GSK Turnaround Story

M&A, pharmaceuticals

For well over 20 years, shareholders of GlaxoSmithKline PLC (GSK) have been on a long journey to nowhere, with the pharmaceutical company lagging well behind its peers. That’s why activist investor Elliott Management has been pushing the company to come up with a plan to correct years of stock price underperformance and operational drift.

The underperformance of GSK stemmed directly from the ill-fitting merger of the old GlaxoWellcome and SmithKline Beecham businesses.

Poznan, Poland – October 28.2020: The Glaxosmithkline headquarters office building in Poznan. LOGO. GaxoSmithKline also called GSK is a British pharmaceutical company.

However, this poor marriage will be undone when the consumer healthcare (SmithKline) and pharmaceuticals (Glaxo) businesses formally divorce in July. This split should allow each company to deliver more value for their shareholders. GSK will still have a large controlling stake in the carved-out spinoff company, Haleon.

For GSK investors, the implications are that this split will turn into a real moneymaker.

The GSK Divorce

There is reason to believe that hiving off the consumer healthcare business via a new stock market listing is the best outcome for a pharmaceutical business that suffered from a lack of investment under its old corporate structure.

The spin-off consumer healthcare company, Haleon, will remove around $11.1 billion from the company’s top line. The rationale behind this move—rather than simply selling off Haleon—is that the cash generative, but low margin, consumer healthcare business can be leveraged to provide the resources that are needed to upgrade GSK’s rather thin pharmaceutical pipeline.

Consumer giant Unilever PLC (UL) offered $68 billion for Haleon in January because of its attractive portfolio of vitamins, pain relief, and oral health products.

But GSK turned down the offer because, in simple terms, the consumer healthcare cash cow business will be milked to provide funding to boost GSK’s pharmaceutical efforts.

Based on Haleon’s portion of total sales, Julian Hoffman of Investors Chronicle in the U.K. believes the company could safely take on 25% of GSK’s debt—about $5.8 billion—without a problem. He added that one way to “mortgage” Haleon might be to increase its debt burden in relative terms so that pharmaceutical GSK can add leverage to its own balance sheet, without increasing its net interest costs.

GSK’s Future Path

GSK is already gearing up for what it hopes will be a bright future.

On April 13, GlaxoSmithKline announced a $1.9 billion deal to purchase a U.S. biotech company, Sierra Oncology.

The deal’s price tag doesn’t look unreasonable, given that it is roughly three times consensus peak sales expectations of $630 million for Sierra’s lead experimental drug, momelotinib, J.P.Morgan analysts wrote in a note to clients.

Momelotinib, which Sierra Oncology acquired from Gilead Sciences in 2018, is designed to treat anemic patients who have a type of bone marrow cancer called myelofibrosis. The treatment should be submitted for U.S. marketing approval this quarter. Results from a late-stage trial in January showed the drug was successful in reducing disease symptoms and cut patients’ dependence on blood transfusions.

This gives GSK a late-stage product for the treatment of myelofibrosis patients with anemia—a co-morbidity that makes the cancer difficult to treat. Myelofibrosis affects about 18,000 patients a year in the U.S.

GlaxoSmithKline is confident the drug can start to make a contribution to the top line beginning in 2023. If Momelotinib proves to generate enough benefit for this patient group, then it is reasonable to assume that GSK will likely be able to charge a premium for the product.

The acquisition is expected to close in the third quarter and will complement Blenrep, GSK’s treatment for multiple myeloma, another form of blood cancer. There’s about a 70% overlap in customer base between momelotinib, Blenrep and other haematology products, according to Luke Miels, chief commercial officer at GSK.

The company’s oncology business last year accounted for only about 2.8% of total pharmaceutical sales and recently suffered trial setbacks on two cancer compounds that were once touted as potential blockbusters.

The Sierra deal is a sure sign that management intends to push the company into areas (such as cancer treatments) where returns will be much higher. Oncology therapies are the favorites of many pharmaceutical companies because of fast-track development timelines and those higher returns.

This is good news for long-suffering GSK shareholders. They seem to approve so far: the stock has gained about 15% since the latest strategy was unveiled at a capital markets day at the end of February.

Despite the recent rally, GlaxoSmithKline stock still—in valuation terms—lags far behind its peers with a forward PE of only 14. This reflects many years of underperformance and disappointment.

This should make both value investors sit up and take notice. If GSK’s turnaround can merely track the performance of its peers, then there is potential for a higher-than-average return for GSK shareholders.

GSK is a buy anywhere in the low $40s price range.

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