Assessing the Impact of the Organon Spin-Off on Merck

Merck is progressing toward the spin-off of its subsidiary, Organon & Co., which is expected to be completed by the end of the June.  Organon will include Merck’s women’s health products, biosimilars and certain established brands, most of which have lost patent protection.  (For a more complete analysis of Organon, see my primary report dated April 14, 2021.)

Based upon Merck’s 2021 financial guidance, the information contained in Organon’s Form 10 registration statement and my analysis, I have estimated that Merck’s projected earnings, excluding half a year of Organon’s results (under the assumption that the spin-off will be completed on June 30) will be $5.15 on a GAAP basis and $6.12 on a non-GAAP basis.  That compares with management’s EPS guidance for the full year 2021, without adjusting for the spin-off, of $5.52-$5.72 on a GAAP basis and $6.48-$6.88 on a non-GAAP basis.  At the midpoint of those ranges, my projections imply that the loss of Organon’s revenues and earnings will reduce Merck’s actual full year 2021 EPS by about $0.44 per share.

The big question that is undoubtedly on many investor’s minds is how will the market value Merck shares post the spin-off?  According to my analysis of Organon, I estimate that the Organon stock that will be distributed to Merck shareholders will be worth about $7.10 per share.  If I am correct, that implies that the rest of Merck, post the spin-off, is currently valued at $70.53 per share, based upon yesterday’s closing price of $77.53.  At that price, Merck post-Organon is valued at 13.7 times projected GAAP EPS and 11.5 times non-GAAP EPS.

Excluding Organon’s full-year projected 2021 results, I estimate Merck’s base retained business will generate 2021 GAAP earnings of $4.76 per share and Non-GAAP EPS of $5.72.  At the current net share price (excluding the estimated value of Organon) of $70.43, I estimate that the market is currently valuing Merck’s base retained business at 14.8 times projected 2021 GAAP EPS and 12.3 times Non-GAAP EPS.

This does not factor in the cash that Merck will receive in the spin-off.  According to my analysis, the total value of Organon stock that will be distributed to Merck shareholders is worth $18 billion, but Merck will receive $9 billion in cash.  Thus, it is distributing to its shareholders a little over 9.2% of the company’s total equity value of $196.4 billion; but only a net 4.6% of its equity value, adjusted for the receipt of cash.

More importantly, Merck will be left with a pharmaceuticals portfolio that on balance has better growth prospects.  The company still faces some significant patent expirations beginning with the $5 billion Januvia, Janumet and Janumet XR franchise in 2022-2023 and the now $14.4 billion (and still growing) Keytruda juggernaut in 2028.

Yet, the company will be simpler to manage after cutting the number of separately-reported pharmaceuticals in its portfolio essentially in half to about 25.  The sale of Organon should therefore put Merck in a better position to grow through internal development, collaborations or acquisitions, including possibly an acquisition of a large publicly-traded pharmaceutical or biotechnology company.  Throughout its more recent history, Merck has shifted course when necessary in order to sustain its business and continue its growth.

According to my analysis, the spin-off of Organon is essentially a wash from an earnings multiple perspective.  After the spin-off, based upon its current valuation, Merck’s stock currently looks like it will continue to trade slightly below the peer group[1] average of 12.8 times projected 2021 consensus non-GAAP earnings (according to estimates compiled by S&P Global Market Intelligence).

Yet, if investors recognize its higher growth potential following the spin, they could award the stock a higher multiple.  Each additional point to its forward P/E multiple (based upon Non-GAAP earnings) would add $5.72 to the stock price.  So a one-point increase in the multiple, which would put its pro forma valuation slightly above the peer group average, would deliver about an 8.0% return to shareholders.

My analysis suggests that both Organon and Merck post-spin are attractive investments that offer reasonably good, if modest, upside potential.  It is likely, in my mind that at its current price of $77.53, Merck will deliver a total return above 10% over the next 6-12 months, through its 3.4% dividend yield and at least one point of earnings multiple expansion. I plan to update my analyses of Merck and Organon after Merck reports 21Q1 results on Thursday, April 29 and Organon hosts its Investor Day on May 3.

My reports on both Merck and Organon are available upon request.


[1]  According to my analysis, Merck’s peer group includes ABBV, AMGN, AZN, BAYRY, BIIB, BMY, GILD, GSK, JNJ, MRK, NVO, NVS, PFE, RHHBY, SNY and TEVA.

April 28, 2021

Stephen P. Percoco
Lark Research
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