If you are a
Johnson & Johnson
shareholder who covets its
subsidiary, J&J has a deal for you.
Johnson & Johnson (TICKER JNJ) plans to distribute to its shareholders about $40 billion of stock in Kenvue, its consumer products business with brands like Tylenol, Listerine and Bandaid. J&J is using a splitoff rather than a spinoff, and there are key features that retail investors need to understand before they decide to participate.
For those who want to own Kenvue, the deal is attractive because Johnson and Johnson is offering to make the swap at a 7% discount to Kenvue’s stock price. The actual exchange ratio will be based on the trading prices of J&J and Kenvue in a three-day pricing period from Aug. 14 to 16.
Here are some key things that investors need to know about the deal:
- Johnson & Johnson (Ticker JNJ) investors have to opt in to the exchange offer to participate and they have until Aug. 18 to make a decision. J&J holders should be getting information from their brokerage firms about the offer.
- J&J holders can swap all, some or none of their shares. If holders do nothing, they will keep all of their J&J stock. This differs from a spinoff in which holders of the parent company’s stock automatically get shares of the spinoff company.
- The transaction will be taxed favorably for J&J holders, according to tax expert Robert Willens. “There is little doubt that the distribution will be tax-free,” Willens told Barron’s in July. Indeed the deal is conditioned on favorable tax treatment, according to J&J.
- Johnson & Johnson took Kenvue public in May, selling about 200 million shares and retaining 1.7 billion shares, or roughly 90%. J&J said it planned to distribute its remaining stake by year-end to its shareholders and announced the exchange offer on July 24—a few months earlier than expected.
As with past exchange offers by companies like General Electric (GE),
(DD), J&J is offering holders an incentive to swap into Kenvue shares.
J&J holders will get roughly $107.50 in Kenvue stock for $100 in J&J shares. Without the incentive, there would be little reason for J&J holders to swap their shares for Kenvue.
J&J stock offers a play on the healthcare giant’s pharmaceutical and medical-device business. Kenvue is a consumer play whose closest peer is
(HLN), which holds the consumer health businesses of Pfizer and
J&J trades for around 16 times projected 2023 earnings and yields 2.8% while Kenvue fetches about 19 times estimated 2023 earnings and yields 3.3% based on an 80-cent annual payout announced recently.
The higher P/E on Kenvue reflects the durability of its consumer brands and modest growth prospects with analysts seeing mid-single earnings annual growth off the 2023 base. Barron’s wrote favorably on Kenvue prior to its May IPO.
One issue is talc liability. J&J suffered a setback recently—and its stock declined —when a judge ruled against a legal tactic that it had used to try to limit its legal risk as it seeks to settle the matter. J&J is assuming Kenvue’s talc liability for the U.S. and Canada with Kenvue retaining it for the rest of the world. The suits stem from sales of Johnson’s Baby Powder that contained talc.
It’s not easy to peg the international legal risk for Kenvue but Moody’s Investors Service wrote earlier this year that it assumes that liability will “remain immaterial.”
J&J said on July 24 that it would distribute 1.5 billion shares in the exchange offer and as many as 1.7 billion shares. Wall Street is assuming the full amount gets distributed.
The $40 billion Kenvue split-off is the largest one ever—roughly double the size of General Electric’s exchange offer for
Wall Street arbitragers have been attracted to the J&J split-off to capitalize on the 7% discount on Kenvue stock. They are buying J&J and selling Kenvue to capture the spread. This probably has helped push up J&J stock and depress Kenvue shares lately.
J&J shares were up 0.7% Wednesday to $169.91, while Kenvue (KVUE) gained 1% to $23.48.
A tricky part of the split-off is that J&J shareholders who elect to participate in the offer likely will face a proration, meaning they won’t get all the Kenvue stock they want. The offering is likely to be oversubscribed, resulting in the proration.
The question likely is how much of a proration. Several Wall Street analysts connected with trading desks have written reports on the exchange offer. Let’s say that 20% of J&J holders elect to make the exchange—a little lower than the participation in the GE/Synchrony split-off.
In that scenario, Barron’s estimates that the proration would be around 40%, meaning that participating J&J holders would be able to swap 40% of their stock for Kenvue and retain 60% of their J&J stock.
J&J holders who want to exchange less than 100 shares won’t be subject to proration.
Another wrinkle is that the exchange offer is capped at 8.05 shares of Kenvue for each J&J share. That likely won’t be an issue with the current ratio at 7.7 based on the relative prices of the stocks. But sharp moves in either company’s stock could put ratio above 8.05 which would decrease the value of the offer for J&J holders.
For instance, if Kenvue stock falls to $22 and J&J stock remains around $170, J&J holders would get roughly $177 in Kenvue stock in the exchange offer based on the cap of 8.05 Kenvue shares, a 4% premium rather than the stated 7.5%, Barron’s estimates
J&J is providing a daily update on the exchange offer that shows what investors would receive based on the past three days’ trading prices. The update Wednesday indicates that J&J holders would get about $183 a share in Kenvue stock for each J&J share now trading at about $170, a roughly 7.5% bonus. The actual exchange ratio will be announced in two weeks.
J&J holders who make the swap may get a post-deal bonus. Kenvue stock could appreciate once the exchange offer ends as arbitrage buying ends while J&J stock could come under downward pressure. Historically, that is the way it has worked.
One issue is whether index funds that own J&J will participate. Some may not since Kenvue isn’t in the S&P 500 index, although it’s possible that it could be added to the index soon.
Another issue is retail participation. Retail holders are seen as more passive and less willing to participate, given the complexity of the deal, than institutional investors.
J&J is offering investors information about the split-off in a Q&A on a web site and in an S-4 statement from Kenvue.
Why do a more complex split-off? It effectively amounts to a giant J&J stock buyback funded with Kenvue stock with J&J likely to retire roughly 8% of its shares. A spinoff would retire none. J&J said that it views a split-off as the “appropriate path forward to bring value to our shareholders.”
Cutting through the complexity, the deal looks like a good one for J&J holders. They get the opportunity to buy Kenvue shares, which are down to around $24 from a high of nearly $28, at a discount.
Write to Andrew Bary at firstname.lastname@example.org