Pfizer faced a rough 2012 after Lipitor's loss of exclusivity in November 2011. Pharmaceuticals still made up 87% of total sales, but the segment's 11% dip was difficult to make up elsewhere. The picture isn't quite as bleak if investors exclude Lipitor -- pharmaceutical sales grew a modest 1.4% but were still essentially flat after accounting for unfavorable exchange rates.  

The company's pipeline has potential, but a management team eager to unlock potential wanted to make a more immediate splash. How do you do that? The company chose to spin off its second most lucrative business, animal-health subsidiary Zoetis , as a separate entity. Investors should know that Pfizer isn't the only pharmaceutical company with an animal-health division that also faces concerns regarding the patent cliff, pipelines, and shareholder dismay.

Although some management teams have ruled out the possibility of a breakup for now, given the advantages, should investors expect more spinoffs in the near future?


Spinoffs pending?
Zoetis is currently the only pure play for investors looking to tap into the animal-health industry, but that doesn't negate the competition. Here's a look the top animal-health businesses being hidden within pharmaceutical companies:

Company, Parent

2012 Sales

2012 Sales Growth

% of Total Sales

Zoetis, Pfizer

$4.3 billion

3%

7.3%

Merck Animal Health, Merck

$3.4 billion

4.5%

7.2%

Merial, Sanofi

$2.9 billion

3.1%

6.2%

Elanco, Eli Lilly

$2.0 billion

21%

9%

Source: Company 2012 SEC filings.   

These companies could all gain from following the spinoff trend. Similar to Pfizer, Merck recently lost exclusivity on its signature blockbuster, Singulair. Sales of the drug fell 30% to $3.85 billion in 2012 but will fall even further this year as generics gain traction.

Sanofi's Merial offers well-known products such as Frontline and Heartgard, which drove emerging-market sales growth 17.6% last year. The company's December acquisition of Dosch Pharmaceuticals' animal-health division will give Merial access to the growing Indian market and highlights the myriad of opportunities the industry offers.  

Eli Lilly's Elanco is the smallest of the bunch but is also the fastest growing. Investors might be surprised to learn that the domestic market grew by a staggering 30% in 2012, compared with "only" 12% growth in international markets. In fact, the company generated 57% of its sales last year from the United States market.

Why it works
Before the Zoetis IPO, fellow Fool Keith Speights highlighted that the spinoff technique is far from perfect. Pfizer untethered one of its fastest-growing business segments at the same time its core pharmaceutical business slows. I mentioned that 2012 sales actually grew if Lipitor is excluded and have previously written about reasons for cautious optimism when it comes to the future of Big Pharma, but the risks are real.

Despite the well-founded concerns Keith laid out, the spinoff unlocks value on two fronts for Pfizer. First, allowing the animal-health company to be completely independent will allow Pfizer to focus on developing its pipeline, while Zoetis won't be held back by pharmaceutical patent woes, although you have to imagine that the two were pretty independent before the spinoff. Second, Pfizer still owns 83% of Zoetis shares. This allows the pharmaceutical giant and its investors to tap into share appreciation on the open market. Not to mention that Pfizer wields plenty of voting power to nudge the company into intriguing growth deals.   

What growth lies ahead?
According to Zoetis' S1 filing, the animal-health industry represents a $100 billion-per-year market opportunity that is expected to grow at a CAGR of 6% between 2011 and 2016. Zoetis has capitalized on worldwide growth by expanding sales 53% from the $2.8 billion it garnered in 2009.

There are several important advantages for the industry that will enable steady growth for years to come. The S1 filing states that R&D is faster and less expensive than its human-health counterpart, sales are more evenly spread across a company's entire portfolio (lack of blockbusters is a good thing), and brand loyalty reigns supreme.

Alternatives for slowing pharma
Spinoffs don't make sense for every company. For instance, management at Merck recently dismissed the idea of breaking up its animal-health division, opting instead to keep the growth under one big umbrella. The company's recently released 2012 results contained just three sentences on its animal-health segment. Was this done intentionally to deflect attention?

Keep in mind: Zoetis' IPO didn't magically solve Pfizer's problems overnight. and it's still too early to gauge the market's appetite for such a company. Should the companies I've mentioned resist the temptation of a spinoff, what other options exist to appease shareholders?   

An increased focus on pipeline biologics, which face less generic competition and can target a broad range of indications, is occurring throughout the industry. Sanofi, with an impressive lineup and pipeline from subsidiary Genzyme, may be the best positioned of this group. The company's latest batch of biologics ("New Genzyme") grew 16.9% in 2012.

Small molecules still have a place in Big Pharma's heart, however. Lantus propelled Sanofi's diabetes segment to nearly $6 billion in sales last year, while Merck's Januvia/Janumet line pulled in another $5.75 billion. Eli Lilly boasted eight blockbuster drugs last year that included depression drug Cymbalta, which accounted for 22% of total revenue for the company.

And of course, acquisitions are always on the radar for Big Pharma companies, although I'll label any possibilities as speculation and leave it at that.

Foolish bottom line
The decision for a spinoff comes down to a management team's preference for growth: Capture it internally or let it ride on the open market. In the long term, I think it will be tough for pharmaceutical companies to resist the possibilities of rolling out their animal-health divisions. A wildly successful Zoetis will only make the itch worse and turn up the volume from shareholders worried about stalling growth engines.

Can Merck beat the patent cliff?
Merck, a titan of the pharmaceutical industry, stumbled into 2013 and continues to battle patent expirations and pipeline problems. Should the company follow Pfizer's lead and spin off its animal-health division? Is Merck still a solid dividend play, or should investors be looking elsewhere? In a new premium research report on Merck, the Fool tackles all of the company's moving parts, its major market opportunities, and reasons to both buy and sell. To find out more -- and get a full year of free updates -- click here to claim your copy today.


The article Should Big Pharma Follow the Spinoff Trend? originally appeared on Fool.com.

Fool contributor Maxx Chatsko has no position in any stocks mentioned.  Check out his  personal portfolio  or follow him on Twitter, @BlacknGoldFool , to keep up with  his writing   on energy, bioprocessing, and emerging technologies. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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