the higher-than-expected price tag, Holford says that Pfizer may target spun off drugs units of Abbot Labs and Bristol-Myers ( BMY).

"The rich multiple offered for Pfizer's Nutrition business reinforces our view that Abbott is significantly undervalued on a sum of the parts basis and that significant value can be unlocked following the spin-off of AbbVie."

Previous to Monday's deal, Pfizer had been one of the most aggressive post-crisis M&A players, buying Wyeth in 2009 for over $60 billion and King Pharmaceuticals for $3.3 billion a year later. Overall, Pfizer has cut $230 billion worth of deals since 1987, according to Bloomberg data, which shows that its average acquisition is nearly $4 billion.

In 2011, Pfizer saw its profitability rise to a post-recession high of $12.8 billion on sales of nearly $67.5 billion.

For more on health care sector spinoffs see how a Covidien split continues the breakup of the Tyco empire. See 5 short sighted stock spinoffs for more on corporate breakups.

-- Written by Antoine Gara in New York.

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