GlaxoSmithKline / Pfizer Consumer Merger...rational.

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• -GlaxoSmithKline and Pfizer are merging their consumer health businesses to form the largest OTC drug maker in the world. 
• -The transaction is expected to create synergies resulting in nearly 30% earnings growth for the new company. 
• -Financial engineering through recapitalized balance sheets and multiple arbitrage will unlock additional value for shareholders. 
• -Both GlaxoSmithKline and Pfizer are coming out ahead. GlaxoSmithKline is effectively splitting into two more focused companies while Pfizer is selling a non-core asset at a premium in a tax-advantaged spin/merge.

Merits of the Deal 

On December 19, 2018, GlaxoSmithKline  and Pfizer  announced the two companies would merge their consumer healthcare businesses in a JV that will be spun off within the next 3 years. GlaxoSmithKline will own a controlling ownership of 68%, and Pfizer will own 32% of the JV. This is an all-cash deal that is set to create the world’s largest OTC drug company. 

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GSK and Pfizer to create consumer healthcare JV

The merger is expected to result in £0.5 billion cost synergies by 2022. As you can see from the below table, the current standalone businesses generate a total of £1.72 billion in pre-tax profits at a 17.5% margin. The combined pro forma business will generate roughly £2.22 billion in profits at a 22.6% margin (assuming no top line growth). This represents a 29% increase in earnings, creating significant value for shareholders of both GSK and PFE.

Synergies will come from a variety of sources, including cuts to duplicative jobs and procurement. The key driver is scale. Greater scale will help the new company negotiate better rates with all of its suppliers as well as reach more shelf space with retailers. This comes at a time when healthcare providers and pharmacies are consolidating. Furthermore, online retailers like Amazon are threatening branded consumer products with white-label goods sold at discounted prices.

The new company, which will be named “GSK Consumer Healthcare”, will be a consumer brand powerhouse, including the global franchises listed in the chart below and many more. These brands are primarily mature cash cows that require little investment in innovation. However, the new company will reinvest 25% of the cost synergies back into R&D.

Implications for GSK

This is a much bigger deal for GSK, where the consumer business represents 25% of earnings versus 7% at Pfizer. Interestingly enough, GSK trades at a discount to both pharma and consumer peers despite paying out a higher dividend yield. If executed well, the company could see a meaningful boost to its share price, which has been stagnant for years.

This transaction shows that newly appointed GSK CEO, Emma Walmsley, is assertive in transforming the company. Walmsley became CEO in April 2017, after running the company’s consumer health business. 

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She has made a number of big M&A deals in her short tenure. In March 2018, the company bought out Novartis’ stake in GSK’s consumer healthcare business for $13 billion. In March 2018, GSK announced it would sell some of its consumer assets to Unilever . In December 2018, GSK announced a $5.1 billion acquisition of cancer drug maker TESARO. 

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All of these transactions show Walmsley’s strategy of focusing new investment in next-generation pharma drugs, while preparing the consumer business to be a standalone operation. Investors should expect GSK to continue acquiring pharma assets in order to strengthen its pipeline before consumer health is separated.

Implications for Pfizer

The deal’s implications for Pfizer are more straightforward. The company had been trying to sell its consumer business for over a year and failed to find a cash buyer. This deal presents Pfizer a way to offload its consumer business at a premium, while capturing the upside of future financial benefits from the combined company. The premium it receives comes in the form of a greater ownership in the new company than is simply justified by the earnings contribution. Pfizer will own 32% of the combined company, even though its assets only generate 28% of the pro forma revenue. The 10-20% premium Pfizer receives has been referred to as a “control premium” to secure GSK’s ability to manage the new company. (Más)

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