| 2021 | 2022 | ||||||
| Price: | 28.45 | EPS | 5.46 | 0 | |||
| Shares Out. (in M): | 250 | P/E | 5.2 | 0 | |||
| Market Cap (in $M): | 7,113 | P/FCF | 5.8 | 0 | |||
| Net Debt (in $M): | 9,580 | EBIT | 2,096 | 0 | |||
| TEV (in $M): | 16,693 | TEV/EBIT | 8.0 | 0 | |||
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Quoting kuppy in his recent Valaris write-up,
“Roughly two decades ago, a brilliant investor wrote a book on how to make money off of special situations, with a focus on spin-offs. Since then, every aspiring investor has read this book and the opportunity set has been picked over, leading to compressed returns.”
Presented below is a recent spin-off that appears to be trading at a very attractive valuation, and that likely has been subject to the dynamics of selling by price-insensitive owners of the parent company, for whom the spin-off shares represent less than 5% of the parent share value.
Merck spun off Organon (OGN) last week. From a share price in the mid-30s last week, and over $38 in when-issued trading two weeks ago, OGN has descended in a straight line to its current price of $28.45.
Per the Information Statement, Organon will be a global pharmaceutical company with a portfolio of more than 60 trusted medicines. Our portfolio is comprised of our growing contraception and fertility business including patent-protected Nexplanon (etonogestrel implant), an expanding biosimilars business and is led by a stable franchise of trusted established medicines. Organon’s portfolio of products generate strong cash flows that will support investments in future growth opportunities in women’s health. We will pursue opportunities to partner with innovators looking to commercialize their products by leveraging our scale around the world, with presence in more than 140 markets. Organon will focus on revenue growth using an efficient operating model to improve margins and generate strong cash flow to fund our long-term vision.
Is this company cheap?
At Merck’s investor day on May 3, 2021, Organon management provided a view on OGN’s prospects going forward.
The webcast and slides are available at:
https://organoninvestorday.connectid.cloud
Rather than repeat what you can see in the presentation, I will focus on an analysis of the financial outlook provided by the company. The ranges in Slide 6 in the Financial Outlook sections are used to project performance for 2021:
|
Low |
High |
|
|
$ millions |
2021 |
2021 |
|
Revenue |
$ 6,100 |
$ 6,400 |
|
EBITDA |
2,196 |
2,432 |
|
% of revenue |
36.0% |
38.0% |
|
Interest expense |
(400) |
(400) |
|
D&A |
(100) |
(115) |
|
EBT |
1,696 |
1,917 |
|
Tax |
(331) |
(335) |
|
Tax rate |
19.5% |
17.5% |
|
Net Income |
1,365 |
1,582 |
|
EPS |
$ 5.46 |
$ 6.33 |
|
Shares outstanding |
250 |
250 |
|
Share price |
$ 28.45 |
$ 28.45 |
|
P/E |
5.2x |
4.5x |
|
EBITDA |
2,196 |
2,432 |
|
Capex |
(244) |
(192) |
|
% of revenue |
-4.0% |
-3.0% |
|
D&A - Capex |
(144) |
(77) |
|
EBITDA - Capex |
1,952 |
2,240 |
|
Cash |
500 |
500 |
|
Debt |
10,080 |
10,080 |
|
MV |
7,113 |
7,113 |
|
EV |
16,693 |
16,693 |
|
EV/EBITDA-capex |
8.6x |
7.5x |
|
FCF to equity |
1,221 |
1,505 |
|
MV/FCF |
5.8x |
4.7x |
|
Implied FCF yield |
17.2% |
21.2% |
|
implied dividend |
244 |
301 |
|
% of FCF |
20.0% |
20.0% |
|
Dividend per share |
$ 0.98 |
$ 1.20 |
|
Dividend yield |
3.4% |
4.2% |
Sections highlighted in blue are company projections.
The company is cheap enough that buyers at these levels are unlikely to sustain a permanent loss of capital.
The company has projected that revenues will bottom out in 2021 after having declined over the last few years, and will grow low- to mid- single digits going forward.
An analysis of the upside if things work out well for the company:
|
Upside |
|
|
|
|
|||
|
High |
5% |
Revenue CAGR |
|
|
5 Year |
||
|
$ millions |
2021 |
2022 |
2023 |
2024 |
2025 |
2026 |
CAGR |
|
Revenue |
$ 6,400 |
6,720 |
7,056 |
7,409 |
7,779 |
8,168 |
5% |
|
EBITDA |
2,432 |
2,567 |
2,710 |
2,860 |
3,018 |
3,186 |
|
|
% of revenue |
38.0% |
38.2% |
38.4% |
38.6% |
38.8% |
39.0% |
|
|
Interest expense |
(400) |
(400) |
(352) |
(342) |
(287) |
(259) |
|
|
D&A |
(115) |
(115) |
(115) |
(115) |
(115) |
(115) |
|
|
EBT |
1,917 |
2,052 |
2,242 |
2,403 |
2,616 |
2,811 |
|
|
Tax |
(335) |
(359) |
(392) |
(420) |
(458) |
(492) |
|
|
Tax rate |
17.5% |
17.5% |
17.5% |
17.5% |
17.5% |
17.5% |
|
|
Net Income |
1,582 |
1,693 |
1,850 |
1,982 |
2,158 |
2,319 |
|
|
EPS |
$ 6.33 |
$ 6.77 |
$ 7.40 |
$ 7.93 |
$ 8.63 |
$ 9.28 |
8% |
|
Shares outstanding |
250 |
250 |
250 |
250 |
250 |
250 |
|
|
Share price |
$ 28.45 |
$ 37.00 |
$ 46.09 |
$ 55.86 |
$ 66.26 |
$ 77.42 |
22% |
|
P/E |
4.5x |
5.5x |
6.2x |
7.0x |
7.7x |
8.3x |
|
|
EBITDA |
2,432 |
2,567 |
2,710 |
2,860 |
3,018 |
3,186 |
6% |
|
Capex |
(192) |
(202) |
(212) |
(222) |
(233) |
(245) |
|
|
% of revenue |
-3.0% |
-3.0% |
-3.0% |
-3.0% |
-3.0% |
-3.0% |
|
|
D&A - Capex |
(77) |
(87) |
(97) |
(107) |
(118) |
(130) |
|
|
EBITDA - Capex |
2,240 |
2,365 |
2,498 |
2,638 |
2,785 |
2,941 |
|
|
Cash |
500 |
500 |
500 |
500 |
500 |
500 |
|
|
Debt |
10,080 |
8,876 |
7,591 |
6,189 |
4,689 |
3,057 |
|
|
MV |
7,113 |
9,251 |
11,522 |
13,966 |
16,565 |
19,356 |
|
|
EV |
16,693 |
17,627 |
18,614 |
19,655 |
20,754 |
21,913 |
|
|
EV/EBITDA-capex |
7.5x |
7.5x |
7.5x |
7.5x |
7.5x |
7.5x |
|
|
FCF to equity |
1,505 |
1,606 |
1,753 |
1,875 |
2,040 |
2,189 |
|
|
MV/FCF |
4.7x |
5.8x |
6.6x |
7.4x |
8.1x |
8.8x |
|
|
Implied FCF yield |
21.2% |
17.4% |
15.2% |
13.4% |
12.3% |
11.3% |
|
|
implied dividend |
301 |
321 |
351 |
375 |
408 |
438 |
|
|
% of FCF |
20.0% |
20.0% |
20.0% |
20.0% |
20.0% |
20.0% |
|
|
Dividend per share |
$ 1.20 |
$ 1.29 |
$ 1.40 |
$ 1.50 |
$ 1.63 |
$ 1.75 |
8% |
|
Dividend yield |
4.2% |
3.5% |
3.0% |
2.7% |
2.5% |
2.3% |
|
Sections highlighted in blue are company projections. Some of my assumptions are highlighted in yellow.
Note that OGN projects pro forma debt at spin-off of $9.5 billion, which I have adjusted upwards by $600 million for one-time post-spin-off costs anticipated by the company.
Annual returns over five years in this scenario are 22% in price appreciation and 3% in dividends.
The share price above is projected by keeping the EV/(EBITDA – Capex) multiple constant, with equity appreciation accruing from debt pay-down. Obviously, this multiple may well increase in the short term as selling by Merck shareholders ends, and longer term as financial leverage declines. Finally, OGN is positioning itself as a women’s health company, which could attract an ESG premium.
Conclusion: Many questions may have not been addressed in this analysis, but I chose to focus on the core issues of valuation and upside. My goal is to provide a quick analysis of what I believe to be a very attractive situation, where the dynamics that have led to this investment opportunity may soon end.
1) Short term - selling pressure from price-insensitive Merck shareholders ends
2) Longer term – OGN lives up to its projections for 2021 and beyond (particularly by showing some sales growth in 2022)
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