Kimberly-Clark Mulls Spin-Off Of Health Care Division To Create Shareholder Value

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Kimberly-Clark

Kimberly-Clark (NYSE:KMB), the manufacturer of Kleenex tissues and Huggies diapers, recently announced that it is mulling a tax-free spin-off of its health care division.  If the company receives the necessary approvals from the board, the spin-off would be completed by the end of Q3 2014 and would give rise to an independent publicly traded company. Kimberly-Clark intends to make the transaction tax-free by carrying out a tax-free distribution of 100% of the new company’s stock to Kimberly-Clark shareholders. [1] According to our model, the health care division accounts for slightly more than 7% of Kimberly-Clark’s value, implying about $3 billion in value.

See Our Full Analysis for Kimberly-Clark’s Stock

Kimberly-Clark’s health care division sells surgical and infection prevention products for the operating room. It also owns a portfolio of innovative medical devices that focus on pain management, respiratory and digestive health. The division generated close to $1.6 billion in net sales in 2012, accounting for about 7.7% of total company net sales. About 70% of the division’s net sales come from North America, the remainder coming from Europe and Asia. The health care business has been a part of Kimberly-Clark’s portfolio since 1970. However, the company now feels that the division’s strategic fit and growth priorities have changed during the course of time. [1]

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Our price estimate of $106 for Kimberly-Clark is in line with the stock’s market price.

Why We Think It Makes Sense To Sever The Business?

1. Slowing domestic market and flat market share: The U.S. is the largest market for disposable medical devices in the world, but it has been witnessing declining growth rates for the last 5-6 years. The health care division’s market share of the global health care market was also more or less flat during 2010-2012. Health care should perform better as a separate company as it will have more flexibility in pursuing growth and expansion opportunities.

2. Low profitability: Health care EBITDA margins stood lower than 18% in each of the last three fiscal years, while company-wide EBITDA margins were 19% or higher. EBITDA represents profits after factoring in typical expenses, such as cost of goods and services sold, SG&A expenses and R&D expenses. We adjust EBITDA figures to exclude non-recurring charges and non-cash charges, such as stock-based compensation expenses along with adjustments for pension and operating lease expenses. Kimberly-Clark conducts the majority of its health care manufacturing operations from low-cost sites in Latin America and Asia. This restricts the scope for further reduction in operating expense to improve EBITDA margins.

The division hasn’t shown enough strength in the first three quarters of fiscal 2013 either. During the nine months ended September 2013, health care net sales declined by 1% to $1.2 billion, compared to the same period a year ago. Health care operating profit was also flat, while all other divisions posted more than 5% growth in operating profit. [2]

3. Other businesses are faster growing and have higher profitability: With consistent year-on-year increases in dividends, Kimberly-Clark has a good dividend history. Divesting slow growing and low profitability business, and focusing on the ones that offer better growth opportunities has allowed the company to create value for its shareholders. For instance, the company recently completed the restructuring of its European diaper business in order to improve profitability and to focus resources and investments on businesses that can deliver more sustainable returns.

Exiting the slow growing diaper market in Europe has allowed the company to focus on faster growing emerging markets, where the sale of baby care products is increasing at a fast rate due to factors such as a large population, stronger purchasing power and greater brand awareness among consumers. In Q3 2013, Kimberly-Clark’s diaper volume sales were higher by 45% y-o-y in China, 35% in Russia and 20% in Brazil. [3]

According to the management, the spin-off could slow the rate of dividend increases in the short-term. In the long-term, we think that the spin-off will create greater shareholder value by allowing the company to further increase its focus on its core strength, the personal care business. Spinning-off health care should be easy for the company as it is the company’s most independent business and has the least overlap with other businesses. We will update our model once the final details of the transaction are announced.

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Notes:
  1. Kimberly-Clark Pursuing Spin-Off Of Health Care Business, Kimberly-Clark Investor Relations, November 14, 2013 [] []
  2. Kimberly-Clark Q3 2013 Quarterly Report, Kimberly-Clark Investor Relations, November 1, 2013 []
  3. Kimberly-Clark’s CEO Discusses Q3 2013 Results – Earnings Call Transcript, Seeking Alpha, October 22, 2013 []