Abbott Spin-Off Continues Health Care Firm Streamlining

Pharmaceutical companies continue to retreat from the old strategic thesis that they could operate as virtual supermarkets dispensing a diversity of products and services as long as they could be grouped under the umbrella of health care. Although the various product lines were supposed to be connected by treatment of people, the linkage for business purposes is highly tenuous, say industry experts. Rather, they note, there is little that is complementary, with drugs, medical devices, hospital supplies, consumer products, and health care services governed by different skills, customer bases, purchasing channels, and other fundamentals. The latest pharma-based company to take a scalpel to operations is Abbott Laboratories, which announced in August that it would shed a hefty chunk of its hospital products business in tax-free spin-off. In the opinion of industry analysts, it won’t be the last such amputation, as more companies channel the bulk of resources into drug discovery and development. “This is a fundamentally different business than Abbott,” says Peter Lawyer, Vice President and a health care expert at Boston Consulting Group. “It’s hard to make trade-offs among therapeutic areas. Lots of pharma companies handle it, but there is always an internal hassle on resource allocation and issues like that,” he says. Unlike pharmaceuticals, based on chemistry research and heavily dependent on discovery and development, hospital products are creatures of manufacturing efficiency, and their primary customers are hospital purchasing departments as opposed to drugstore chains, pharmaceutical distributors, and pharmaceutical benefits managers (PBMs). “I don’t see that there is a huge amount of synergy across the two areas,” Lawyer says. Michael Steiner, leader of the worldwide health care practice at Bain & Co., notes that the products being lodged in the newly independent but as yet unnamed new company are “old-fashioned, low-growth, low-tech” offerings with single-digit growth and margins. “It has a different set of business capabilities and different management styles,” he adds. “It is a cost-driven business.” Prospects seen as divergent Similar analytical footprints can be found in other health care split-ups, which have included Eli Lilly & Co.’s exit from medical devices, Pfizer Inc.’s departure from consumer products, and Merck & Co.’s spin-off of its Medco PBM business. Analysts are in general agreement that the spin-off is good for Abbott. The company should show improved performance, freed of the hospital products drag and in position to intensify its focus on the pharmaceuticals business. Abbott also will get a hefty exit fee from the departing unit, which, as frequently happens with spin-offs, will borrow to pay an undisclosed amount in upstream dividends. Abbott management says that the newly independent company, which sells about $2.5 billion worth of electronic drug delivery systems, infusion therapy and critical care products, and intensive care pharmaceuticals each year, also faces a bright future. They say that the business enjoys leadership positions in several of its lines, and can upgrade technologies, do acquisitions, and expand abroad, where it currently does only about 15% of its business. Although conceding the advantages, outside analysts say that hospital products is a tough business to navigate. Lawyer says, for example, that acquisition and consolidation prospects face limits. With only a handful of competitors in the intravenous segment, “consolidation at that end of the market is difficult to really accomplish because of regulatory issues.” But he notes that there may be expansion opportunities in areas like generic formulations, which is “fairly fragmented” and has “reasonably high entry barriers.” “There could be some acquisitions in that area to pick up share and other advantages,” he comments. The BCG consultant also says that a potential consolidator may have to tread carefully because of the “schizophrenic pressure” exerted by hospital purchasing departments and outsource organizations. In pure economic terms, he says, buyers would like to source more product from fewer buyers, similar to the procurement trends being pushed by auto manufacturers, capital goods makers, and big retailers. But at the same time they are wary of allowing their suppliers to become too big and too powerful, and are not demanding rapid consolidation. “The economics may be there but the realities of the marketplace may not permit that (consolidation) as intensively as the economics may dictate,” he says. Steiner agrees, saying, “Hospitals want to deal with more powerful suppliers, but they don’t want monopolies.” The better acquisition opportunities may in fact rest overseas. Steiner points out that it is difficult for an outside vendor to sell into Europe because there are several difficult health care systems, ranging from private to government-run. Orders are “very much based on the relationships of suppliers and purchasing departments,” which gives large local producers an edge. To crack the market, Steiner says, an American firm may have to acquire the largest hospital supplier in a country on the continent. Abbott says it chose the spin-off over selling to a private equity buyer because the tax-free divorce created more shareholder value. But Steiner believes that LBO sponsors could be more active in future divestitures because low-tech, cash-generating hospital products firms are ideal additions to their portfolios. “The private equity firms are hungry for this type of deal,” he says. Copyright 2003 Thomson Media Inc. All Rights Reserved. http://www.thomsonmedia.com