Kenvue Inc. (KVUE, Financial), the former consumer products segment of health care giant Johnson & Johnson (JNJ, Financial), will fully separate from its parent next week as the company distributes the roughly 90% of the shares it currently holds to its shareholders that have decided to take the exchange offer. The company decided to go for the split off route rather than the more common spinoff route in separating out Kenvue. This means shareholders will have had to tender in the Johnson & Johnson shares via their brokers they want to exchange for Kenvue shares. The exchange is expected to be tax free for the shareholders as the same shareholders are simply exchanging shares for shares and there is no money and capital gains involved.
Final exchange ratio and expectations
Johnson & Johnson announced on Aug. 16 that it has determined the final exchange ratio. For each share of Johnson & Johnson common stock, it will deliver 8.0324 shares of Kenvue common stock. This is very close to the cap for the exchange (8.05 Kenvue shares per J&J share) the company had established prior to the exchange announcement.
Based on the final exchange ratio, Johnson & Johnson currently expects to accept for exchange approximately 190,955,436 shares of common stock if the exchange offer is fully subscribed. The exchange offer is currently scheduled to expire at the end of the day on Aug. 18. Observers expect the offer to be over-subscribed as the company was offering a 7% discount for Kenvue shares in order to incentivize shareholders to take up the offer.
Implications of the split for Johnson & Johnson
Basically, I see this as a rather complicated way for Johnson & Johnson to buy back its own stock as the number of shares outstanding will go down as it exchanges its shares for Kenvue. The company clearly want to focus on its higher growth and more profitable pharma and medtech business, where it has a dominant position. Kenvue focuses of self medication products (Over the counter drugs), skin care and oral care products. While its consumer business is quite large, the industry itself does not have growth characteristics.
Impact on Kenvue
J&J is unloading the Kenvue Inc (KVUE, Financial) business to investors at a forward PE of around 17 for a business which is basically flat to low single digit growth. Kenvue's past 3 years revenue growth was less than 2%. J&J had decided that it does not want to be in a flattish growth business. Kenvue also benefits as it gains a shareholder base which wants to own its stock (given that they have had to actively and consciously exchange their J&J stock). Normally in a spin-off situation many shareholders do not want to own the spun off stock and the spun-off shares are then dumped into the market thus creating selling pressure before fundamental kick in. However because J&J went the split off route rather than the spin-off route the selling pressure had started after the exchange offer was announced and should abate when the exchange deadline ends.
Arbitrage opportunity and stock dynamics
Because of the 7% discount built into the exchange offer, I believe traders have been buying Johnson & Johnson stock and shorting Kenvue stock to take advantage of the arbitrage opportunity. This can be seen in the price action of both stocks. While Johnson & Johnson is up about 7% from Kenvue's debut on May 4, Kenvue is down about 17%. I expect this dynamic to reverse in the coming weeks as arbitragers sell J&J shares and buy Kenvue shares to close out their positions.
Future prospects for Kenvue
The second catalyst I anticipate for Kenvue is that it will be joining the S&P 500 index at a date that will be announced in the near future. This announcement should be coming any day now. This means the stock will experience buying pressure as indexes rejig their portfolio to accommodate Kenvue. Many pension funds and institutions which imitate the indexes will also buy the stock.
Conclusion
Kenvue is an interesting short-term play. Because of the dynamics of the split off and the addition of the company into the S&P 500, I expect the stock to rise in the short term. But I think this bounce will not last beyond three to six months. However, in the longer term, I think the stock is a little overvalued given its low growth profile. However, the company has a roster of strong brands (like Tylenol, Aveeno, Listerine, Neurogena, Johnson's etc.) and a steady business. I think a price-earnings ratio of about 12 to 15 is more appropriate for this company rather than the PE multiple of 17.73 it sports currently.
