California-based Theravance Inc (NASDAQ:THRX)’s announcement that it would split into two distinct companies has drawn a sharply positive reaction from investors.
As part of the split, the pharmaceutical company looks poised to turn its current drug-marketing joint venture with London-based GlaxoSmithKline plc (ADR) (NYSE:GSK) into an independent firm. Meanwhile, it will create a development-focused biopharmaceutical company out of its existing R&D division. Whereas the first firm could generate long-term annual revenue of more than $4 billion through sales of pre-approved drugs, the R&D firm will be limited only by its ability to develop successful compounds and treatments.
Theravance Inc (NASDAQ:THRX) is not currently profitable, and the company has recently posted a worrying decline in R&D expenditures. As such, this split should not be construed as a slam-dunk deal. Indeed, the development-focused firm could easily turn out to be a disaster in the making. At the same time, there may be tremendous opportunity for profit in both companies. Investors who believe that Theravance has some promising drugs in its pipeline would do well to investigate this deal further.
At this point, Theravance Inc (NASDAQ:THRX) primarily concerns itself with finding, developing and commercializing various biopharmaceutical compounds for use in a variety of medical applications. The company has a number of compounds in varying stages of development and approval, including an adult ADHD treatment in Phase II clinical trials and several respiratory treatments that may be commercialized within the next two years. Some of the company’s most promising drugs and compounds have been developed in partnership with GlaxoSmithKline plc (ADR) (NYSE:GSK), a multinational pharmaceutical company with a market capitalization of over $120 billion. GlaxoSmithKline’s most recognizable commercial drugs and compounds include the NicoDerm smoking cessation aid, the Polident denture adhesive and the Tums over-the-counter antacid.
Financial Comparison with Competitors
It goes without saying that these two companies are very different. Although they have few direct competitors in common, it might be instructive to compare them to a company that has some experience with R&D spin-offs, PDL BioPharma Inc. (NASDAQ:PDLI).
Compared to GlaxoSmithKline, PDL BioPharma Inc. (NASDAQ:PDLI) and Theravance both have anemic market capitalizations. In 2012, PDL earned almost $212 million on revenue of about $374.5 million. ROA for PDL was 79% and grew its revenue by 18%. By contrast, Theravance Inc (NASDAQ:THRX) posted a loss of $140.5 million on paltry revenue. It is hoped that the upcoming split will boost Theravance’s revenues dramatically. For its part, GlaxoSmithKline plc (ADR) (NYSE:GSK) earned $6.8 billion on $42.2 billion gross revenue in 2012. PDL BioPharma Inc. (NASDAQ:PDLI) is up 22% in the last year and Theravance is up 63%.
Although Theravance Inc (NASDAQ:THRX) has adequate cash reserves of nearly $560 million, it also has debts of about $460 million. PDL has a cash balance of $148.9 million to complement a debt load of about $310 million, and heavily indebted GlaxoSmithKline finds itself with about $6.3 billion in cash on hand to around $31.1 billion in debt.
The Split’s Components: One Safe, One Risky?
Due to the very different business models to which each split component will inhere, industry observers believe that Theravance Inc (NASDAQ:THRX) is trying to distance its risky R&D division from its more predictable biopharmaceutical partnership. With an infusion of cash from GlaxoSmithKline, this latter component will have several opportunities to create and market a big-name drug that could return capital to the company’s shareholders in a big way. Indeed, a key FDA approval milestone recently made this outcome significantly more likely. If final approval for the partnership’s COPD medicine comes through, it could turn into the company’s first successful compound.
At this point, the precise structure of the deal as well as the size and scope of any spin-off dividend that current Theravance shareholders stand to earn remain unclear however Theravance’s management team has indicated that the split will occur sometime in late 2013 or early 2014. Investors who wish to position themselves in front of this deal would do well to determine their course of action by then.
How Investors Might Profit
Given the divergent risk characteristics of the split’s two components, investors may have multiple means of profiting from this deal. Investors who might naturally be attracted to a promising company like Theravance Inc (NASDAQ:THRX) may wish to establish a long position in the newly independent partnership. By contrast, those who have no problem with the idea of investing in risky pharmaceutical start-ups may find greater opportunity in shares of the R&D company. Although this second component could take longer to pan out or simply never produce investment-worthy returns, it might also offer tremendous value in the out years.
It should be noted that Theravance’s shares initially jumped by more than 13 percent on the news that it would split into two companies. This suggests that the firm’s current investors feel strongly about separating its more risky components from its Glaxo operation. Investors who are inclined to follow the smart money may be better served by a position in the more conservative option.
In sum, this deal presents an exciting and fairly unusual opportunity for Theravance and its shareholders. With regulatory approval imminent for at least one of its drugs, the partnership with GlaxoSmithKline looks to be the deal’s safer component. However, the R&D division may produce eye-popping long-term gains. In either case, investors would do well to watch Theravance’s next moves as closely as possible.
The article Theravance Looks to Reward Shareholders by Splitting Into Two Distinct Companies originally appeared on Fool.com and is written by Mike Thiessen.
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