By Scott Murphy

The global economy dictates that successful companies compete daily for their own survival in a corporate sense and also in the minds of their customers. Wall Street is only happy to oblige by coming up with innovative and often replicated strategies from their collective corporate toolboxes. In some ways, you could view this symbiosis as the world’s greatest financial construction firm. They build it up to break it down, often repeating the process as decades pass and memories of the individual participants fade.

The year 2021 found this process to be alive and well. In both the initial public offering (IPO) market as well as the corporate reorganization area, various companies decided to split up their organizations into smaller, more nimble entities with greater transparencies. Investors found it much easier to value these newly structured companies.

Within the Tufton Capital portfolio universe, household names such as Johnson & Johnson (JNJ), DuPont (DD), General Electric (GE), Becton Dickinson (BDX) and Exelon (EXC) have decided that less is more, and each has announced a plan to execute a corporate restructuring. As a large cap, dividend-focused investment firm, we rarely participate in the IPO markets due to the simple fact that the characteristics of an IPO do not meet our investment criteria. However, we often value the existing portfolios of companies that have made the decision to create shareholder value by generating spin-offs of various operating divisions within their corporate structures.

Using Johnson & Johnson as the most recent example of a Tufton portfolio company spin-off, we first start the process by gaining an understanding of the official reason and rationale promoted by the company’s management team. With the help and counseling from Wall Street, we look for a well-crafted reason for the action, and the assurance that the end result should be financially beneficial for our clients. It is fairly straightforward why JNJ wanted to split into two. The newly formed company will hold and operate the consumer healthcare businesses (think Band-Aid, Neutrogena, Tylenol), while the NEW and improved Johnson & Johnson will operate the pharmaceutical and medical device businesses. On the surface, this makes a great deal of sense given the difference in growth rates and the overall maturity of the various businesses. Almost every other large pharmaceutical company has done this in the past using a well-rehearsed and often used tool in the Wall Street reorganization toolbox. Using history as a guide, the odds are in favor that the spin-off will most likely lead to the creation of shareholder value due to the past successes notched by other pharmaceutical companies.

Then we dig into the actual JNJ filings with the Securities and Exchange Commission (SEC)  in order to determine what businesses are going into which company and with what provisions attached. It is often the case that one of the two split companies will contain more debt and less growth-oriented business lines, and therefore will be valued at a much lower amount versus the other company containing the sexier and higher growth assets. This will most certainly be the case with the JNJ split.

Finally, Tufton analysts will attempt to value the businesses on a stand-alone basis by comparing JNJ’s financial statements with various industry and company peer groups. This will allow us to see if JNJ management is doing its fiduciary duty in splitting the company fairly. While this is more art than science, we reach a decision and take action based on the collective wisdom of our analysts and the entire Tufton investment team.

With our commitment to value investing over a long period, we predict that the JNJ split will be beneficial to our clients.