GE and Johnson & Johnson are splitting up, but investors aren't biting

Published Sat, Dec 4 202110:09 AM EST

Jesse Pound @/in/jesse-pound @jesserpound

Last month's announcements from GE and Johnson & Johnson of impending corporate splits provided a jolt to the conglomerate stocks, but the excitement has quickly faded. Both stocks moved higher in the immediate aftermath of the announcements, with GE popping 5.8% at the open on Nov. 9 and JNJ rising 2.6% when trading began on Nov. 12 , but they have since sunk below their previous levels. In fact, both stocks had already fallen below those prices before fears of the new Covid variant spooked global markets Friday, Nov. 26. The landmark moves were cheered by many Wall Street analysts and professional investors, who argued that the valuation of the companies' individual pieces —the so-called "sum of the parts" — should prove to be more valuable than the bundled versions. Part of the idea behind these type of moves is that the companies will be more valuable separate than they are together because they will appeal to different types of investors. "[The value investors] want dividends, they want basically cash coming from the business in which they own stock. And then there is the other group which is not so keen on getting dividends and so forth but they look at the growth opportunities," said Robert Burgelman, a professor at Stanford Graduate School of Business who studies corporate breakups. However, those bets have not paid off so far, proving some more cautious analysts correct in the short term. As of the Dec. 3 market close, shares of JNJ were down about 2% from pre-announcement levels while GE had dropped nearly 15%. JPMorgan's Stephen Tusa, a longtime skeptic of GE, said in an initial note on Nov. 10 that the stock appeared to be overvalued even with some added benefit from the breakup. "Bottom line, prior attempts at portfolio 'value creation' have fallen victim to weak underlying details versus the historically positive narrative under the GE umbrella. Most spins tread water between announcement and consummation, but a flat stock is the best case to us — even the Bull math is less than 10% upside," Tusa said. GE, an industrial conglomerate, is splitting itself into three companies focused on aviation, health care and energy . However, Tusa said in a follow-up note on Nov. 29 that even the split-up GE may struggle to find new investors, especially ones who are comfortable with its unique debt structure. "With the breakup now coming, it's unclear who GE is calling out as its 'peers' as in the past they have clearly highlighted [electrical equipment and multi-industry] companies, and we rarely come across Healthcare investors, for example, who would ultimately cover the spin who want to talk GE. In other words, this peer set is changing, and a look at how they are judged on debt is sometimes more strict than GE has been treated," he said. JNJ, which is splitting its consumer products unit from its pharmaceutical and medical device businesses, may have an easier time defining itself to investors than GE, but there are still questions about its upside. UBS analyst Kevin Caliendo said in a Nov. 12 note that the benefits for the company appeared largely to be a speculative bet on the narrower companies improving management performance. "The combined SOTP suggests an [enterprise value] range of $430 - $460B versus the current EV of $445B, meaning for JNJ shareholders, the primary benefit would be to allow management to focus resources to improve the growth and margin profiles of the remain segments," the UBS note said. Similarly, Atlantic Equities analyst Steve Chesney praised the move in the Nov. 15 note but said the immediate upside was limited. "We think this is a wise and long overdue move, which will hive off the lowest growth/margin segment that we believe only saw limited synergies with the rest of the business. That said, with JNJ bulls historically arguing in favor of a conglomerate premium given JNJ's diversified business model, it remains to be seen how the move will be interpreted by markets," Chesney said. To be sure, the benefit of splits can sometimes be seen at times other than immediately following the announcement. The stocks could have priced in such a move when a reorganization was widely expected or could move higher after the split is complete and investors learn more about the individual pieces. "Most of the time, in steady situations, the stock market will get ahead of the CEOs. It often happens," Burgelman said, but added that the moves could still prove to be successful as investors get a better grasp of the new companies down the road. -CNBC's Michael Bloom contributed to this report.

A monitor displays General Electric (GE) signage on the floor of the New York Stock Exchange.

Michael Nagle | Bloomberg | Getty Images

Last month's announcements from GE and Johnson & Johnson of impending corporate splits provided a jolt to the conglomerate stocks, but the excitement has quickly faded.