Despite Third Point, low expectations for Amgen breakup

October 26
12:39 AM 2014

Amgen Inc (AMGN.O), one of the world's largest biotechnology companies, will unveil next week its first strategy update since early 2013, but few expect a major shift like the split-up recently proposed by Daniel Loeb's Third Point hedge fund.

In a letter to investors on Tuesday, Loeb said Amgen has "all the hallmarks of a hidden value situation" and should divide into an innovation-driven entity and a low-spending, slower-growth company made up of its older drugs.

Third Point is not the first among investors or analysts to suggest the company would benefit from splitting into different companies, echoing a blueprint activists have advanced in various industries.

But Amgen is likely to resist such calls. At least some investors in the biotech say that is fine with them, given the company's steady returns as well as the potential disruption from a split to its distribution model and tax structure.

"This thing is a massively successful money machine. Why anybody would want to interrupt that I don't know," said Bill Smead, portfolio manager of the Smead Value Fund, which owns 357,000 Amgen shares.

An ISI Group survey this week, taken after Loeb kicked off his campaign, found 65 percent of responding investors think the company should not split up.

Amgen will announce its third quarter earnings on Monday, followed by a "business review" meeting in New York with analysts on Tuesday. The company last updated its long-term strategy in February 2013, shortly after Chief Executive Robert Bradway took office.

Since then, Amgen's shares have climbed 71 percent, compared with a 98 percent gain for the Nasdaq Biotechnology Index .NBI over the same period. Unlike other biotechnology companies, Amgen also pays an annual dividend yielding around 2 percent.

Loeb argued that shareholder value would be unlocked by separating Amgen's older products, like anemia drugs Epogen and Aranesp and white blood cell booster Neupogen, from the company's experimental prospects, which include cholesterol treatment evolocumab and leukemia drug blinatumomab.

But at a Wall Street forum last month, Bradway said Amgen had considered such a breakup, but did not believe it would create significant value because of the company's single manufacturing and distribution channel.

He also cited the company's "very efficient tax structure," which stems from its practice of producing many of its drugs in Puerto Rico. Under a nearly 100-year-old section of U.S. tax law, companies that have Puerto Rican manufacturing operations are allowed to exclude from federal tax much of the income generated by those plants.

That structure, along with tax credits and other tax reduction strategies, has helped cap Amgen's effective tax rate, which the company forecasts at 15 to 18 percent this year, well below the 35 percent top U.S. corporate tax rate.

Breaking up the company could push the tax rate for Amgen's "legacy" business as high as 35 percent, RBC Capital Markets analyst Michael Yee said in a research note.

Sanford Bernstein analyst Geoffrey Porges, who first proposed an Amgen split-up in June, dismissed that argument, saying "there are a thousand ways companies could manage tax."

Porges, and others on Wall Street, expect Amgen to unveil on Tuesday plans to improve its operating profit margin, which he estimated in the low 40 percent range this year, compared with rates of 52 percent and 70 percent, respectively, for peers like Celgene Corp (CELG.O) and Gilead Sciences Inc (GILD.O).

That might be enough to stave off calls for more radical change, especially since Amgen shares, after dipping in May, are up nearly 30 percent year to date, he said.

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