Taking a 'first look' at Pfizer after an activist investor takes a big stake

Continuing my theme of "piggybacking on activism"...

After taking a first look yesterday at industrial gas company Air Products and Chemicals (APD), in which my college buddy Paul Hilal recently took a stake, today I'd like to take a look at pharmaceutical giant Pfizer (PFE).

It recently attracted the attention of another guy I've known for the better part of two decades: Jeff Smith, the founder of activist hedge fund Starboard Value. This new Wall Street Journal article has more details: Activist Starboard Value Takes $1 Billion Stake in Pfizer. Excerpt:

Activist investor Starboard Value has taken a roughly $1 billion stake in Pfizer and wants the struggling drugmaker to make changes to turn its performance around, according to people familiar with the matter.

Pfizer had a market value of about $162 billion as of Friday. Its shares have been roughly cut in half from a record high notched in late 2021 after the company delivered the world's first Covid-19 vaccine. They are little changed so far this year, compared with a 21% rise in the S&P 500.

Starboard has approached two former Pfizer executives, Ian Read and Frank D'Amelio, to aid in its efforts, and they have expressed interest in helping, the people familiar with the matter said. Read was Pfizer's chief executive officer from 2010 to 2018 and handpicked current CEO Albert Bourla as his successor. D'Amelio was its chief financial officer from 2007 to 2021.

The stock has been a dismal performer in both the short and long term. It has been more than cut in half since reaching an all-time high at the end of 2021 and has now sunk to a level it first reached more than a quarter century ago:

It's easy to see why the stock has done so poorly...

As I've said many times, almost all stocks tend to follow earnings over time. And in Pfizer's case, after a massive spike due to COVID vaccines, operating income – which has been in a downward trend for a dozen years – plunged in the past year to $3.2 billion. It hasn't been at that level in 27 years, as you can see in this chart:

Operating cash flow has tracked operating profit, and Pfizer has minimal capital expenditures ("capex"), so the company has generated massive amounts of free cash flow ("FCF") – averaging nearly $15 billion annually over the past two decades:

Pfizer has used its huge FCF in three ways: modest share repurchases (almost none in the past five years), a huge dividend (the stock now yields about 5.8%, one of the highest in the S&P 500 Index), and the occasional large acquisition (which, in light of Pfizer's performance, appear to have been duds):

Lastly, despite FCF that easily covered its dividend until a year and a half ago, Pfizer's net debt has skyrocketed to $62.8 billion due to four large acquisitions totaling nearly $67 billion in 2022 and 2023 (Biohaven Pharmaceuticals for $11.6 billion, Global Blood Therapeutics for $5.4 billion, Arena Pharmaceuticals for $6.7 billion, and Seagen for $43 billion):

Lastly, turning to valuation, with a $228 billion enterprise value (the roughly $165 billion market cap plus net debt), Pfizer trades at 4.1 times revenues and 19.9 times earnings before interest, taxes, depreciation, and amortization ("EBITDA"). (Trailing 12-month net income is negative, so there's no price-to-earnings multiple.)

This isn't cheap... And even if Pfizer's FCF reverts to $15 billion, the enterprise value is still more than 15 times this amount.

In conclusion, I'm not going to do a deeper dive into Pfizer for a variety of reasons...

Despite huge cash flows, the company has created little shareholder value for nearly three decades. The earnings trend over the past decade is alarming, as is the spike in debt. I tend to be skeptical of large acquisitions, most of which, as numerous studies show, destroy value (which appears to be the case with Pfizer).

Additionally, I worry that Pfizer's brand has become tarnished due to its association with the COVID vaccines, which have become highly divisive (for more on this, see this well-timed short pitch on Pfizer that was posted on Value Investors Club on November 23, 2021).

Even with all of these concerns, however, it's entirely possible that Starboard Value does well with this stock. Maybe the recent acquisitions and/or drugs in Pfizer's pipeline turn into big winners – reversing Pfizer's fortunes and stock price.

I would need to have conviction about this to want to own the stock, but I'm not qualified to make this judgement.

So I'll wish Jeff Smith good luck and move on...

Best regards,

Whitney

P.S. I welcome your feedback – send me an e-mail by clicking here.