How the Deal Is Structured
Covidien has authorized the controlled repurchase of up to $2 billion of its own shares on the open market. At the company’s current share price of roughly $68, this program’s full realization would result in the buyback of as many as 30 million Covidien shares. Relative to the company’s total float of about 470 million shares, this would result in the cancellation of roughly 6 percent of its outstanding shares. Although some market-watchers argue that the move has already been priced into the company’s shares, such a move has the potential to boost Covidien’s stock by an additional 5 to 10 percent from its current levels.
Complications and Caveats
Market-watchers have reacted to past Covidien buybacks with skepticism. Indeed, the company does have a history of authorizing share buyback programs and subsequently failing to take meaningful action on them. However, it is too early to say whether that will be the case in this situation. Under the circumstances, it would be foolish for investors to assume a negative outcome. The downside risks of doing so may be significant.
However, it is possible that other aspects of Covidien’s performance will serve to detract from any positive buyback-related effects. For instance, the company could report an unforeseen charge related to the impending Mallinckrodt spin-off or badly miss an earnings target to the downside. Investors who do not feel strongly about Covidien’s underlying strength should not be swayed by this move.
Long-Term Industry Outlook and Possible Plays
Going forward, Covidien clearly seeks to position itself as a principal player in the medical device and wound care sub-industries. With its spin-off of Mallinckrodt, it has divorced itself from much of the costly research and development work that it once conducted in order to focus on more stable streams of revenue. In the long run, this is liable to produce substantial rewards for long-term investors. Indeed, Covidien’s recent dividend boost might be the first sign that its out-year strategy is working.
Of course, the medical device industry is just as competitive as the pharmaceutical industry. Investors must perform their own due diligence to determine Covidien’s worth as an investment vehicle.
In sum, Covidien’s latest share buyback program is an encouraging sign that the company’s growth strategy remains intact. Once it has completed the Mallinckrodt spin-off, Covidien will be free to focus on building up its core operations and returning additional cash to its shareholders. As such, investors would do well to look at the stock at these levels.
The article Buybacks Could Keep Up This Stock’s Momentum originally appeared on Fool.com and is written by Mike Thiessen.
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