Wednesday, February 08, 2006

A Quarter-Trillion Buyout? Imagine the Fees!

No doubt the PowerPoint slides are being reviewed, critiqued, and reworked at the Pfizer corporate office in preparation for Friday’s Big Analyst Meeting.

Pfizer, hailed Company of the Year by Forbes Magazine in its January 11, 1999 issue, has lately fallen on very hard times—both business-wise and stock price-wise, and analysts, widows, orphans and brokers are eagerly looking for guidance at tomorrow’s first post-collapse presentation to Wall Street’s Finest.

Is it any coincidence that Pfizer’s stock peaked at $50.04 on April 16, 1999—just three months after the Forbes Cover Story?

Everybody on Wall Street has either experienced first-hand or knows examples of the “Cover Story Curse”—the tendency of major publications to recognize a major trend, fad, or corporate success precisely as that trend, fad, or corporate success has bred the seeds of its own destruction—and Pfizer is Exhibit A of the Cover Story Curse.

[As readers might recall (see “The Last, Best Hope for Prosperity” on June 12), Time Magazine provided the most recent “Cover Story Curse” last summer, when its “Home Sweet Home” cover story (“Why we’re going gaga over real estate”) preceded the top in the house-buying mania by maybe three months.]

And so it was that Pfizer-the Great slowly lost its way, until earlier this year anxious callers to “Mad Money” asked Cramer for advice on their holdings in what had once been regarded as the bluest of blue-chip stocks.

“I am giving you permission to sell Pfizer!” Cramer would scream, slamming the “Sell-Sell-Sell” button and no doubt contributing to the wash-out bottom in the stock, shortly before welcome litigation news and a huge dividend boost sent the stock up, and altered the mood among Pfizer investors from feeling we’re-all-doomed to the more hopeful it’s-not-dead-yet.

And now the Wall Street Journal reports that Pfizer may be preparing to sell the old Warner-Lambert consumer franchise, comprised of Listerine, Visine and other stalwarts that have lately been knocking the cover off the ball in comparison to the drug business.

Numbers being tossed around are as high as $11 billion, and interest is said to be high.

But why stop there? Why stop at selling off $4 billion or so worth of Pfizer’s $50 billion in sales? Why not sell the whole thing? And I don’t mean a merger with, say, P&G or some Big European Drug company.

I mean a good old fashioned leveraged buyout.

The idea is probably as farfetched as it sounds, and the probability is next to nil. I would never buy the stock on the assumption that some private equity group could round up the quarter-trillion or so that it would cost to leverage-up the company.

Also, Pfizer guys are corporate guys—they like the company, they like the lifestyle to which it has accustomed them, and they have probably become too accustomed to being the buyer to ever think about being the seller, despite the fact that they have granted themselves something like a half a billion shares worth of stock options.

And they are probably not the most entrepreneurial management in America.

I say that because I once sat on the train to New York next to a Pfizer executive. He spent the entire train ride—more than an hour—working on his laptop computer moving boxes around on an organizational chart.

I am not making that up.

But a leveraged buyout of the ex-Company of the Year is worth thinking about, if for nothing else than trying to understand the valuation currently accorded to Pfizer on the market.

The math is really pretty simple:

1. Pfizer had EBYYY—“Earnings Before Yadda-Yadda-Yadda”—of around $22 billion last year. (In serious terms, EBYYY is what Wall Street calls “EBITDA”—earnings before non-cash charges, such as depreciation, and capital-related charges, such as interest and taxes.)

2. Pfizer has no debt, net of cash. In fact, Pfizer has a lot of cash, thanks to the repatriation of $30+ billion from overseas entities as part of the so-called “Jobs Act.”

So let’s pretend a leveraged buyout group paid $32 a share for PFE—just pretend. Call it 7.4 billion shares outstanding, and that would cost the buyers $237 billion.

Now, pretend the buyers put up $37 billion of their own equity and borrow the remaining $200 billion, upon which they might theoretically pay, what, 9% interest—about $18 billion annual interest expense?

(Hey, Russian Federation bonds yield roughly 6%—and which credit would you rather own, a country run by an ex-KGB agent or a company whose business is keeping aging Baby-Boomers alive?)

So, under these assumptions, Pfizer’s EBYYY of roughly $22 billion would cover the $18 billion annual interest tab, with $3 billion available for capital expenditures (which amounted to something under $2.5 billion last year) or dividends to the new owners.

Furthermore, the new owners—being rapacious high-leverage types—could immediately set about selling off assets (the Listerine franchise, for example) to the highest bidders, in order to reduce debt or, more likely, pay themselves fat dividends and the kind of “advisory” fees that LBO groups grant themselves once they control the piggy bank.

Far-fetched? Yes.

But here’s the most compelling part: figure that the average LBO generates legal, banking and advisory fees of up to 5% of the value of the deal.

5% of $237 billion is $11.9 billion—$11.9 billion of fees for Wall Street’s lawyers and bankers and analysts!

Dream away! But don’t expect an announcement tomorrow.

Jeff Matthews
I Am, In This Case, Making It Up

© 2005 Jeff Matthews

The content contained in this blog represents the opinions of Mr. Matthews. Mr. Matthews also acts as an advisor and clients advised by Mr. Matthews may hold either long or short positions in securities of various companies discussed in the blog based upon Mr. Matthews' recommendations.


Honorable Justice Jorge P. Smythe said...

When you sell off Warner after the LBO you'd stick it with what 50%, 75% of the debt? Then you'd have 100, 75 billion in debt on 18 billion EBYYY. Let's do it.

DaleW said...

[As readers might recall (see “The Last, Best Hope for Prosperity” on June 12), Time Magazine provided the most recent “Cover Story Curse” last summer, when its “Home Sweet Home” cover story (“Why we’re going gaga over real estate”) preceded the top in the house-buying mania by maybe three months.]

As I have pointed out, the Economist had an equally bearish cover story about the housing bubble at that time. Net net, the stocks are sideways since then. Check out the UK builders relative to the top in housing there in 2004. They're up a bunch. It's not like the market didn't know at that time what you were talking about. I disagree the media were universally bullish about housing -- this was one of the most widely forecast bubble bursts ever, which means the stocks discounted this ahead of time.

Anonymous said...

Jeff, I'm not saying you're "making this up", but you're dreaming if you think the deal makes sense.Pfizer could very well trade to $32 on its own because the tape looks like it's turned and stocks in motion often stay in motion, but the idiots or bankers that would be willing to own that debt, well, I think they got wiped out lending money to emerging telecom broadband companies in 2000. The problem with Pfizer is Lipitor, because what the heck are they going to do when the patent runs out? That drug produces some half of the ebyyy that you're talking about.The stream isn't like Coke or Tide detergent or something that with proper marketing will make money from now till judgment day.Maybe their lab can come up with enough stuff to replace Lipitor, but they've demonstrated no ability along those lines of late. McKinnell is a talented politico, but he's a business idiot, and the 4 billion shares he used to buy Warner and Pharmacia, he'll be super lucky to break even on over the 11 some years that Pfizer will have owned a patented Lipitor.I think you're right that Pfizer got washed out, and when it got out that Marty Whitman bought some, it buoyed the value investing crowd, but there's a lot stocks that you could buy that could go from $26 to $32, and Pfizer's about the ugliest horse you could hitch your wagon to.

RDS said...

FYI- I have spent days moving organizational chart blocks around for a big oil firm that rhymes with chernoble.

Johnny Debacle said...

The bank loan market (the source of the cheapest LBO financing) is very very hot right now. Their have been a couple "biggest since RJR" type deals in a row Sungard and more recently Georgia Pacific.

whydibuy said...

Nelsons analysis is right. Divesting the consumer div is a sign of mgt cluelessness. BMY back in '01 divested their consumer div to focus on being a branded pharma only. Only problem was r&d is anything but guaranteed. At least the consumer stuff steadied the earnings yr to yr. But it gave the BMY guys something to tout about how they were increasing shareholder value and providing a rational for bonuses for achieving corp goals. BMY stock is down since and has become dead money with no prospect in sight. Ditto for PFE. Mgt is stiring the sh*tpot and getting a little excitement but the future is not all that bright. Blockbusters like lipitor don't come along everyday. And remember to floats these giants have; BMY 3 bil shrs, PFE 8 bil shrs. Gee, that means for PFE to make another $ 1.00 per shr they have to generate 8 bil profit. Not exactly chump chg. And I seem to remember Buffett saying he considered the large pharmas back in '04 but felt their business had changed. He didn't elaborate but I'd bet he felt they were to speculative for equaling their past performance.

The Irrational Investor said...

I agree with Nelson. I don't hear much of a compelling argument for owning shares in this company, even from Whitman.

Does current patent legislation have anything to do with the state of this company, MRK, BMS, and GSK? I think it's a question worth asking.

tahoe kid said...

Regarding Nelson Yu's comment about Lipitor, U.S. District Court Judge Joseph Farnan Jr. ruled on Dec. 16, 2005 in favor of Pfizer. His ruling upheld Pfizer's two patents and blocks generic competition for Lipitor until June 2011.

whydibuy said...

So what? MRK's Zocor goes generic in 4 months and will gut lipitors sales. And speaking of invasion of privacy, PFE wants to experiment on gps tags on their drugs to track them. That way they'll know what your using.

tahoe kid said...

I would argue doctors don't switch drugs on patients to save money. They switch for better efficacy and/or fewer side effects. Generic Zocor could capture share of new scripts that might otherwise go to Lipitor.

esbarr said...

Yes, the blah blah covers the interest expense, but in this scenario where is the amortization of said debt? Perhaps that would be for the bankruptcy/distressed investors, a whole new layer of fees, to decide.

Mediacrity said...

... I linked to your blog here, in an item on one of your pals.
Just FYI. Actually you can delete, as it is O/T.

Jeff Matthews said...

The hostility shown here towards Pfizer at, what, 12-times earnings reminds me the hostility shown towards Google during the IPO--when, it turned out, Google was being offered for what would turn out to be only 15-times 2005 earnings.


BDG123 said...

I really love this idea. Listen, I will call up Henry Kravis and the three of us will "do" lunch and develop the concept further. Game?

While we are at it there are a few others I think would benefit from the same thing. One is in my back yard. Bob Evans Farms. Selling at much less than book value and 500 of the choicest retail properties in the midwest. A true pig by any investment measurement but a brand gem. I want to buy the company, sell off the retail assets to Vornado and be another Eddie Lampert.

The Irrational Investor said...

while you're at it, add Rex Stores to your list.

whydibuy said...

GEEEZ, Jeffy, a contrarian play?? PFE is only on the recommended list of 26 of the top 30 market letters Mark Hulbert follows and has 16 buy or strong buys from wall street with no sells or reduces. But, other than those it looks like you'll be alone in the trade on long side.