The dream coming true day for value investors

It must be a heart-broken sad day for many traders for sure but on the contrary it was a great day for value investors like a dream coming true! That was the day on Jun 25 that AbbVie (ABBV) announced to pay about $63 billion to buy out Allergan, acquiring the company and its medical aesthetics business lead by Botox (see more details here). ABBV got a haircut immediately by about 15% that day while Allergan catapulted as expected. For those who held ABBV for short term trading purposes, of course it was like a hell day but I was really happy as I was actually waiting for something like this to happen! I like ABBV as it is a great company with long term track record for healthy profitability, especially its supper safe long term dividend growth history. I was waiting for a moment to get in cheaply and finally the day came on Jun 25 with a bombshell for many. This is exactly the time I have been talking for years how to use your cash to buy great dividend stocks when no one is interested, a perfect Buffett’s moment of “being greedy when others are fearful”!

Let me be clear here, I don’t think the M&A is a good move for ABBV for the sake of innovations! Not at all. Actually both companies are struggling for their pipelines and I think this is a major reason, a good reason, for traders to feel sad and dump ABBV in earnest! But for long term value investors, innovations are not necessarily a critical part in their equation. The main concern is whether or not ABBV can continue to be very profitable with healthy cash flows and high return on equity. That’s the essence of long term wealth building with DRIP that I have been promoting for years!

So what is happening to ABBV right now? Well, not a very good position for it if it wants to maintain its healthy cash flow. You see, ABBV is holding a product, Humira, that is unbelievably successful and generating sales that no one can even come close to it, $20 billion annual sales. The next all time great blockbuster is Pfizer’s Lipitor, which peaked at about &12 billion per year for sales before the generics stepped in. I don’t know if we will see another $20 billion drug any time soon. Needless to say, ABBV has been enjoying a great time with such a profit monster for years but unfortunately its good time is quickly approaching its end, in less than 3 years from now. Since Humira is doing so great, it is generating about 60% of all the ABBV revenue each year. As long as Humira can continue to do so, it is great for ABBV but when its patent loses protection, its sales will fall off the cliff immediately, often 50% or more almost overnight. Although Humira is a biologic that is more difficult to copy and therefore the post-patent cliff may not be that big, but still it will be a meaningful bite to its profit margin. That’s why ABBV has been trying for some years to boost up its pipeline in order to make up the gap when the reckoning day is inevitably coming. But it has failed several major M&As recently as the potential blockbuster candidates they licensed in or bought out all failed unfortunately. With only about 2 years left in facing the patent cliff, there is an urgent need for the management to find out something that is not only big in sales but also reasonably immune to competition. It is not an easy task folks by all means when we are talking about billions of dollars deep hole. That’s why ABBV turns to Allergan, not for its innovation but more for the existing cash flow actually, an uncommon M&A strategy. Per ABBV CEO Robert Gonzalez, smaller deals without the near-term ability to bring in $10 billion to $15 billion in revenue were a lower priority, in part because "you can't risk on a lot of binary events, because you don't know if they're going to play out or not."  Therefore AbbVie made a sea change in their strategy last month; in seeking to dig itself out of its hole of dependence on Humira revenues, the company turned to Allergan and its Botox medical aesthetics franchise- which comes with the advantage of strong branding that gives it a chance of survival independent of its intellectual property protection. Botox can generate $8 billion annual sales at the moment which is very stable and at least per ABBV’s research, it is quite difficult to copy and therefore safe to continue bringing in the significant amount of cash flow that ABBV is desperately looking for.
I personally agree with this strategy from the value investing perspective and I was happy to catch the knife when it was falling, sort of speaking! So far so good as ABBV almost immediately bounced back after the one day haircut. I cannot say the $65ish level is the absolute floor for ABBV for this round of correction but I bet it is the bottom area, barring anything more significantly negative showing up. I’m happy to hold ABBV for years to come while enjoying a 6% dividend yield that is hardly seen for a great and extremely safe stock by all means! For long term investment I’d rather use my money for such dividend growers than chasing high flying stocks that will come and go easily over time! ABBV is one of the safe bets as far as I can see for value investing at the moment.