Examining GE's Spinoff with Healthy Skepticism

There seems to be a healthcare spinoff around every corner these days.

In just the first week of January, Johnson & Johnson saw its stock prices increase by 0.81%. This was a great start to the year for the company, and investors are hopeful that this trend will continue throughout the year.

GE's consumer unit Kenvue has officially filed for an initial public offering.

Baxter's newly spun-off healthcare unit started trading, and the company announced plans to spin off its kidney care unit. Swiss giant Novartis is meanwhile working on spinning off its generic Sandoz business.

Healthcare is in a league of its own when it comes to spinoffs. An analysis of recent breakups by Houlihan Lokey found that from 2019 to 2022, the sector tied for first place with information technology.

Spinoffs are an attractive way to drive shareholder return for a few reasons. They are tax-efficient and they allow the parent company to reduce complexity where size in and of itself confers no strategic advantage. Meanwhile, the newly established company gains autonomy to make better decisions.

Technologies' management is arguing that a more nimble company will make faster and better decisions.

On its face, that makes sense. A spun-off company that is not encumbered by the parent company's focus on a higher growth division can focus on what it does best, which can boost top- and bottom-line growth. An analysis by Morgan Stanley (which acted as a lead adviser in the GE spinoff) of medical technology spinoffs since 2000 showed that they outperformed the S&P 500 by about 20% in their first year as independent, listed companies.

Although newly spun-off companies may come with some benefits, they also come with some risks that need to be considered. In recent years, spin-offs have often become a way for large companies to get rid of underperforming units, while also saddling the new company with unwanted debt. A closer look at Morgan Stanley’s list reveals that the most recent spin-offs have underperformed the S&P 500, with older, more successful ones like AbbVie (spun off from Abbott) and Covidien (spun off from Tyco and later acquired by Medtronic) skewing the numbers. Of the five most recent spin-offs in Morgan Stanley’s list—SeaSpine Holdings, Varex Imaging, Alcon, Siemens Healthineers and Envista Holdings—only Siemens Healthineers outperformed the S&P 500 two years on from the transaction.

GE HealthCare looks like a good growth opportunity as a stand-alone company. Rising healthcare demand should allow the company to expand its ultrasound business, while its imaging and patient care solutions divisions have relatively low margins that could be expanded by focused management.

The company's valuation is uninspiring. Shares closed at $58.95 on Friday, at the higher end of Morgan Stanley analysts' valuation range of $52-$59. The Edge Group, a research firm focused on special situations, has a target of $54.52 for the stock, reflecting an enterprise value of 12.7 times forecast 2024 earnings before interest and tax—a discount to peer Siemens Healthineers.

GE Healthcare is carrying a large amount of debt, with about $15 billion in debt and pension liabilities. This is a large number compared to the company's market capitalization of $27 billion. Jim Osman, the Edge Group's chief executive, says that with such a high debt load, the company may choose not to pay dividends at this time.

According to a 20-year study by the Edge, large-cap spinoffs typically see a 7% drop in stock prices during their first 30 days of trading. However, over the long term, these stocks tend to outperform the market, returning an average of 22% two years after the spinoff. For investors with a long-term perspective, GE HealthCare could be a good investment at current prices. However, for those looking for immediate outperformance, it may be worth waiting for a better entry point.