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Johnson & Johnson spun off its consumer health business, which makes products such as Aveeno baby lotion, from its pharmaceuticals and medical devices business.
Tiffany Hagler-Geard/Bloomberg
Johnson & Johnson
shareholders will soon have a choice.
They can continue to hold their Johnson & Johnson stock (ticker: JNJ), betting on the company’s strength in pharmaceuticals and medical devices, or swap it for stock in
Kenvue
(KVUE), the consumer health company that makes wound dressings, Listerine and Tylenol. Johnson & Johnson released Kenvue in May.
JNJ has yet to release details of the offer, but Chief Financial Officer Joseph Wolk said on the company’s earnings conference call Thursday that the tender offer could “come as early as the next few days.” It’s earlier than expected; Wall Street had thought JNJ would process its 90% stake in Kenvue at the end of the year.
Many people will have to make a call on a potentially confusing exchange offer. JNJ has a huge retail investor base, with one of the highest percentages among large companies in the world.
S&P500
.
JNJ owns 1.7 billion Kenvue shares worth about $40 billion after going public in May by selling about 300 million shares publicly.
There were two main options for JNJ after this deal given its intention to distribute its stake to shareholders. One of the choices was to pursue a simpler spin-off, in which he would distribute his stake in Kenvue on a pro-rata basis.
This would mean JNJ holders would get approximately 0.65 Kenvue shares for every JNJ share, Barrons estimates. We calculated this by dividing Kenvue’s stake in JNJ of 1.7 billion shares by JNJ’s 2.6 billion shares outstanding.
JNJ stock was up 1.1% on Friday at $170.19 while Kenvue was down 2% at $24.01.
Instead of a direct fallout, the approach
AT&T
used in 2022 with its participation in
Discovery of Warner Bros.
(WBD), JNJ will make a more complex voluntary exchange offer, known as a split on Wall Street.
Based on previous splits, here’s how it can work. JNJ must give its holders a reason to exchange their shares for Kenvue shares. To do this, it is likely to actually offer JNJ holders a bonus which could be around 8% based on previous transactions.
JNJ’s share price is now about seven times that of Kenvue. To encourage a trade, he could offer JNJ holders about $184 worth of Kenvue stock, or some 7.6 Kenvue shares, for every share of the parent company.
The advantage of a spin-off, which Dupont did with its stake in International Flavors and Fragrances in 2021, is that it amounts to a big buyout paid for by Kenvue stock. JNJ could withdraw around 8% of the shares.
Another advantage is that JNJ holders have the option of keeping their JNJ shares or exchanging some or all of their holdings tax-free for Kenvue shares.
Joe Cornell, who runs research firm Spin-Off Advisors, says spin-offs are less common than spin-offs. He likes splits because they reduce the parent’s share count and increase earnings per share.
Splits are “normally good for investors because the parent company encourages the split exchange by offering a decent discount to investors interested in swapping their shares in the parent company for shares in the new split,” he said.
Once terms are announced, Wall Street arbitrageurs can spring into action and buy JNJ shares and short Kenvue shares to capture a spread. The tricky part is that the exchange offer could be oversubscribed, meaning JNJ holders may be prorated or only able to exchange a portion of their shares for Kenvue. The pro rata in the Dupont tender was about 50%.
JNJ said one of the benefits of the deal is that Kenvue will have a base of holders that “has chosen to own its shares.” After a demerger, there is often a sale of the spin-off company by the shareholders of the parent company who do not want to hold it.
The downside of an exchange offer is the value drain that comes in the form of the effective discount that JNJ will have to accept to encourage its holders to make the exchange for Kenvue.
AT&T felt that was too high a price to pay.
“The amount of rebate we had to provide – we thought that was a bridge too far. It would have benefited short-term holders at the expense of our large retail shareholder base,” Chief Financial Officer Pascal Desroches said at the time.
JNJ may have an easier time convincing holders to make the switch, as Kenvue is a stable company that owns well-known brands such as Band-Aid, Tylenol, and Listerine. It pays a dividend of 3.3%, higher than JNJ’s 2.8%
Kenvue stock fell 2% on Thursday as investors anticipated an abundance of Kenvue shares, received via the exchange offering, hitting the market. The good news is that the exchange offer should clear the market and give Kenvue a group of investors willing to hold its shares.
Baron’sa wrote favorably of Kenvue ahead of its IPO, citing its stable business, a valuation of around 19 times current year earnings, a dividend yield of more than 3% and the prospect of average annual earnings growth.
Write to Andrew Bary at andrew.bary@barrons.com