October 26, 2017

Breakingviews: Animal Health Spinoff May Be Just The RX for Lilly

by Breakingviews.

An animal-health spinoff may be just the prescription for Eli Lilly. The $90 billion outfit is weighing the sale or float of its pet and livestock drug business. Lofty valuations make it tempting to raise cash when the firm’s core pharma business has had some pipeline stumbles. But U.S. regulatory approval for its arthritis treatment is the real remedy investors seek.

The company failed to get a green light for an Alzheimer’s treatment in 2016, but the odds were stacked against success in that case. The rejection of its arthritis drug by the U.S. Food and Drug Administration in April was a bigger surprise. The company plans to resubmit the potential blockbuster by the end of January. While investors wait, they can focus on the animal-health unit.

This used to be a backwater. Nearly every pharmaceutical firm had one to repurpose human drugs for animals. Preventing kennel cough or heartworm doesn’t carry the prestige of curing Alzheimer’s, but the market has warmed to the cash these businesses generate.

Consumer spending on pet care is rising steadily. Innovation is slower and surer, and there’s less pressure from rivals selling generic pills. Zoetis, the biggest animal-health company, spends about 8 percent of revenue on research and development, less than half what a typical human-drug firm shells out.

Zoetis shares have risen two and a half times since its spinoff from Pfizer in 2013, far outperforming the performance of the S&P 500 and its parent’s stock. Other firms snapped up rivals’ animal-health divisions. Lilly paid $5.4 billion for Novartis’ unit in 2014, and then $885 million for Boehringer Ingelheim’s pet-vaccine arm.

Valuation may explain Lilly’s possible change of heart about the business. Zoetis is growing slightly faster and has higher margins than Lilly’s animal unit. It is valued at over a 15 percent premium to Lilly as a whole, based on estimated earnings before interest, tax, depreciation and amortization. Or consider that Lilly paid almost five times revenue for Novartis’ animal division. Zoetis is currently valued at around seven times.

If the market can be persuaded that the two are similar, a spinoff or sale might generate some value. Granted, it’s not the same as an arthritis drug that could generate over $1 billion a year in revenue, but investors probably won’t quibble over found money.


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