Analyst face-off: Abbott Labs
The health care company made a big Lasik buy this week. But was it worth it? A bull and a bear give us their respective takes.
NEW YORK (Fortune) -- Shares of Abbott Laboratories stabilized Tuesday after dropping more than 2% in the previous session when it said it would buy the industry's biggest Lasik vision equipment maker for $2.8 billion.
Over the past few years, investors have cheered on Abbott, a $26 billion health care company that makes everything from arthritis and cholesterol drugs to stents. But Monday's purchase of Advanced Medical Optics had the market scratching its head.
"There are mixed feelings on Monday's announcement of its intention to acquire Advanced Medical Optics (EYE), but the fact is that Abbott fundamentally does acquisitions really well.
"If we look back at its historical acquisitions - Knoll Pharmaceuticals in 2001, which brought Humira, and Kos Pharmaceuticals in 2006 - they are very, very good. This one's going to be good too.
"They're buying a company nobody likes right now. It's kind of the Buffett mentality. When things look horrible and people are fearful, Abbott comes in and gets a very good price.
"Abbott has a very strong pharmaceutical division that includes its crown jewel, Humira, an arthritis drug that has shown explosive growth even though it's already over $1 billion in annual sales. In the third quarter, worldwide sales increased 50%.
"One thing that's been underestimated by most analysts and the investment community is how robust the Rheumatoid Arthritis market is. Even if it tapers off it's going to have several step-downs of double-digit growth.
"Also, Abbott doesn't face losing patents like other pharma companies. They're only losing one big patent, which is Depakote. It doesn't have as bad a cliff three to four years out.
"Their drug pipeline is probably not as strong as some of its competitors. On the flip side, in 12 months a lot of stuff that's in early stage development will be on investors' radar. We are also going to see more acquisitions that allow Abbott to turn around its pipeline relatively quickly."
"There are two issues I have with Abbott Laboratories: The first is valuation, the second is earnings quality. The majority of operating profit comes from pharmaceuticals. So for valuation, I do a sum of the parts. When I do that, Abbott's trading at a significant premium to the pharma group.
"For example, in 2008 they're trading at 15 times earnings. Pharma only trades at 10 times earnings. I can't get to a valuation that equals the current stock price. Pharma is the dominant piece of their business, and unless you give them a very high premium, you just can't make the math work.
"The second problem is earnings quality. For the last four years Abbott has taken a litany of gains or charges every quarter. It's very aggressive accounting. Real underlying earnings growth is quite a bit lower than reported numbers, and that will catch up to them. I can't point to a quarter or year they'll run out. But it's a continual steamroller.
"On Monday's acquisition of Advanced Medical Optics: they could have spent the money better somewhere else with better long term potential. They're getting a good price to sales for this, but does it really help the long-term story? Not really.
"They also have a very thin pipeline relative to other pharma companies. They have cholesterol drugs and two early stage collaborative products with Genentech (DNA). Unless they acquire a pipeline, it's going to catch up with them. But that's going to be tricky because they're not the only ones in town thinking that. Buying a pipeline - everyone's looking at that."
Sound off on the face-off: Tell us what you think about Abbott's latest purchase.