Market response to Pfizer’s (NYSE:PFE) acquisition of Hospira (NYSE:HSP) was immediately favorable. Pfizer shares were up by about $1, to close Friday at $33.18. This article examines the acquisition and concludes that it increases the desirability of Pfizer as a long-term holding.
A Few Simple Tests
Based on market cap, Hospira is 7% of Pfizer, well under the 25% maximum size I prefer for acquisitions. While not exactly a bolt-on, it can be folded in easily, and integration should proceed smoothly. The deal is expected to be immediately accretive, to the tune of 10 to 12 cents per year, with more to come.
Hospira’s margins are substantially lower than Pfizer’s, and it’s difficult to find a common metric by which to compare valuations. At the market price following the announcement, HSP has a P/S of 3.35, compared to 4.19 for the acquirer. EV/EBITDA checks in at 22.72, compared to Pfizer at 10.15.
Pfizer’s CEO Ian Read has proven abilities at cost-cutting, and it’s reasonable to look for considerable synergies to develop over the next few years. Based on this consideration, the price paid does not seem excessive.
Hospira’s pipeline is the strategic rationale underlying the transaction. Here’s CEO F. Michael Ball, on the 3Q 2014 earnings conference call:
Moving to the biosimilar front. In early August, our partner Celltrion, submitted a 351(k) application for regulatory approval of biosimilar infliximab to the FDA which was the first submission in the U.S. for a biosimilar monoclonal antibody. In addition, we recently strengthened our partnership with Celltrion. We invested in a 5-year $200 million convertible bond issued by Celltrion in late September, and as a result, also modified our existing distribution rights and other commercial terms. Hospira now has exclusive rights, which used to be co-exclusive, for biosimilar infliximab and trastuzumab in the United States and a number of other major markets. And, we now have exclusive rights in the majority of Western Europe for trastuzumab. Our new arrangement not only further solidifies our partnership with Celltrion, it also supports our efforts to enable improved access for patients around the world to these safe and effective treatments which offer significant cost savings.
In a November 2014 article, I discussed the size of Pfizer’s cuts to R&D, and the apparent strategy of buying or partnering to fill in gaps left by the cost-cutting. At the time I questioned the approach, although I elected to invest on the basis that shares would be working their way up to $44 over the next few years. Commenters generally regarded the strategy as viable.
Hospira has a generics business and a device business, which may or may not find a lasting place in Pfizer’s portfolio. Biosimilars are the key consideration here.
SA Contributor Trevor Lowenthal has pointed out the severity of the patent cliff for Celebrex, Zyvox and Viagra, while affirming the quality of Pfizer’s pipeline. He proposes a buy-write strategy, with covered calls set high enough to avoid being subject to dividend capture.
Following the R&D cuts, and with the board authorizing a $11 billion dollar buyback, Pfizer looked like it was on the road to becoming a cash cow/buyback machine. That model becomes questionable if the reduction in R&D and other spending directed at growth leads to a declining business.
The acquisition is reassuring, since it demonstrates that management is keeping the need for growth firmly in mind when allocating capital.
As mentioned above, I’ve been looking for shares to reach $44 over the next two to three years. The acquisition appears to support that outlook, and I’ll be continuing along the same lines.
I have two positions: a LEAPS covered call and a vertical call spread. I’m long PFE Jan 2016 25 calls, against which I’m short May 2015 35 calls. In addition, I’m long the March 2015 27/30 vertical call spread.
For dividend investors, the yield at 3.38% is generous. The company cut the dividend in 2009 but has since increased on an annual basis. Given management’s demonstrated interest in acquisitions and divestitures, and the dependence on the pipeline, which is not guaranteed, investors looking for the security of steady dividend growth may face disappointments. To me, capital appreciation provides the primary motivation for ownership in this situation.