What 3M’s Health Care Spinoff Means for Investors – The Motley Fool | Vette Leader

3M‘s (MMM 1.72%) Last month’s spin-off announcement caught the market by surprise and inevitably led to comparisons General Electric‘s (GE 1.30%) upcoming separation. Both companies plan to spin off their healthcare businesses in 2023 (with GE also planning to spin off its power and renewable energy businesses together in 2024) to unlock value for shareholders. Let’s take a look at 3M’s plans and what they mean for the stock’s investment case.

3M spinoff plans

Management plans to:

  • A tax-free spin-off of the healthcare business by the end of 2023, creating two new companies, the healthcare business and New 3M.
  • New 3M will retain a 19.9% ​​stake in Healthcare, which will be sold over time – GE has the same plan for GE Healthcare.
  • Healthcare will be spun off with “net debt at 3.0x-3.5x Adjusted EBITDA and positioned for rapid deleveraging,” according to the press release announcing the spin-off.
  • The healthcare business will include medical solutions (54%), oral care (17%), health information systems (14%), separation and cleaning science (11%), with a food safety business (4%) set to be divested before the spin-off occurs.

It’s an aggressive move, and the rationale seems obvious: spin off the healthcare business and unlock the value locked up in a business that’s being discounted because of industrial deals at 3M. As such, 3M shareholders receive the full value of the company and it is better run by more focused management. Additionally, the strength of the healthcare business will allow it to have its own capital structure and will likely make it easier to raise money for investments. It’s pretty much the same playbook that GE runs for its healthcare spin-off.

The capital structure argument is weakened by the fact that the new healthcare company is “positioned for rapid deleveraging,” meaning it will deleverage, exit the market, and receive more favorable terms as a healthcare company.

There is a problem

It’s a compelling idea, but unfortunately there’s a problem here. While GE is spinning off its most enduring business, and arguably one that would receive the highest market valuation, 3M’s healthcare business has been a disappointment in recent years. In fact, the healthcare business is one of the main reasons for 3M’s dramatic underperformance relative to the market over the past five years.

The numbers tell the story. During Investor Day in 2016, then-CEO Inge Thulin told investors that the healthcare segment would grow organic sales by an average of 4% to 6% in local currency between 2016 and 2020. Investors should get used to that number, as then-CFO Nick Gangestad told investors on another investor day in 2019 to expect an average return of 4% to 6% from 2019 through 2023. But here’s the thing: 3M’s healthcare business hasn’t been consistently close to that number over the years (see table below). There’s the standout 2021, but that’s due to a rebound after the lockdown-hit 2020. There’s no way to hide that the segment has beaten management’s forecasts.

Of course, this did not go unnoticed, and management took significant entrepreneurial action. In 2019, the company bought Acelity, a wound care and specialty surgical equipment company, for $6.7 billion and M*Modal’s technology business (health information services) for $1 billion. In 2020, the company sold its drug delivery business for $650 million, and 3M will spin off and merge its food safety business with it neogene later this year.

Unfortunately, it’s difficult to point to any tangible improvement in a segment that’s grown from an operating profit margin of over 30% in 2016 to just 23.8% in 2021.

Metric

2015

2016

2017

2018

2019

2020

2021

2022 estimated

Organic sales growth in local currency

3.7%

3.6%

3.9%

2.6%

1.5%

1%

8.6%

“Mid Single Digit”

Data source: 3M SEC filings.

3M’s healthcare business isn’t its forte

The spin-off might make perfect sense, but it’s hard to argue that 3M’s healthcare business is being held back by the rest of 3M. In fact, that’s one of the problems, and despite concerted efforts over the years, its performance has been patchy at best. Therefore, 3M investors shouldn’t get too excited about the spin-off. A good comparison is made with GE Healthcare, a company that GE is spinning off because it’s doing well and will likely unlock value. In contrast, 3M’s healthcare segment is actually one of its weak points that management has struggled to strengthen in recent years.

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