Pfizer (PFE) is an interesting company. Like most pharmaceutical players, they have superb operating margins and have been able to sustain their value creation even in the COVID-19 environment. Indeed, Pfizer has already recovered to pre-COVID highs. But still, Pfizer has an appealing capital allocation commitment. They have become more conservative in their M&A approach and we suspect that their main use of cash outside of organic reinvestment will be to support the ample and low-payout dividend. We are interested in their income proposition and potentially their value proposition, which will depend on the distortions that will be caused by the Upjohn split-off, a substantial and ambiguous corporate event.


Upjohn-Mylan Merger

The Upjohn split-off is an important step in Pfizer’s plans to become a more focused biopharmaceutical company similar to the likes of Regeneron (REGN) and Bristol-Myers Squibb (BMY). Within Upjohn are some of Pfizer’s famous legacy but off-patent drugs like Viagra and Lipitor. What will remain with Pfizer are some of their more promising drugs in their oncology portfolio as well as their pediatric vaccines. Moreover, they will also continue to develop potential treatments and preventions for COVID-19, for which they thankfully receive little speculative premium as we’ll demonstrate later.

(Source: 2019 PFE 10-K)

Shareholders will receive shares of Upjohn until they are immediately merged with Mylan (MYL) to form Viatris, whereby Pfizer shareholders will be left with a 57% ownership in Viatris and Mylan shareholders will have 43%, reflecting the value-add of Upjohn’s iconic portfolio as well as their tangibly higher margins. What’s more is that Upjohn, once split, will raise $12 billion in debt, the proceeds of which will be returned to Pfizer, keeping their debt level at a reasonable ~2.4x Net Debt/EBITDA.

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On the day of this split-off, in an efficient market, we should see a decrease in Pfizer’s value inversely related to the value attributed by markets to the Upjohn shares. Because volatility breeds opportunity, we are going to wait to see how sharply Pfizer’s business is repriced before we decide to buy. We are not interested in becoming involved in Viatris, as their volume procurement programmes, on which they substantially rely in emerging markets like China, creates a lot of operating volatility. We prefer the opportunity to get involved in a more value-add biopharma company with patented drugs on valuable platforms which the Pfizer biopharma segment provides.


With this analysis, we will be able to set our decision threshold. First, we want to understand what a fair value for Upjohn would be, so we can see what the multiple on the RemainCo would be after splitting.

(Source: Mare E-Lab Research Database)

For the multiple, we took Mylan as a comparable. In order to find the statistic to apply that multiple to, we ran a regression on Pfizer’s past disclosures where revenue splits between the segments are given. Based on a difference in difference analysis, we determined that the EBITDA margin for Upjohn could be as high as in the mid-50-60% range. Given that Mylan already generates margins in excess of 30%, we think this checks out since Upjohn’s portfolio is more branded and powerful. Using this margin estimate, we conservatively applied this to 2019 figures, which were somewhat depressed due to unfortunate developments in the volume procurement programmes.

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Using the Upjohn EV, we subtracted that from Pfizer’s current EV in order to arrive at a figure for the RemainCo, which constitutes Pfizer’s biopharma business. To find the multiple on that business, we divided the residual EV by our regression estimate of the biopharma EBITDA, which incidentally was almost identical in margin to Bristol-Myers’. With those figures, we found the implied multiple.

(Source: Mare E-Lab Research Database)

This multiple is in the middle-upper range of our biopharma comp group, with Regeneron leading the pack after its COVID-19 run-up.

(Source: Mare E-Lab Research Database)

We think that the results of this analysis are satisfactory, and are a sanity check telling us that we likely correctly calculated Upjohn’s margins using DiD. With the EV of the biopharma business, we were able to find the consequent price we should expect for Pfizer shares on the day of the split-off. The NFP was calculated with various financial obligations as well as the proceeds expected from Upjohn’s debt raise.

(Source: Mare E-Lab Research Database)

Risks and Concluding Remarks

With currently a 50% payout ratio providing a buffer for the higher expected payout ratio post merger, sustaining what might end up being a ~4.7% at a $33.94 price, shows the attractiveness of the income proposition, rare for a pharma company. Since we are in an uncertain environment, we are happy with fairly valued and high quality businesses providing an income proposition. Hopefully, volatility on the day, or perhaps another market pullback, will allow us to buy Pfizer at even more depressed prices. At that point, we would expect capital appreciation as well.

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Besides the fact that Pfizer doesn’t have the most robust pipeline of pharma companies, trailing just behind Bristol-Myers, there are risks that our targeted fair price might be too high. Perhaps Upjohn deserves a premium over Mylan, and failing to recognize that could risk us buying at an uneconomical price. However, due to the stability of the business, with both breakthrough drugs and an oncology portfolio comparable to Bristol-Myers, we think that this company would be a valid store of value for almost any investor’s portfolio in these volatile markets.

Disclosure: I am/we are long NVS. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.