Shareholders in pharmaceutical company GSK (GSK) – also known as Glaxo or GlaxoSmithKline – have a big decision to make later in July when potentially 25% to 35% of the value of their investment will be handed back to them in the form of new shares in GSK’s consumer healthcare unit, Haleon.

Investors will effectively have three choices; keep their shares in Haleon, sell the shares and reinvest back into GSK, or sell the shares and reinvest elsewhere.

In this feature Shares reveals the key facts and investment considerations needed to make an informed decision.

WHY IS IT HAPPENING?

The board of GSK believe both companies will be able to operate more successfully as separate entities.

The product focus and investment requirements of the two businesses are very different. For example, GSK spends around 15% of sales on research and development compared with 3% at Haleon.

The split will allow GSK to focus on biopharmaceuticals, developing innovative vaccines and specialty medicines. Meanwhile, Haleon provides an opportunity to invest in a world-leading focused portfolio of category-leading consumer health brands including Panadol painkillers and Sensodyne toothpaste.

The name Haleon was created from old English words meaning ‘in good health’ and ‘strength’ from ‘Hale’ and ‘Leon’ respectively.

WHEN IS THE DEMERGER?

The demerger will happen on 18 July. Eligible GSK shareholders will be given one share in Haleon for each share owned in GSK.

Haleon’s ordinary shares will be listed on the premium segment of the London Stock Exchange and should join the FTSE 100 index soon after.

Prior to the demerger, the holding company for Haleon will pay dividends worth more than £7 billion to GSK and joint venture partner Pfizer (PFE:NYSE).

Following the demerger at least 54.5% of Haleon will be held by GSK shareholders, 13.5% by GSK itself and 32% by Pfizer.

Pfizer is also transforming its business into a more focused global leader in science-based innovative medicines and vaccines. The US company has said it intends to sell down its stake in Haleon in a disciplined manner.

Pfizer’s stake could be worth more than £11 billion which might be viewed by some investors as an ‘overhang’ of stock.

That said, GSK and Pfizer have agreed to a lock-up of their respective holdings until 10 November 2022 at the earliest.

WHAT HAPPENS ON DEMERGER DAY?

Market conditions will determine how the shares trade on the day, but it is likely GSK shares will fall to reflect that it has handed a big chunk of its stake in Haleon to shareholders and so it has fewer assets.

After the market close on 18 July GSK will consolidate its existing shares, returning the share price to around the same level as before the demerger. This will ensure the comparability of earnings per share with prior periods.

EVERYTHING YOU NEED TO KNOW ABOUT HALEON

In 2018 GSK bought Novartis’ (NOVN:SWX) 36.5% stake in their consumer healthcare joint venture for £9.2 billion. In 2019 GSK merged its consumer healthcare interests with assets from Pfizer under a new joint venture to create what is now Haleon.

Non-core brands have been divested, leaving a more focused business with so-called ‘power brands’ now representing nearly 60% of revenues.

Haleon has grown its revenues by a compound annual growth rate of 12% a year since 2014 to £9.5 billion and EBITDA (earnings before interest, tax, depreciation and amortisation) by 18% a year to £2.4 billion, expanding the margin from 15.2% to 22.8%.

The number of manufacturing sites has been reduced from 41 in 2015 to 24 in 2021. More than 80% of products sold are locally sourced.

Management anticipates delivering 4% to 6% organic annual revenue growth with a sustainable moderate margin expansion and a high cash conversion.

The growth strategy includes making selective bolt-on acquisitions to supplement organic growth as Haleon aims to consolidate a fragmented consumer healthcare industry.

To give an idea of the extent of market fragmentation, Haleon is the market leader in pain relief through ‘power brands’ including Panadol, Voltaren and Advil but only commands a market share of 15%.

THE STRUCTURE OF HALEON

The portfolio of brands is divided into oral health, vitamins, minerals and supplements, pain relief, respiratory health and digestive health.

The global consumer healthcare market is worth around £150 billion, implying Haleon has just over 6% market share. The largest segment is vitamins, minerals and supplements (£46 billion) where Haleon holds the leading position through its Centrum brand.

Haleon is a global business and generates 41% of revenues from Europe, Middle East, Africa and Latin America, 37% from North America and 22% from Asia Pacific. Just over two thirds of sales are generated from developed markets.

HALEON’S COMPETITIVE ADVANTAGE

The company has deep technical and scientific capabilities and employs over 1,400 highly skilled scientists. It has a strong scientific pedigree which has seen 19,000 regulatory applications and approvals made over the last three years.

These capabilities provide insight into consumer health needs and drive sustainable growth through increased penetration of the existing market as well as emerging opportunities.

Haleon has built strong routes to market and possesses effective distribution capabilities. For example, it has direct relationships with around 3 million healthcare professionals, and it has developed broad pharmacy coverage.

The relationship with healthcare professionals is important because practitioners exert considerable influence on first time and repeat purchases.

Management claim 85% of pharmacist recommendations lead to a purchase and those healthcare professionals that have close relationships with Haleon recommend its products up to five times more per week in some markets.

WHAT IS THE GROWTH STRATEGY?

Since 2019 Haleon has disposed of businesses which cumulatively had around £1 billion of revenues, of which 90% had experienced negative growth trends.

These actions have mathematically increased the growth potential of the remaining portfolio.

Growth is anticipated to come from increased penetration of the faster growing segments such as oral health and vitamins, minerals and supplements which are expected to grow in mid-to-high single percentage digits.

By 2025 these segments are expected to be generating around half of total revenues.

Emerging markets are expected to grow in high single percentage digits and to grow their share of total revenues from 31% to the high 30s.

The e-commerce channel is expected to be the fastest growing segment, increasing in double digits, and to double its share of total sales to a mid-teen percentage by 2025.

HOW MUCH MONEY DOES IT MAKE?

In the past two years Haleon has generated an average £1.6 billion of free cash flow a year. This represents 17% of revenues.

The company has provided clear guidance on how it plans to use future free cash flows. The priorities are to invest to support sustainable growth, pay dividends and reduce debts.

Haleon aims to reduce its net debt to EBITDA ratio (a measure of financial leverage) to below three times by the end of 2024 and to maintain a strong balance sheet.

This implies Haleon will join the stock market with some debt despite historically having operated without any debt while inside GSK.

It is anyone’s guess how much debt it will have, but it will be greater than £7.2 billion. The logic is that if the goal is to reduce leverage to below three times by 2024, it must be greater than three times today (£2.4 billion EBITDA x 3).

Our best guess is that Haleon will list with around £10 billion of debt.

WHAT IS HALEON WORTH?

GSK has already rejected a £50 billion takeover approach from consumer goods giant Unilever (ULVR) on the grounds it undervalued the business and its potential.

The Unilever offer was made for the company including net debt. If £10 billion of net debt is in the right ballpark, it suggests Haleon could list with a price tag of at least £40 billion.

We are assuming management doesn’t want the embarrassment of listing Haleon at a price below an offer it rejected on valuation grounds.

One ‘get out of jail’ card that management could use is ‘difficult market conditions’ but arguably that was also the case in March when Unilever made its move.

A different way to look at the potential listing value is to use peer metrics. US group Procter & Gamble (PG:NYSE) trades on an EV (enterprise value) to EBITDA ratio of 17.8 according to Stockopedia data.

Putting a similar rating on Haleon implies an enterprise value of £42.7 billion (£2.4 billion x 17.8). Deducting anticipated net debt implies £32.7 billion of equity value.

The above analysis provides a broad range for the equity value of the business of between £33 billion and £40 billion.

One final consideration for prospective investors is that if Haleon lists at the lower end of the range it may become a takeover target.

WHAT ABOUT THE SLIMMED-DOWN GSK?

Following the demerger GSK will be a pureplay biopharma and vaccines business. We believe it is an attractive business which offers double-digit profit growth potential over the medium term.

The presence of activist investors will keep management’s ‘feet to the fire’ and ensure further operational improvements. The 2022 PE ratio of 14.8 looks attractive relative to the growth potential and quality of the business.

The relative attractiveness of GSK versus Haleon will become clearer when the valuation of Haleon is known.

Both companies are high quality businesses and offer defensive qualities to a well-diversified investment portfolio during difficult markets.

‹ Previous2022-07-07Next ›