While GE HealthCare will deliver better growth as a stand-alone, the new company’s valuation looks stretched and its leverage is high
By guest author David Wainer
Jan. 7, 2023
Healthcare spinoffs are everywhere you look these days.
Just in the first week of January, Johnson & Johnson JNJ 0.81%increase; green up pointing triangle‘s consumer unit Kenvue officially filed for an initial public offering, GE GE 0.91%increase; green up pointing triangle‘s newly spun-off healthcare unit started trading and Baxter announced plans to spin off its kidney care unit. Swiss giant Novartis, meanwhile, is working on spinning off its generic Sandoz business.
Even in a world where spinoffs are all the rage, healthcare stands out. An analysis of recent breakups by Houlihan Lokey found that from 2019 to 2022, the sector tied for first place with information technology.
Generally speaking, spinoffs are usually an attractive way to drive shareholder return. First of all, they are tax-efficient. But more important, they allow the parent company to reduce complexity where size in and of itself confers no strategic advantage. Meanwhile, the newly established company gains autonomy to make better decisions. That is the idea with newly listed GE HealthCare GEHC -0.08%decrease; red down pointing triangle Technologies, whose management is arguing that a more nimble company will make faster and better decisions.
On its face, that makes sense. Unencumbered by the parent company’s focus on a higher growth division, the lower-growing spun-off company focuses on what it does best, allowing it to boost top- and bottom-line growth. An analysis by Morgan Stanley (which acted as a lead adviser in the GE spinoff) of medical technology spinoffs since 2000 showed they outperformed the S&P 500 by about 20% in their first year as independent, listed companies.
But newly spun-off companies often come with some baggage and need to be examined closely. In recent years, they have often become a way for large companies to bid goodbye to underperforming units while slapping some unwanted debt on the new company. A closer look at Morgan Stanley’s list reveals that the most recent spinoffs have underperformed the S&P 500, with older, more successful ones like AbbVie (spun off from Abbott) and Covidien (spun off from Tyco and later acquired by Medtronic) skewing the numbers. Of the five most recent spinoffs in Morgan Stanley’s list—SeaSpine Holdings, Varex Imaging, Alcon, Siemens Healthineers and Envista Holdings—only Siemens Healthineers outperformed the S&P 500 two years on from the transaction.
Looking at GE HealthCare, the case for growth as a stand-alone is a good one. Rising healthcare demand should allow the company to expand its ultrasound business, while its imaging and patient care solutions divisions have relatively low margins that could be expanded by focused management.
But it is hard to get excited about the company’s valuation. The newly listed shares closed at USD 58.95 on Friday, at the higher end of Morgan Stanley analysts’ valuation range of USD 52-USD 59. The Edge Group, a research firm focused on special situations, has a target of USD 54.52 for the stock, reflecting an enterprise value of 12.7 times forecast 2024 earnings before interest and tax—a discount to peer Siemens Healthineers.
GE HealthCare is highly leveraged with about USD 15 billion in debt and pension liabilities, a big number for a company with a market capitalization of USD 27 billion. With such a high debt load, it may opt not to pay dividends for now, according to Jim Osman, the Edge Group’s chief executive.
In the Edge’s 20-year study of large-cap spinoffs, stocks dropped on average 7 % in their first 30 days of trading but returned 22 % two years post-spin. For investors with patience, investing now could pay off in a few years because GE HealthCare’s seasoned management team should drive revenue and margin growth. For those looking for outperformance in the near term, it probably is worth waiting for a better entry point.