J&J / Kenvue – Exchange Offer – Special Situation

J&J / Kenvue – Exchange Offer – Special Situation

July 25, 2023

JNJ: $172.07

Market Cap: $447BN

Recommendation: Buy 99 shares of JNJ, Exchange for shares of KVUE

Expected Profit: $1,282 / 7.5%

Summary

J&J (JNJ) recently announced an exchange offer whereby investors can exchange their JNJ shares for shares of Kenvue (KVUE), J&J’s consumer health business. To incentivize the exchange, JNJ investors will receive $107.53 of value in KVUE shares for every $100 of value in JNJ shares. I expect the exchange offer to be oversubscribed, However, there is an odd lot provision such that any JNJ shareholders with 99 shares or less (odd lot provision) will not be prorated. Thus, there is an opportunity to buy 99 shares of JNJ and exchange them for shares of KVUE. This should result in a profit of ~7.5% / $1,282 (at current prices) in a 1.5 months. The profit is not guaranteed (of course!) but is low risk, in my opinion. To participate in this exchange offer, you must contact your broker. It will not happen automatically.

Additional Details

J&J (JNJ) IPO’d ~10% of its consumer health business, Kenvue, in May 2023. It retained ~90% of the business.

Kenvue is the world’s largest consumer health company by revenue.

Key brands include: AVEENO®, BAND-AID® Brand Adhesive Bandages, JOHNSON’S®, LISTERINE®, NEUTROGENA ®, TYLENOL® and ZYRTEC®.

J&J, in conjunction with Q2 earnings, announced on July 20 that it would “split off” shares of Kenvue as an exchange offer.

On July 24, 2023, J&J formally announced that it would proceed with the exchange offer for Kenvue. JNJ will split at off at least 80.1% of Kenvue shares.

The terms of the exchange are as follows:

For every $100 shares of JNJ that you own, you will receive $107.53 of KVUE shares.

Since this exchange represents an attractive return in a short period of time, I expect the offering to be oversubscribed (similar to previous exchange offers that I’ve covered).

However, there is an odd lot provision such that if you own fewer than 100 shares, you will not prorated.

Here is the exchange offer filing and a website which tracks the exchange offer indicative exchange ratio..

This offering is very similar to the many other split off/exchange offers that we’ve participated in.

Examples:

LLY/ELAN Exchange Unhedged trade worked well.

DHR/NVST Exchange Unhedged trade worked well

ECL/CHX Exchange Unhedged trade worked well

DD/IFF Exchange – Unhedged trade worked well

MMM/NEOG Exchange – Unhedged trade did not work

How to Execute the Trade

JNJ is currently trading at $172.07 per share.

KVUE is currently trading at $24.70.

Here’s how the math works at current price levels.

Step 1

Buy 99 shares of JNJ for $172.07 per share. Total cost of $17,035.

Step 2

Per the exchange offer, shareholders who elect to exchange their JNJ shares will receive KVUE shares at a 7% discount or at a price of $22.97 ($24.70 x (1-7%)).

$17,035 / $22.97 = 741 shares of KVUE

741 shares of KVUE / 99 shares of JNJ = 7.49. 7.49 is lower than the max exchange ratio of 8.0549. If the ratio were higher than 8.0549, the number of KVUE shares would be maxed out at 797 (8.0549 * 99).

Step 3

Sell KVUE shares that are received once the exchange goes through.

At current prices, the trade is expected to generate a profit of $1,282. Most brokerage firms don’t charge commissions anymore! Schwab (my broker) will charge me $39 to execute the exchange. So my expected net profit decreases slightly, but the trade is still a good low risk/month long investment.

In terms of timing, the exchange offer expires on August 18, 2023 (unless JNJ changes it), and so I recommend that you buy JNJ shares no later than August 16th to ensure you make the deadline (it takes two trading days for your purchase to settle). After you purchase shares, call your broker and ask them to tender your shares.This is important. Your participation in the exchange isn’t automatic.

I created a spreadsheet to track the profitability of this trade. Here is a screenshot of it:

You can access the spreadsheet here:

JNJ / KVUE Exchange Offer Spreadsheet

(to edit, make a copy of the spreadsheet and plug in your own assumptions)

Thoughts on Kenvue (KVUE)?

I think Kenvue looks relatively attractive.

Kenvue is the world’s largest consumer health company by revenue.

Key brands include: AVEENO®, BAND-AID® Brand Adhesive Bandages, JOHNSON’S®, LISTERINE®, NEUTROGENA ®, TYLENOL® and ZYRTEC®.

The company has a solid financial profile and expects to generate good results according to its 2023 guidance:

Analyst expect continued steady growth going forward:

The best comp is probably Haleon (GSK/PFE consumer spin-off) which trades at 14.2x NTM EBITDA and 18.4x NTM EPS. KVUE is trading at 13.6x NTM EBITDA and 19.6x NTM EPS. It looks reasonably valued.

What are the risks?

JNJ Sells Off

If you buy JNJ and it sells off prior to the exchange, you could lose money. I’m not particularly worried about this risk, as investors will likely bid JNJ shares up to take advantage of the share exchange.

A major sell off could happen if some random negative news hits JNJ (for instance negative news in a lawsuit or a setback in a pipeline drug). This is unlikely but did happen in our last exchange offer MMM/NEOG.

If JNJ does sell off, it would have to sell off by ~7.5% for you to lose money. Plus, you are hedged if you short your KVUE exposure.

I looked back at the performance of the parent during similar transactions and found that it usually performs well (average: +2.1; median: +3.9%)

The Exchange Is Canceled or the Odd Lot Provision is Removed

This transaction has been contemplated for years, and I don’t expect it to be canceled. It could be delayed indefinitely, but I don’t think it will be removed.

The odd lot provision could be removed, however, this has never happened for split off transactions (that I’m aware of). Nonetheless, it could happen!

Kenvue (KVUE) Stock is Weak After the Share Exchange Closes

If the share exchange closes and investors who’ve exchanged their JNJ shares for KVUE shares make 7.5%, but then KVUE shares immediately depreciate by more than 7.5%, this trade will lose money. However, you could short the number of KVUE shares that you expect to receive to lock in your profit.

I haven’t decided yet but I will likely hedge at least a portion of my KVUE exposure. But if you can’t short shares (or are buying JNJ in your retirement account and can’t short your exposure), I still believe the transaction is attractive.

It’s worth noting that typically the best performance comes from an unhedged position according to Special Situations Investments’ excellent analysis.

Disclosure

Rich Howe, owner of Stock Spin-off Investing (“SSOI”), doesn’t own JNJ shares but plans to buy them. He will likely hedge his KVUE exposure. All expressions of opinion are subject to change without notice. This article is provided for informational purposes. We do not warrant the completeness or accuracy of this content. Please do your own due diligence and consult with an investment adviser before buying or selling any stock mentioned on www.stockspinoffinvesting.com.