How to Repel Elliott? Undo a $40 Billion Discount

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Doing a big demerger is an expensive and time-consuming exercise that underperforming companies often pursue in the hope of deterring a shareholder activist. This hasn’t prevented GlaxoSmithKline Plc from attracting the attention of activist-in-chief Elliott Management Corp. That begs the question of what more the U.K. drugmaker should be doing.

Glaxo is in a tough situation due to past poor performance in research and development. It’s failed to replace blockbuster drugs losing patent protection. Blame largely falls past management and shareholders for prioritizing dividends over investment. Under Chief Executive Officer Emma Walmsley, Glaxo is trying to catch up. But it takes time to rebuild a drug pipeline, and for perceptions to change.

There is a happier tale to tell. The more bullish analysts reckon Glaxo could be worth roughly 35-45% more than its current share price — an uplift worth potentially 30 billion pounds ($42 billion) on top of its current 67 billion-pound market capitalization. No wonder Elliott is sniffing around.

There’s reasonable confidence around the value of Glaxo’s consumer unit that’s about to be spun off. The upside lies in persuading investors to put a higher value on what remains, which will comprise distinct pharmaceuticals and vaccines businesses. Analysts at JP Morgan Chase & Co. and Goldman Sachs Group Inc. value the consumer side at 26 billion pounds and 31 billion pounds debt free, respectively. But the former ascribes the rump an enterprise value of 63 billion pounds, while the latter gets to close to 100 billion pounds.

The share price is reflective of the bearish view. One concern is that the vaccines business could be disrupted by the messenger-RNA technology that’s behind some Covid jabs. That may be too pessimistic as it’s unlikely to call for replacing existing inoculations already proven to be safe and effective. As for the pharma piece, the question is whether this deserves to trade on a sharp discount to peers. Goldman puts it on a 9 times multiple of 2022 Ebitda, while the European sector trades on around 11 times. That already looks cautious, given that Liberum analysts reckon Glaxo’s sales growth will be just as resilient as peers’ up to 2030.

Results will take time to emerge. What can Glaxo do to improve sentiment right now? A forthcoming strategy update is a chance to give the pharma business the financial flexibility it has been denied for years. That means modest debt and low dividends in the short term.

Glaxo can also run a proper process to assess who the best people are to lead each newly independent business. That should happen as a matter of course when any company is separating. It’s clearly important here. Walmsley’s consumer background helped make her the ideal pick when she was appointed in 2016 and the demerger was undecided. The future of Glaxo’s then consumer joint venture with Novartis AG needed resolving, research productivity was woeful and the company needed an unsentimental reappraisal from a relative outsider.

Today, the consumer business is a world leader, yet the turnaround in pharma and vaccines has barely begun. Having a generalist manager like Walmsley rather than a specialist lead the separated medicines business needs justification. Likewise, the pharma side would benefit from a board with strong science and industry experience. Chairman Jonathan Symonds is a former investment banker and finance director. The point of a demerger is focus after all: The leadership should display pharma expertise.

Walmsley’s pharma record remains unproven. She has made strong hires and done a big deal. But the shake-up in R&D doesn't look as radical as it could have been. Take for example what Pascal Soriot has done at AstraZeneca Plc. After taking control in 2012, Soriot consolidated R&D at new labs in Cambridge, England, along with the head office. At Glaxo, R&D operations in Pennsylvania and Stevenage in the U.K. are overseen from California. That looks quite hands-off.

Against that backdrop, there should be nothing automatic about the leadership of the demerged businesses. Symonds is unwise to have already said the team in place is the one to lead Glaxo beyond the split. With Elliott on his back, he needs to keep his options open.

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

Chris Hughes is a Bloomberg Opinion columnist covering deals. He previously worked for Reuters Breakingviews, as well as the Financial Times and the Independent newspaper.

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