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Pfizer Inc. (PFE), AstraZeneca plc (ADR) (AZN): Is Concentration Better Than Diversification in Pharma?

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Pfizer Inc. (NYSE:PFE) recently completed the spin-off of its animal health unit, Zoetis Inc (NYSE:ZTS). The company offered to acquire its stake in Zoetis for a 7% discount, in exchange of all or part of its shareholding. This is subject to an upper limit of 0.9898 shares of Zoetis common stock per share of Pfizer Inc. (NYSE:PFE) common stock. This spin-off is expected to reflect on Pfizer Inc. (NYSE:PFE)’s EPS beginning 2014. Before Zoetis Inc (NYSE:ZTS)’ IPO in February, Pfizer held nearly 401 million class B shares of Zoetis, which it now aims to convert to Class A shares of the animal health company.

Pfizer Inc. (NYSE:PFE)

This spin-off follows Abbott Laboratories (NYSE:ABT), which spun-off AbbVie Inc (NYSE:ABBV) on New Year’s Day. This is indeed becoming a common practice, with analysts predicting more spin-offs in the industry.

Why spin-offs?

The pharma industry is one of the riskiest. Actually, I cannot think of a riskier industry than pharmaceuticals.

The main risk in investing in the pharmaceutical industry is the high spending associated with research and development against uncertain results of products developed. Competition is also heating up in the industry, with some of the rivals actually opting to acquire the underdogs, a good case example being AstraZeneca plc (ADR) (NYSE:AZN)’s acquisition of Omthera Pharmaceuticals.

Concentration seems to be the main reason for the spin-offs, as it would allow the companies to focus on developing products within their main lines of business. For instance, Pfizer Inc. (NYSE:PFE) can now focus on its biopharmaceuticals products by directing its research and efforts at the products currently in its pipeline. Ian Read, Pfizer Chairman and Chief Executive Officer said:

“We expect that this exchange offer will continue to deliver value to Pfizer Inc. (NYSE:PFE) shareholders by reducing the number of our outstanding shares in a tax-efficient manner. At the same time, we believe that this transaction better positions Pfizer to focus on our core business as an innovative biopharmaceutical company.”

According to the company’s most recent update, as of May 9, there are 74 products in the pipeline, 18 of them in phase three and 6 in registration. This compares flatly to the company’s previous update on Feb. 28, 2013, which revealed 17 products in stage three and seven in registration.

With specialization, Pfizer will be able to come up with numerous biopharmaceutical products for human health. Pfizer will also be cutting its payroll budget by about 1,000 employees, which should ease running costs. However, it will also be spinning-off some $4 worth of annual revenue from the unit, which could result in reduced gross margins. However, the EPS is bound to improve if majority of the shareholders take Pfizer’s offer.

By exchanging their shareholding in Pfizer to own, a stake in Zoetis will result in some sort of share buyback for the pharmaceutical giant. Therefore, this spin-off is not only resulting in long-term benefits associated with specialization, but also some near-term benefits in form of stock repurchases.

On the other hand, Zoetis Inc (NYSE:ZTS) is now an independent company, able to develop its own strategic plans with regards to animal health. In 2012, Pfizer invested $400 million in R&D on the animal health unit, but now, Zoetis plans to invest about $385 million to $415 million in 2013. Zoetis is well set to stand on its own and certainly needs no helping hand from Pfizer.

The Kalamazoo, MI-based company has a 60 year-old history with Pfizer, with 29 manufacturing plants located in its Michigan base. It also has other plants in California, Iowa, Maryland, Missouri, Nebraska, North Carolina, and New Jersey, which also houses its headquarters.

Both Pfizer Inc. (NYSE:PFE) and Zoetis shares have fluctuated during the transition period, depicting a relative rally since February. It seems as if the $2.2 billion Zoetis IPO triggered the rally. Both companies had significant rallies, with shares of Zoetis rising from the offer price of $26 to $34. However, the shares are now down to $31, and continue to fluctuate. On the other hand, shares of Pfizer rallied from $27.70 in Feb, up to around $31 in April, before sliding to $28.26 as of June 7.

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