GlaxoSmithKline LLC Historical Analysis and Valuation December ...

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Dec 3, 2012 (4 years and 6 months ago)

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GlaxoSmithKline Valuation


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GlaxoSmithKline LLC

Historical Analysis and Valuation

December 2011











BMGT443 Section 0201


David Cencula

Stephanie Chon

Yilun Hu

Kevin Reilly

Ben Rosengard

Qing Zhao








GlaxoSmithKline Valuation


1

Company Background

GlaxoSmithKline (GSK) is a global healthcare firm that

is engaged in the
development,
manufacturing

and marke
ting of pharmaceuticals, vaccines and
consumer health products
.
GSK
has fifty key prescription drugs across nine therapeutic classifications. In 2010, the drug sales by
therapeutic category were: 31% respiratory drugs, 1
9% vaccines, 11% from antiviral
medications
, 11% cardiovascular and 11% oncology.
Their leading drug is Seretide/Advair, an
asthma
inhaler
medication
that has sales of $8 billion

annually
.

Over the previous few years
,

GSK has been extremely aggressive in M&A activity.
On
July 22, 2009, it acquired

Stiefel Laboratories, Inc for

$2
.9 bil
lion. On October 30, 2009, it
partnered with Pfizer’
s HIV business
to form
ViiV Healthcare Limited. On November 10,

2009,
GSK spent 29 million British pounds
to acquire Laboratoire Pharmaceutique Algerien.
GSK also
re
cently acquired NovaMin Technology Inc for 87 m
illion

British pounds and Laboratorios
Phoenix for $253 million.


Comparables Analysis


The pharmaceutical industry is extremely competitive, with several major players
accounting for most of the sales.

We

gathered information about the competitive landscape

of the
industry

through research on Hoovers, IBIS World and Bloomber
g. Our research identifies five

companies that are
sufficiently

similar to

GSK: Pfizer (PFE), Merck (MRK), Abbott (ABT),
Sanofi (SNY),

and AstraZeneca (AZN). We used Bloomberg’s real
-
time data to analyze the
EV/Sales, EV/EBITDA, EV/EBIT, P/E, PEG and P/B ratios
,

for

forward year
s

one and two of
each firm. We used GSK’s enterprise value from our “As Is” Valuation, which will be explained
in the subsequent section
.
For the most part,
GSK’s ratios were higher than
those of their
competitors
. For example, EV/Sales1 was 3.2 compared to an average of 2.09, the EV/EBITDA1
GlaxoSmithKline Valuation


2

was 8.26 compared to an average of 5.32, the EV/EBIT1 was 10.79
compared t
o an average of
6.84 and the P/E1 was 12.54 compared to the average of 9.4.
See
Figure 1

in the appendix for
the full comparables analysis.

GSK had a similar PEG ratio to PFE and MRK, but had significantly higher
EV
ratios.
This shows that GSK is getting m
ost of its

additional value from its long
-
term growt
h rate
expectations. GSK’s long
-
term growth rate is 7.2% in comparison t
o PFE’s 4.22% and MRK’s
4.92%. Although i
t is unclear if GSK has a higher

ROIC compared to PFE and MRK, we assume
that they

are comp
arable.

Looking at GSK versus ABT provided

us with

more concrete inf
ormation. ABT has a
higher long
-
term growth rate at 9.2%, and almost the exact same
EV
ratios. Since GSK’s growth
rate is about 25% lower than ABT,

but their ratios are similar, T
his suggests that
GSK has a
higher ROIC than ABT, since its growth rate is lower and the EV ratios are nearly identical.

SNY had a long
-
term growth
rate of
-
.7% and AZN had a long
-
term growth rate of
-
.17%. Both companies currently have unsustainably high
earnings levels. GSK’s
EV
ratios are
significantly higher. To be specific
, the

GSK EV/EBIT1
ratio
is about 75% higher than SNY and
more than twice the level of
AZN
’s ratio
. This
is

a result of SNY and AZN’s low growth
expectations. Since SNY and AZN only have slightly lower ratios than PFE and MRK, it is clear
that they must have a significantly higher ROIC than them. However, it is still difficult to
determine if GSK has a higher o
r lower ROIC than SNY and AZN. It is clear GSK is valued
higher because of their growth expectations. However, since SNY and AZN have a negative
PEG, we cannot completely evaluate their ROIC. If we had to
guess, AZN and SNY may have a
slightly higher ROIC
than GSK, but it is unclear.


GlaxoSmithKline Valuation


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ROIC Drivers

The end of year ROIC for GlaxoSmithKline decreased from 37.4% to 26.1% over the
previous five years. This decline can be attributed to a decrease in the pretax ROIC, as well as an
increase in the tax rate.

The ta
x rate increase of nearly 13% is mainly explained by non
-
operating concern; therefore, to find how the operations of the business affected the EOY ROIC,
it would be helpful to see why the pretax ROIC decreased significantly, from 54.1% in 2006 to
45.8% in
2010.

The decrease in pretax ROIC can be attributed mainly to an increase in the invested
capital to sales ratio from .6 to .69, although there was also a decrease in GSK’s operating
margin (from 32.3% to 31.6%).

The decrease in the operating margin can b
e mainly explained
by a decrease in the gross margin, which went from 82% to 79.3% over the five year span.

This
was aided by an increase in depreciation (from .041 to .059), but slightly offset by decreases in
SG & A (which went from .461 to .417).

The
invested capital to sales ratio increased due to a sharp change in the intangibles to
sales ratio, which increased from $.18 per dollar of sales in 2006 to $.43 per dollar of sales in
2010.

This change can be attributed to the multitude of acquisitions th
at occurred in 2007 and
2009.

These acquisitions greatly increased goodwill.

PP & E to sales also aided the increase in
invested capital to sales, increasing slightly from $.314 to $.322.

Other net assets to sales
remained steady at .015.

The operating

working capital to sales decreased over the previous five years, which
slightly offset some of the increases in invested capital to sales caused by the increase in
goodwill.

OWC to sales decreased by about $.16, moving from $.084 in 2006 to
-
$.08 in 2010
.


The sharp decline in operating working capital to sales can be explained by two metrics.
GlaxoSmithKline Valuation


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For one, days sales outstanding decreased by about 14 days, moving average collection time on
receivables from 87 days to 73 days. Additionally, days payable incre
ased by about 60%, from
82 days in 2006 to 134 days in 2010.

This ability to extend the time to payments was favorable
to the OWC to sales ration. These decreases in OWC to sales were slightly offset by inventory
days, which decreased by nine days over th
e last five years.

See
Figure Two
in the appendix
for the “ROIC Driver Tree.”

Cash Flow Analysis

The gross cash flow from operating activities was $59.1 billion, with $48 billion coming
from NOPLAT and $11 billion reconciled for depreciation.

Working ca
pital increased by $3
billion, while capital expenditures totaled $14 billion over the previous five years.

Gross
investment was $10 billion, while goodwill totaled $12 billion.

Most of this was derived from
the plethora of acquisitions in 2007 and 2009.


Free cash flow totaled $37 billion. Non
-
operating
cash flowed out in the volume of $7 billion over the last five years.

That left a total of $31
billion of cash flow available to investors.

See
Figure Three
for the full chart detailing the
sources of
cash flow.

GSK made significant use of the $31 billion of cash available to investors over the last
five years.

A total of $3.5 billion was paid out to investors in the form of interest from 2006 to
2010.

GSK increased their outstanding debt by $12 billi
on over the last five years, while
decreasing their long term operating provision by $968 million over the same period.

Minority
shareholders gained $259 million in payments.

GSK paid out $25 billion in dividends and made
$14 billion in share repurchases

over the last five years, which hel
ped increase their EPS metric.
Other adjustments to equity totaled $1.4 billion.

Total flow was $31 billion to investors over the
last five years.

See
Figure Four
for the full chart detailing the uses of cash flow.

GlaxoSmithKline Valuation


5

“As

Is” Valuation

The “as is”

valuation will show us how the market currently views GSK’s sales growth,
margins and cash flow in the future. We first gathered
additional data from Bloomberg, and used
Wall S
treet analyst expectations for the next two years

in
sales growth
. After gathering the sales
and operating income (EBIT) estimates, we applied this to our model. Therefore, in 2011 and
2012 we had an EBIT margin of 29.63% and 30.82%. We were able to generate these sales
estimat
es and EBIT margin
s by adjustin
g the cost of goods sold margin to 22.7% in 2011 and
21.6% in 2012.

GSK had a negative sales growth from 2008 to 2010, largely as result of the global
financial crisis. However, in the future, analysts project this trend to change. Sales grow
0.7% in
2011
and 3.8% in 2012. Therefore, we reasonably expect GSK can maintain a

positive sales
growth in the future. Without making any further adjustments, the stock price we were getting
was significantly higher than it currently is. This means we had to make furth
er adjustments to
get within a $1 of the current price.

Our first adjustment was to sales growth after 2012.
We do believe GSK will have a
positive sales growth in the future, but we revised these numbers down to .5% from 2013 to
2021. This was a result of

our research in Hoovers, IBIS World, Bloomberg and other online
sources. GSK generates about 65% of its revenues from the U.S. and Europe. These markets are
expected to grow at a much smaller rate in the future. Their U.S. sales have been declining at an
average of 1.4% over the past five years, and Europe is expected to slow to 1% in the future. In
addition, GSK has been exposed to a patent cliff, including their best selling drug
Seretide/Advair ($8 billion revenue). The threat of customers switching to
generic brands is the
main reason the market currently has GSK growing sales at a small rate.

GlaxoSmithKline Valuation


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We then adjusted GSK’s
Cost of Goods Sold mar
gin to 27.7% from
2013
-
2021. This is a
much larger margin than GSK has historically had. This is attributed to the ma
rket’s expectation
on pricing pressure
.

Increased competition in this industry and expiring patents has put pressure
on GSK. The market has also seen rising commodity costs. We were very surprised at how large
of increase this forecast was, but it was the
only way GSK could be at their current share price.

We decided to leave GSK’s SG&A margin at the same rate. We then took an average of
GSK’s tax rate from 2005 to 2009, leading us to a 29.1% rate. 2010 had an extremely high tax
rate, and we do not expect G
SK to have that same level in the future. After these adjustments, the
EBIT margin from 2013 to 2021 was 24.7%, significantly lower than GSK has historically
operated at. This reflects the markets unfavorable predictions in the future.

From the DCF and E&P

valuation we got $129,791 b
illion of operating value, and
a
$141,006
billion enterprise value.
GSK’s stock price on Dec 1, 201
1 is $44.17 per share, and we
go
t the price at $44.97 per share from the DCF and EP valuation models, close to the observed
marke
t value of the firm.


The market is currently expected GSK to have an ROIC of just over 26% starting in
2013. This is below the average in the previous five years. Analyzing the ROIC chart, shows
how GSK’s ROIC declined tremendously in the recession. Wall
Street analysts expect their
ROIC to climb to around 30% in 2011 and 2012. But the market believes that GSK does not
have significant competitive advantages in comparison to their rivals, and are losing to many
patents. In addition, the market must believe

there are many unfavorable industry trends
including pricing pressures from rising competition.

See
Figure Five

in the appendix for the “as
is” valuation.


GlaxoSmithKline Valuation


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Economic Analysis

The status of the United States economy

can be captured by the Leading Economic Index
(LEI). “
The Conference Board Leading Economic Index®

(LEI)

for the

U.S. increased 0.9
percent in October to 117.4 (2004 = 100), following a 0.1 percent increase in September, and a
0.3 percent increase in
August. (conference board).” This increase in the LEI shows growth in
the United States Economy. The LEI is made up of leading, coincidental and lagging indicators
(conference
-
board). An example of a leading indicator is unemployment which for November
2011 120,000 non
-
farm payroll jobs were added lowering the national unemployment rate to
8.6% thus having a positive impact on the economy (
“Employment”
).

According to Bloomberg, the raw beta of GSk is

0.559 and the adjusted beta is 0.71.
This beta
refl
ects
this company’s stock performance is historically less volatile than the market
as a whole. This makes sense since the pharmaceutical industry is consistently profitable

and
traditionally distributes dividends. Pharmaceuticals are considered one of t
he most price
inelastic goods, since individuals require medications in good times and bad. This would make
this industry less volatile than the overall market.

Industry Analysis

T
he
spread of ROIC over WACC has been persistently high in the pharmaceuti
cal
industry (Koller). In order to explain

the favorability of investing in a particular industry,
it is
helpful to look at
the

Porter’s Five Forces model
.

Buyers of pharmaceuticals

currently have little bargaining power
, as

seen by the high
margins the

consumers pay over the cost of goods sold. In addition, due to patents consumers do
not always have a choice
when picking drugs. In five

years it is expected that buyers’ power will
GlaxoSmithKline Valuation


8

increase
,

which will be less favorable for the profitability of the ind
ustry.
Patent cliffs and the
introduction of more commercial substitutes will give buyers more power in the industry. We
currently rate
buyer power
as a 5, decreasing it to a level of
4.5
in five years
.

Currently
,

suppliers have little bargaining power
with this industry. This is due to
suppliers of raw materials and chemicals rely heavily on the business of this industry (IBIS).
Five years in the future,

it is forecasted input costs will increase and therefore diminish margins
(IBIS). Thus
, we

curren
t
ly give

supplier

power a

rating
of 5, and expect it to decrease to

a
4.5

five years from now.


There are no feasible substitutes for pharmaceuticals. Of course
,

one could opt
for
holistic healing

instead of
drugs; but,
for the most part
,

there is no rea
l substitute for drugs when
they are needed. Therefore
,

we rate the current level of substitutes as a 5
.
In the future, due to
the emergence of standard and undifferentiated drug products, we see more substitutes emerging
over the next five years; theref
ore, we give it a rating of 4.5 in the future.

T
his industry has incredibly high entry/exit barriers. According to IBIS World, the
pretax cost of developing a [drug] is thought to be as high as $1.3 billion (IBIS). In addition, the
fact that this industr
y is among the most highly regulated is a large entry obstacle (IBIS). In five
years, this industry is expected to sustain its high entry barriers
,

but will not keep the current
rating of 5. Due to the increase in number of small pharmaceutical/biotech f
irms involved in
research, a larger corporation can acquire these firms

in order to enter the industry. Therefore
the five
-
year entry/exit barrier goes from a current

level

of 5 to 4.5.

According to IBIS World, this industry is highly competitive and
its rivalry is only
increasing. Despite the intense competition drug companies are still able to maintain high
GlaxoSmithKline Valuation


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margins therefore the current rivalry really isn’t in the form of pricing pressure but rather in the
form of products offered. However, over th
e next 5 years it is expected that this increase in an
already highly competitive industry will take the form of pricing pressure. The current patent
cliff and the emergence of over the counter (OTC) alternatives add to any pricing pressures
(IBIS). Thus

the current ri
valry rating is reduced from 4 to 2.5,

reflecting the increase in
price
rivalry.

Currently, we give the industry a rating of 4.8 in the Porter’s Five Forces model.
However, given the patent cliffs and increased competition, we expect this
to fall in the
upcoming years. Five years from now, we estimate that the industry will enjoy a rating of about
4. Although this is still a positive spread of ROIC over WACC, margins will be squeezed and
therefore overall profitability in the industry wil
l decrease.

The industry quick ROIC is
a simplified way to determine the attractiveness of the
industry.

Using the operating income and total invested capital (
interest
-
bearing
debt + equity)
for GSK and 5 of its competitors, an ROIC can be calculated for

each company and the industry
by averaging the company’s ROIC’s. In doing so, GSK’s quick ROIC was 10.25%
,

compared to
the industry average of 9.20%.

By definition, GSK enjoys a competitive advantage in the
industry.
Comparing the industry ROIC of 9.2%

of a WACC of 8%, it is seen that this industry’s
spread is positive
,

and therefore it is a favorable industry to operate in.

With regards to the 5 forces, a positive ROIC spread means that the average of the 5
forces must be above 3. By averaging the s
cores on the 5 Forces Industry Analysis, it is obvious
that this industry has a positive spread and favorable because the current average is 4.8 compared
to the forecasted overall average of 4.5. Meaning the pharmaceutical industry currently is
GlaxoSmithKline Valuation


10

profitable

and favorable
and over the next few years
the industry will become less favorable and
less profitable.

Company Analysis

GSK has an apparent competitive advantage within the pharmaceutical industry
, as

seen
by its quick ROIC being gr
eater than the industry

average

(1
0.25% vs. 9.2%
)
. This competitive
advantage derives from GSK’s diversity

and product innovation. GSK ha
s shown that it is not
afraid to make smart investments in mergers and acquisitions. This willingness to be active can
add up to three perc
entage points to a company’s growth rate (
Koller
). In addition
,

when
companies are this large it is impossible to sustain growth rates organically. In 2009 GSK made
multiple purchases adding to its diverse product line and global market presence. GSK’s
diversification by drug sales by category in 2010: Respiratory: 31%, antivirals: 11%, vaccines:
19%, cardiovascular and urogenital 11%, central nervous system 8%, antibacterials 6%,
metabolic 3% and oncology emesis and other 11% show that it is not reliant

on one type of drug
(IBIS). Also, in 2010 the total sales for each part of the world were: U.S. is 35%, Europe 30%,
emerging markets 16%,
and
others 19% (IBIS).

When it comes to product differentiation, GSK has a claim to fame. It is the only
pharmace
uti
cal company to undertake HIV/AIDS
, tuberculosis, and malaria
,

which are the three
priority diseases of the World Health Organization (IBIS). Furthermore, the only way to combat
the patent cliff that will decrease billions of sales is for this industry
to develop new drugs.
Fortunately for GSK, it has 30 pharmaceutical and vaccine products in late stage Phase III
clinical development

(IBIS
). In addition, by the end of 2012 it is expected to have Phase III data
GlaxoSmithKline Valuation


11

on 15 additional compounds including new t
ype 1 and type 2 diabetes treatments, rare diseases
and cancer treatments

(IBIS)
.

Final Valuation Analysis



From our “as is” analysis of GlaxoSmithKline (GSK), the first factor that jumped out at
us, was the unfavorable outlook on their cost of
goods sold margin. GSK had an average cost of
goods sold margin of 19.3% over the previous five years. However, the “as is” valuation had a
margin increasing up to 27.7% from 2013 to 2021. We do not believe these margins are accurate,
as that is an enormou
s increase. GSK has seen a series of patent expirations and increased
competition from large and small pharma companies, both leading to pricing pressure. Therefore,
we do believe GSK’s cost of goods sold will increase, but not as severely. This led us to
estimating cost of goods sold at 25% starting in 2013 (leaving analyst expectations for the next
two years). SG&A expenses were also left at the same ratio of 41.7% for the next two years, but
were then adjusted down to 41% until 2021. This decrease is the

result of GSK’s restructuring
plan which includes: cutting 3,000
-
3,000 jobs by the end of 2012, halting discovery research and
R&D) in depression and other therapeutic categories, and an overall company mission to control
costs. Lastly, we boosted GSK’s s
ales growth to 1% in 2013
-
2014 and 2% from 2015
-
2021. We
kept a constant sales growth rate starting in 2015 (when many new products hit the market), as it
is extremely difficult to speculate on changes in sales growth rate after the next few years.



Clearly, our group has a much more favorable outlook on GSK, as our final valuation
includes a higher sales growth rate and an EBIT margin is over 3% higher than current market
expectations. GSK is the first huge pharma
ceutical

company to emerge in reason
able health from
a series of patent expectations. GSK’s CEO Andrew Witty has done this through a restructuring
GlaxoSmithKline Valuation


12

and diversification, strong R&D, aggressive M&A activity and expansion into emerging markets.
See
Figure Six
in the appendix for the final valuat
ion.

Strong Product Pipeline



In comparison to their rivals, GSK may have the strongest product pipeline. This is the
strongest proponent to our bullish outlook on GSK. The firm has thirty drugs in the late stage of
the pipeline. This means they have data

on thirty drugs in phase three of clinical trials. Ten of
these drugs may even hit the pipeline but the end of 2012, and most will hit the market by 2015.
There can be a number of potential billion dollar products in the cardiovascular, oncology and
vacci
nes categories. For example, GSK has released one year follow
-
up data from the first every
malaria vaccine RTS,S (Mosquirix). The drug appears to now be excitingly close to hitting the
market. This is a tremendous scientific breakthrough and an unprecedent
ed achievement. After
four decades of malaria vaccine research, they final have stunning results. The vaccination
showed a 47% reduction in severe malaria cases and 54% in clinical malaria cases. This data was
a result of 6,000 children aged 5
-
17 months as

controls in Africa.

More data will emerge within
the next three years of 15,460 children across 11 African countries. Nearly 800,000 people die of
the disease each year, proving this drug can be a revol
utionary product for the world (Franz,
Simon).
Agenu
s, GSK’s small biotech partner, saw their shares r
ise 40% after this
announcement.



There are many other encouraging drugs that can soon hit the market. Benlysta could be
the first lupus treatment in fifty years, Potiga/Trobalt is a treatment for ep
ilepsy and Horizant is a
treatment for the restless leg syndrome. GSK also has high hopes for the new drugs Revolade
and Votrient, both innovative products. Votrient is an oral medication blocking growth of kidney
cancer tumors and Revolade is for blood di
sorders.

In addition, although Seretide/Advair
GlaxoSmithKline Valuation


13

(asthma treatment) lost its patent exclusivity, sales are maintaining due to its drug delivery
device not expiring until 2016. GSK’s diversification into new therapeutic segments has been
paying off. The new
categories of cardiology, oncology and vaccines are registering impressive
performances. Meanwhile, GSK continues to cut R&D spending under therapeutic categories
where they see less growth opportunities such as depression and pain.

M&A Activity



GSK and its major competitors have seen increased competition from small biotech firms
and generic brands. GSK has correctly identified that M&A activity is a great way to stay ahead
and maintain their competitive advantages. In February, GSK sold their en
tire holding in Quest
Diagnostics for $1.7 billion, taking advantage of favorable market conditions. The divestment
demonstrated GSK’s focus on generating attractive returns when appropriate. GSK has also been
extremely aggressive with acquisitions. These
acquisitions include: NovaMin Technology ($116
million) and Laboratories Phoenix ($253 million). But their most important was their global
acquisition of Stiefel Laboratories ($2.9 billion). GSK has the highest market share of 54% in the
dermatology segmen
t and this could grow to 93% after receiving about $1.5 billion in revenues
from Stiefel. GSK expects to see $155 mi
llion in cost synergies in 2012 (IBIS World).

Stiefel has
had three drugs approved by the FDA, an additional drug submitted for approval. Th
e acquisition
demonstrates GSK’s strategy to grow and diversify through acquisitions. GSK has also proved
the advantages to partnering with large pharma
ceutical

competitors. For example, GSK has
received immediate benefits from their HIV partnership with P
fizer. As the industry continues to
consolidate and become more competitive, GSK has done a great job remaining at the top
through their M&A activity.


GlaxoSmithKline Valuation


14


Emerging Markets



GSK has been the most aggressive pharmaceutical company when it comes to
expanding
presence in emerging markets. According to an S&P research report the global drug market in
emerging na
tions will grow at 15
-
17%. The Middle E
ast, Africa and Latin America markets are
expected to

double over the next ten years (IBIS World).

For e
xample, GSK gained approval for
Cervaix in Japan, which is the first cervical cancer vaccine approved by Japan. About 15,000
new women are diagnosed with cervical cancer annually in Japan and about 3,500 of them die.
Because of this major risk, overall par
ticipation is expected to be at 24%. GSK saw a 14% rise in
vaccine sales, and
Cervaix was a major contributor (
Somvanshi, Kiran
).

In addition, GSK has
established partnerships with generic emerging marketing companies including India’s Dr.
Reddy’s Lab
s and

Africa’s Aspen Pharmacare (IBIS World).

As GSK increases their exposure in
emerging markets where they see high sales growth; they’ve done a great job cutting coverage in
markets where they are exposed to generic drug competition and weakness resulting fr
om their
patent cliff. The drug markets in the developed nations of Europe are
expected

to slow to 1
-
3%

(IBIS World).

Industry Outlook



As a result of increased competition, the patent cliff and certain government regulations,
GSK will experience pricing pressure. Therefore, we increased their cost of goods sold margin to
include these industry issues. However, we do see some favorable ind
ustry trends. Since GSK
has a competitive advantage shown through their high ROIC and growth rate, the firm will be
able to capitalize on these trends. The global pharmaceutical and medicine manufacturing market
has grown has been growing at 4.8% and reven
ue is expected to continue to grow
at 3.9% over
GlaxoSmithKline Valuation


15

the new five years (IBIS World).

This is a result of rising demand for quality drugs. First, there is
a global aging population who now has increased access to healthcare. In the U.S. the baby
boomers have re
ached their sixties and seventies and with rising age come rising medical
demand from consumers. In addition, there’s an increased market awareness of being “health
conscious”. This social movement involves eating healthy, getting your shots and vaccines a
nd
has caused an increased demand for quality drugs. As the belief in living a healthier life
increases, the market has become reliant on patented pharmaceuticals and over the counter
medicines. Globally, government agencies have stepped up their health ca
re spending. In the
near term, we believe the reform legislation will negatively affect the market. However, the
significant market expansion should result in increased demand for drugs in the future, For
example, in the U.S., there are 32 Americans who ar
e currently uninsured. After “ObamaCare”
all citizens will be guaranteed the right to health care. Lastly, manufacturing and technology
continues to improve through continued advancements in biochem, genomics and
nanotechnology, which can result in more in
novative products hitting the market.

Reasonableness Check

After completing our final valuation model we analyzed the “ROIC Chart”, as a control,
to ensure our recommendation is not to extreme. The chart confirmed that our analysis was
appropriate. In 2006
, GSK had a ROIC that was not sustainable at 50%. Then, post
-
recession
they hit a ROIC low of 22.3%. According to our price target GSK will operate at an ROIC of
roughly 30% in the next ten years, which is near their average.

See
Figure Seven
for the ROIC

Chart.

Our last task was analyzing our implied comps. GSK had significantly higher ratios in
EV/S
ales, EV/EBIT and EV/EBITDA. This

is because we have their ROIC higher than market
GlaxoSmithKline Valuation


16

expectations. We believe GSK’s EV/EBIT of 12.96 and 12.00 the following yea
r is justified. We
believe GSK’s strong product pipeline and emerging market strategy will lead to a higher ROIC
than Abbot, Pfizer and Merck. Combining a higher ROIC with their current very high long term
growth rate of 7.2 leads to higher ratios. It is m
ore difficult to compare GSK’s ratios with Sanofi
and AstraZeneca. GSK ratios about double the size of each firm. This is a result of the other
firms’ negative long term growth rate. It is unclear whether GSK has a higher ROIC, it appears
the implied comps

may put their ROIC’s at a comparable level. In conclusion, we believe GSK’s
ratios should be significantly higher than their competitors. Although their ratios are almost
double the average of their comps, it is justified because of their long
-
term growth

rate about
75% higher than the average. In addition, we believe their ROIC will be higher than most
competitors.

See
Figure Eight
in the appendix for the full implied comparable analysis.

Price Target



Based on our analysis and assumptions reflected within our valuation, we have
determined a price target of $56.21. This is in comparison to an “as is” valuation of $44.97.
Clearly, this makes GSK a
strong buy
,

as we think the
value of the
stock should be a
bout 25%
higher

than its current
listing
.

Our reasoning is outlined above and our models can be found in
the appendix below. Once again, we issue a
strong buy

rating for the GSK stock.










GlaxoSmithKline Valuation


17





Appendix


Figure One


Comparables Analysis










GlaxoSmithKline Valuation


18






Appendix (continued)


Figure Two


ROIC
Tree





Figure Two (cont.)









GlaxoSmithKline Valuation


19





Appendix (continued)

Figure Three


Sources of Cash Flow














Figure Four


Uses of Cash Flow








GlaxoSmithKline Valuation


20




Appendix (continued)















Figure Five


“As Is” Valuation





GlaxoSmithKline Valuation


21



Appendix (continued)











Figure Five (cont.)















GlaxoSmithKline Valuation


22


Appendix (continued)


Figure Six


Final Valuation









GlaxoSmithKline Valuation


23


Appendix (continued)












Figure Six (cont.)















GlaxoSmithKline Valuation


24

Appendix (continued)






Figure Seven
-


ROIC Chart







Figure Eight


Implied Comparables













GlaxoSmithKline Valuation


25

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GSK Sells Remaining Stake in Quest
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FT.com
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Economic
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share
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sales
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growth
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market
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cap>.


*We also used Bloomberg and ThompsonOne Banker in gathering our data. Screenshots
and
excel files can be provided upon request.

The product pipeline was analyzed through a
spreadsheet provided on GSK’s website.