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P a g e | 1
Undergraduate Student Managed Investment Fund (SMIF)
Presents:
Analysts
Jiaqi Hong
Raias Anthony Khan
Steve Sarkis
Qiudan Yu
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Table of Contents
I. Executive Summary…………………….………………………….………3
II. Industry Analysis…………………….…………………………….… 4-8
III. Company Analysis……………………..…………………………..…8-19
VI. Ratio Analysis........................……..……………………………...…20-33
V. Pro Forma Income Statement...............................................................34-41
VI. Relative Evaluation.......................……..……………………………42-43
VII. Absolute Evaluation......................……..…………………………...44-47
VIII. Recommendation .......................……..…………………………….…48
VIIII. Work Cited.…………………….………………………………….…49
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Executive Summary
The Forest Labs analyst team performed a detailed analysis of the proposed sale of Forest Labs
common stock. After extensively observing the growth and position of Forest Labs as an
emerging leader it offers a potentially high value to the SMIF undergraduate portfolio.
The analysis of Forest Labs included using techniques including ratio analysis in a custom
industry, relative and absolute valuations to make a sound and quantifiable judgment on Forest
Labs. These methods are supported by an overall analytical strategy encompassing fundamental
analysis, valuation, and risk assessment of our highly competitive industry.
.
The absolute valuation calculation shows that Forest Labs is highly undervalued however using
an decisively reduced adjustment factor and negative growths this shows the valuable position of
Forest Labs for purchase at a limit buy as the natural cyclical decline occurs as we near to
closure of Q1. The relative valuation calculation also shows that Forest Labs is fairly valued a
conclusion expounded herein.
The use of the cash flow and absolute valuation as the springboard for the recommendation was
key. This is reflective also with the risk that is involved in the overall pharmaceutical industry
due to heightened regulation climate and the risk of healthcare reform waning over the sector.
Current risk factors that are threatening Forest Labs are the FDA approval process, patent
expirations and finally the contraction on the Healthcare sector. Forest Labs currently has drugs
pending FDA approval, notably a blood-thinner and new drugs encompassing Alzheimer’s and
COPD. Analysts believe that Forest Labs can become the dominant pharmaceutical manufacturer
in its notable ethical pharmaceutical niche accounting for their fully vested business
segmentation in thereof. Forest Labs also has patents running out on several its highest grossing
drugs Namenda and Lexapro. These are Forest Labs top grossing drugs and the patent expiration
will raise questions about their value of the future pipeline after 2013, especially if generic
versions of Namenda and Lexapro are not capitalized on by Forest Labs. If the new drugs to be
launched Q2 of 2012 (Teflaro, Viibryd and Daliresp) there can be serious implications to the
overall business model. Overall with all these questions and risk factors raised the analyst team
decided to utilize the three-legged approach prescribed by SMIF in the analysis of Forest Labs
eventually leading into the strongest points (Absolute Valuation and Cash Flow Analysis which
shows us Forest Labs at the core of the business being extremely profitable in their upcoming
years post 2013 with strong cash flows, growth and increased market share.
Team recommendation: Purchase 150 shares at $30 limit buy order.
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I. Industry Analysis
Overview
Forest Labs is in the Pharmaceuticals sector of the Healthcare industry. The Healthcare industry
has been very positive even through the recession by showing positive signs of revenue growth
as well as risk betas of less than one. Standard & Poor’s lists these companies as biotechnology
companies manufacturing different types of medicine and patenting them. Many refer to stocks
in this industry as defensive because the products and services are essential. Even during
economic declines, people will still call for medical aid and medicine to overcome illness.
Having a dependable demand for goods and services makes this sector less susceptible to
business cycle fluctuations. The factors that affect the Healthcare Industry as well as
Pharmaceutical sectors include healthcare reform bills, aging population, individuals living
longer with chronic disease, technological advancement, as well as epidemics.
FRX Develops, manufactures, and sells both brand-name and generic prescription and
nonprescription drugs in the United States and Europe. The main therapeutic areas that the
company concentrates on include depression, Alzheimer's disease/neuropathic pain,
hypertension, asthma, and gastrointestinal disease.
FRX’s closest competitors are Eli Lily and Co., GlaxoSmithKline, Valeant Pharmaceuticals,
Watson Pharmaceuticals, Pfizer Inc. However, in the custom industry analysis ten companies
were used of a similar nature. These are companies that offer similar products or services relative
to the size of the company, ranging from development of products to managing company
pipeline. This includes FRX, Johnson and Johnson, Merck and Co., Abbott Laboratories, and
Bristol Myers Squibb.
Competitors’ Analysis
In the report, financial data of many peer companies in the industry were used to compare with
FRX’s numbers. Pharmaceutical companies that are conducting businesses very similar to the
nature of FRX’s business were used along with FRX to create a customized industry to get a
better sense of FRX’s performance relative to its peers and industry group. Below lists a few
brief facts about each of the companies and reasons for picking them as competitors.
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1. Eli Lily and Company (LLY)
Eli Lily is a major pharmaceutical company that also develops, produces and distributes drugs.
Some of their main drugs include Prozac and Cymbalta for depression. Eli Lily is a direct
competitor to Forest Laboratories because of their similar product sector focus. Both FRX and
LLY produce central nervous system drugs. In a broader term, LLY and FRX also have similar
market focus. LLY is fully vested in the human pharmaceuticals market. The reason behind the
juxtaposition between LLY and FRX are based on their involvement in human and ethical
pharmaceutical.
2. Pfizer Inc. (PFE)
Although Pfizer is a much more diversified and larger industry player, it has an inclusion of
similar product line and approach as FRX. PFE operates in two segments: Biopharmaceutical,
which includes Primary Care, Specialty Care, Established Products, Emerging Markets and
Oncology customer-focused units, which includes products that prevent and treat cardiovascular
and metabolic diseases, central nervous system disorders, urogenital conditionseye disease and
endocrine disorders, among others, and Diversified, which includes Animal Health products;
Consumer Healthcare products, such as pain management therapies, cough/allergy remedies,
dietary supplements, hemorrhoidal care and other personal care items; Nutrition products, such
as infant and toddler formula products, and Capsugel.
3. Valeant Pharmaceuticals International (VRX)
Valeant Pharmaceuticals International develops, manufactures and markets a broad range of
pharmaceutical products primarily in the areas of neurology, dermatology and branded generics.
Not only does. VRX have a close revenue number to FRX, they also have similar specialization
in the dermatology and neurology therapeutic classes of drugs. Market caps are also similar with
the companies.
4. Glaxo Smith Kline PLC (GSK )
Like Forest Laboratories, GlaxoSmithKline Plc is a research-based pharmaceutical and
healthcare company. It is a major global healthcare group engaged in the creation, discovery,
development, manufacture and marketing of pharmaceutical and consumer health-related
products. GSK manufactures products in the following therapeutic areas: respiratory, anti-virals,
central nervous system, cardiovascular and urogenital, metabolic, anti-bacterials, oncology and
emesis, dermatalogicals and vaccines. They also have a focus on the human pharmaceutical
initiatives.
5. Watson Pharmaceuticals, Inc. (WPI)
Watson Pharmaceuticals, Inc. (WPI) is a peer of Forest Labs because it specializes also in ethical
pharmaceuticals with the patient’s health in mind. Watson Pharmaceuticals is an integrated
global pharmaceutical company, which engages in the development, manufacturing, marketing,
sale and distribution of generic and brand pharmaceutical products. The company operates
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through three business segments. Global Generics, Global Brands and Distribution. The Global
Generics segment includes off-patent pharmaceutical products that are therapeutically equivalent
to proprietary products. This is similar to FRX which stresses the ethical treatment of patients. It
also operates under the product categories of antibiotics, anti-inflammatory, depression,
extended-release, hypertension, oral contraceptives, pain management and smoking cessation
similar to FRX.
Threats
There are numerous threats that can hurt pharmaceutical companies. They can consist of delays
in pipeline, expiration of patents, generic versions of products appearing in the marketplace, the
FDA having a strict hold on new drugs, as well as new entrants entering the industry.
1. Speculations and Delays in Pipeline
Delays in pipeline can seriously affect a firm’s ability to embark on revenue growth. The
pipeline process is as follows. A product gets submitted to the pipeline and it goes through three
different phases in the cycle. During the three phases, testing for the product goes through
numerous rigorous processes. In the end upon completion of phase three the product becomes
filed through an NDA (New Drug Application). After it is filled as an NDA it has to become
approved by the FDA (Food and Drug Administration) and later becomes available to the
market.
2. Expiration of Patents
The expiration of patents on drugs can mean a loss of sales and revenues for the firm. In FRX’s
case, Lexapro which expired in March of 2012 as well as Namenda which is set to expire on
April of 2015, will cause a loss in revenues. However, with an ample amount of cash on hand, as
well as a promising pipeline with new drugs, FRX will not likely get hit that hard from the loss
of these patents. In other cases, struggling firms who lose patents can prove to be disastrous for
their future.
3. Generic versions of products in the marketplace
As name brand products succeed in the marketplace there become generic versions of that
product selling at a cheaper price with the same active ingredient. This can cause harm to firms
with big name brand drugs in that the generic products can become much more popular mainly
because they are much cheaper than the name brand product.
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4. FDA strict hold on new drugs
After a drug has been through the pipeline and filed as an NDA, the FDA has to approve that the
drugs meet all safety guidelines before they can put it out on the market. If there are delays in
this process it can prove to be very harmful for the firm in that they have spent much money on
research and development for the product and now it is at a standstill because it did not get
approved.
5. New Entrants
The entry of new firms into the industry can cause some problems by increasing competition
among other firms especially if the specialize in the same types of drugs. New entrants can come
up with cheaper generic brands as well as better products which can hurt the growth of similar
firms.
Revenue
A custom industry of ten firms in the pharmaceuticals industry was used for comparing revenue
numbers. The companies include FRX, LLY, GSK, WPI, VRX, PFE, MRK, JNJ, ABT, and
BMY. Industry revenues grew at a steady pace for the past eight years. However, it seems to
decline a slight bit in 2012. It falls from 320,682.5 in 2011 to an estimated 314,704.9 in 2012.
This due in large part to new healthcare reforms that cut down on budget as well as the
expiration of patents for numerous firms. The industry revenues were based on the ten
companies listed earlier. The revenues for FRX have been rising for the past seven years but our
estimate has it slightly dropping in 2013. This is mainly due to the expiration of Lexapro, which
is one of FRX’s top drugs.
Trends
Pharmaceutical Trends
New changes to the FDA policy on passing drugs onto the market have been a roadblock for
pharmaceutical companies. This new policy enables a stricter and tougher testing process in
which drugs are not easily passed as they used to be. The average approval time for new drugs
can range from two or three years to one year or less. In years prior there was a simple and quick
approval process that could last just 42-days.
Another change has been with the generic pharmaceutical industry. Firms can now manufacture
generic drugs based on the original product once the patent on the original chemical entity
expires. Also the generic industry can perform this without the expensive clinical trials which
prove a drug is safe and effective that is performed by original companies. Not having to
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perform the clinical trials is key for generic producers to drastically reduce the cost of bringing a
product to market.
Mergers and Acquisition of small biotech companies by larger ones have been common during
recent years. The motive behind this is for large firms to increase market share and expand by
purchasing smaller ones. This creates more capital for the companies. The most common firms
that conduct these mergers are biotech companies, who develop products based on living cells, as
well as some firms who have developed new technology in unlocking the genetic makeup of
human beings.
II. Company Overview
Forest has well-established franchises in the therapeutic areas of the central nervous and
cardiovascular systems, the firm is always exploring new product opportunities that address a
range of health conditions. Forest Labs principal brands include Bystolic®(nebivolol), Daliresp
®
(roflumilast), Lexapro® (escitalopram oxalate), Namenda
® (memantine HCl),
Savella®(milnacipran HCl), Teflaro
® (ceftaroline fosamil) for injection, and Viibryd
®(vilazodone
HCl).
Forest identifies, develops, and delivers pharmaceutical products that make a difference in
people's lives. Forest Labs have been extremely successful in meeting its business objectives and
expanding its franchises, but also derive satisfaction in helping to bring relief to people who are
suffering. Forest Labs credit success to innovation, integrity, and commitment to developing
important products.
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Executives
Howard Solomon Chairman, Chief Executive Officer and
President
Francis I. Perier Jr. Chief Financial Officer, Executive Vice
President of Finance & Administration and
Member of Disclosure, Legal Compliance &
Risk Management Committee
Raymond Stafford Chief Executive of Forest Laboratories - Europe
Marco Taglietti M.D. Senior Vice President of Research &
Development, Member of Disclosure, Legal
Compliance & Risk Management Committee
and President of Forest Research Institute
(FRI)
Elaine Hochberg Chief Commercial Officer, Executive Vice
President of Marketing and Member of
Disclosure, Legal Compliance & Risk
Management Committee
Board of Directors
1. Howard Solomon (Director since 1964)
Mr. Solomon, 83, is Chairman, Chief Executive Officer and President of Forest. He began his
career as an attorney at leading law firms in New York and joined Forest in 1964 as a director
and secretary of the Board while serving as outside counsel for the Company. He became CEO
of Forest in 1977 and Chairman in 1998. Mr. Solomon is a Trustee of the New York Presbyterian
Hospital and previously served on the Board of Cold Spring Harbor Laboratories. He is currently
a member of the Executive Committee of the Board of Directors of the Metropolitan Opera and
Chairman of its Finance Committee. He also serves on the Board of the New York City Ballet.
Mr. Solomon graduated from the City College of New York and holds a J.D. from Yale
University.
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2. Nesli Basgoz, M.D. (Director since 2006)
Dr. Basgoz, 53, is the Associate Chief for Clinical Affairs, Division of Infectious Diseases at
Massachusetts General Hospital (MGH) and serves on the hospital’s Board of Trustees. In
addition, Dr. Basgoz is an Associate Professor of Medicine at Harvard Medical School.
Previously, she served as Clinical Director in the Infectious Diseases Division of MGH for six
years. Dr. Basgoz earned her M.D. Degree and completed her residency in internal medicine at
Northwestern University Medical School. She also completed a fellowship in the Infectious
Diseases Division at the University of California at San Francisco. She is board certified in both
infectious diseases and internal medicine.
3. Christopher J. Coughlin (Director since 2011)
Mr. Coughlin, 59, most recently served as Executive Vice President and Chief Financial Officer
of Tyco International from 2005 to 2010 and remains an advisor to Tyco. During his tenure, he
played a central role in the separation of Tyco into three independent, public companies and
provided financial leadership surrounding major transactions, including the $2 billion acquisition
of Broadview Security, among many other responsibilities and accomplishments. Prior to joining
Tyco, he worked as the Chief Operating Officer of the Interpublic Group of Companies from
June 2003 to December 2004, as Chief Financial Officer from August 2003 to June 2004 and as
a director from July 2003 to July 2004. Previously, Mr. Coughlin was Executive Vice President
and Chief Financial Officer of Pharmacia Corporation from 1998 until its acquisition by Pfizer in
2003. Prior to that, he was Executive Vice President of Nabisco Holdings and President of
Nabisco International. From 1981 to 1996 he held various positions, including Chief Financial
Officer, at Sterling Drug. Mr. Coughlin is currently serving as the lead independent director on
the board of Dun & Bradstreet, where he is a member of the Audit Committee and the
Compensation and Benefits Committee. He also serves on the board of Covidien plc, where he is
Chair of the Compliance Committee. Mr. Coughlin has a B.S. in accounting from Boston
College.
4. Dan L. Goldwasser (Director since 1977)
Mr. Goldwasser, 71, is a practicing attorney and has been a shareholder since 1992 at the law
firm Vedder Price, P.C., where he is a member of the firm’s Accounting Law Practice Group.
Mr. Goldwasser previously served as Chairman of the American Bar Association’s Business
Law Section’s Committee on Law and Accounting and as the American Bar Association’s Co-
Chairman of The National Conference of Lawyers and Certified Public Accountants. From 2003
to 2006, he also was a member of the Auditing Standards Board of the American Institute of
Certified Public Accountants. Mr. Goldwasser holds a B.A. from Harvard University and an
LL.B. from Columbia Law School.
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5. Kenneth E. Goodman (Director since 1998)
Mr. Goodman, 63, is the former President and Chief Operating Officer of Forest, a position that
he held from 1998 to 2006. For eighteen years prior thereto, Mr. Goodman served as Forest’s
Vice President, Finance and Chief Financial Officer and was named Executive Vice President,
Operations in February 1998. From 1975 to 1980, he served as a senior financial officer at
Wyeth, and before that, as a C.P.A. at Main Hurdman, which is now part of KPMG LLP. Mr.
Goodman currently serves Syracuse University as Vice Chairman of the Board of Trustees, a
member of the Executive Committee and Chairman of the Audit Committee; he previously
served as Chairman of the Budget Committee. He is also Chairman of the International Board of
Directors of the Israel Cancer Research Fund and Co-Chairman of its New York Board. Mr.
Goodman is a C.P.A. and holds a B.S. degree from The Whitman School of Management at
Syracuse University.
6. Gerald M. Lieberman (Director since 2011)
Mr. Lieberman, 64, most recently served as the President and Chief Operating Officer of
AllianceBernstein from 2004 to 2009, where he oversaw several critical functions for
AllianceBernstein, including finance, global risk management, technology, operations, human
resources, and investor and public relations. In addition, he was instrumental in developing
AllianceBernstein’s global integrated platform and enhancing its corporate governance and
financial transparency. Prior to joining AllianceBernstein in 1998, Mr. Lieberman held a number
of senior positions at Fidelity Investments from 1993 to 1998, including Chief Financial Officer
and Chief of Administration and he was a member of Fidelity’s operating committee, reporting
directly to the Chairman. Before joining Fidelity, Mr. Lieberman spent 14 years with Citicorp,
where he served as Senior Human Resources Officer and a member of the policy committee,
reporting to the Company’s Chairman and Chief Executive Officer. At Citicorp, he also held
several other senior leadership positions, including Chief Executive Officer of Citibank Mexico
and Division Head of Latin America. Mr. Lieberman is currently serving as a director at
Computershare. He is also a trustee of the University of Connecticut Foundation and was a
practicing C.P.A with Arthur Anderson. He received a B.S. from the University of Connecticut
and attended New York University’s Graduate School of Business Administration.
7. Lawrence S. Olanoff, M.D., Ph.D. (Director since 2006)
Dr. Olanoff, 59, served as Forest’s Chief Operating Officer from 2006 to 2010 and currently
serves as Senior Scientific Adviser to the Company. From July 2005 to October 2006, Dr.
Olanoff was President and Chief Executive Officer at Celsion Corporation, an oncology drug
development company. He also served as Executive Vice President and Chief Scientific Officer
of Forest from 1995 to 2005. Prior to joining Forest in 1995, Dr. Olanoff served as Senior Vice
President of Clinical Research and Development at Sandoz Pharmaceutical Corporation (now a
division of the Novartis Group) and at the Upjohn Company in a number of positions including
Corporate Vice President of Clinical Development and Medical Affairs. Over his entire career,
he was involved in 30 product approvals. In addition, he is currently an adjunct Assistant
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Professor and Special Adviser to the President for Corporate Affairs at the Medical University of
South Carolina (MUSC), as well as a Director of the MUSC Foundation for Research
Development, which is a non-profit foundation created to benefit the university. He holds a
Ph.D. in biomedical engineering and an M.D. degree from Case Western Reserve University.
8. Lester B. Salans, M.D. (Director since 1998)
Dr. Salans, 75, is a Clinical Professor and member of the Clinical Attending Staff of Internal
Medicine at the Mount Sinai Medical School. Prior thereto, Dr. Salans was a senior executive at
Sandoz Pharmaceutical Corporation (now a division of the Novartis Group). Dr. Salans is a
former Director of the National Institutes of Arthritis, Diabetes, Digestive and Kidney Diseases
of the National Institutes of Health. He served as Professor of Medicine and Director of the
Division of Endocrinology at the Dartmouth Hitchcock Medical Center, Hanover, from 1968-
1975. He also founded and is president of LBS Advisors, Inc., a consultancy serving several
pharmaceutical and biotechnology companies, academic institutions, the National Institutes of
Health and many investment firms. He serves on the board of directors of PharmaIN
Corporation, a biopharmaceutical company. Dr. Salans earned a B.A. from University of
Michigan and M.D. from University of Illinois.
9. Brenton L. Saunders (Director since 2011)
Mr. Saunders, 41, has been the Chief Executive Officer of Bausch + Lomb and a board director
since March 2010. Previously, Mr. Saunders served as a senior executive with Schering-Plough
from 2003 to 2010, most recently as President of Global Consumer Health Care. He also served
as Head of Integration for both Schering-Plough’s merger with Merck & Co. and for its $16
billion acquisition of Organon BioSciences. Before joining Schering-Plough, Mr. Saunders was a
Partner and Head of the Compliance Business Advisory Group at PricewaterhouseCoopers LLP
from 2000 to 2003. Prior to that, he was Chief Risk Officer at Coventry Health Care between
1998 and 1999 and a co-founder of the Health Care Compliance Association in 1995. Mr.
Saunders began his career as Chief Compliance Officer for the Thomas Jefferson University
Health System. In addition to the Bausch + Lomb board, he serves on the boards of ElectroCore
LLC and the Overlook Hospital Foundation. He is also the former Chairman of the New York
chapter of the American Heart Association. Mr. Saunders was also recently named to the Federal
Reserve Bank of New York’s Upstate New York Regional Advisory Board. He received a B.A.
from the University of Pittsburgh, an M.B.A. from Temple University School of Business, and a
J.D. from Temple University School of Law.
10. Peter J. Zimetbaum, M.D. (Director since 2009)
Dr. Zimetbaum, 47, has served as Director of Clinical Cardiology at Beth Israel Deaconess
Medical Center in Boston (BIDMC) since 2005 and served as Director of Clinical
Electrophysiology at BIDMC from 2001 to 2005. Additionally, since 2006, Dr. Zimetbaum has
been an Associate Professor of Medicine at the Harvard Medical School (HMS), and he currently
serves on the HMS Standing Committee on Conflicts of Interest. Dr. Zimetbaum received his
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M.D. degree from the Albert Einstein College of Medicine in 1990 and is board certified in both
cardiovascular medicine and cardiovascular electrophysiology.
Cyclicality of Market and Forest Labs
Everything old is new again. It seems like Forest Labs (NYSE:FOREST LABS) is perpetually
beset by worries about its future: Will the company be able to navigate the next patent cliff and
will the company continue to find attractive licensing deals to keep its growth engine running?
Even though the company has pretty much always been able to find favorable answers to the
questions, Wall Street never seems willing to give Forest all that much benefit of the doubt.
Forest Labs released early prescription data and trends for their new drug Daliresp. As of the
week ended March 30, there have been over 135,000 prescriptions written. Overall total
prescription volume in the March quarter increased almost 40% over the December quarter after
having doubled in the fiscal third quarter over the second. New prescription share of the total
market was 1.49% for the week ending March 30 versus 1% for the last week of December,
while TRx share was 1.15% versus 0.75% for the same period. Over 18,000 physicians have
already tried Daliresp, including 39% of all specialists, which is a very positive signal, and over
50% [ph] of physicians have used Daliresp more than once.
Since launch, primary care physicians and other healthcare providers have written approximately
75% of scripts; specialists, around 25%, which is in line with expectations. Forest Labs sales
force has reached 85% of Forest Labs client target audience. Physicians’ interest in Daliresp is
very high, with awareness of products well above 90%. Feedback from pulmonologists and PCPs
is positive, as seen by the fact that most prescribers have written more than once.
Over 30 million patients are taking antidepressants in the U.S. Patients need a first-line
antidepressant that offers efficacy that can help them recover as well as an acceptable side-effect
profile. Furthermore, roughly 50% of patients need an alternative antidepressant, primarily due
to lack of efficacy of the previous agent or secondarily, due to side effects. In either situation,
Viibryd can be that option. Its mechanism of action is different from other antidepressants.
Viibryd's the first and only approved SSRI and 5HT1A receptor partial agonist.
As of the week ended March 30, there have been over 415,000 prescriptions written by
approximately 43,000 prescribers, including almost 44% of high-prescribing psychiatrists.
Approximately 70% of prescribers are repeat prescribers. Since launch, about 43% of scripts
have been written by psychiatrists and approximately 57% by primary care physicians and other
healthcare providers. We're very pleased with the response to this product by not only specialists,
but also primary care physicians.
Bystolic's study has sustained growth so far and is a good example of how we build products
over time to their full potential. Sales in the quarter for Bystolic were $96.9 million, representing
growth of 32.6% year-over-year. At 4 years post-launch, Bystolic's NRx volume has surpassed
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many anti-hypertensive agents while looking at launch-align new Rx volumes. Moreover, total
prescription launch aligned volume is in line with Benicar, a first-line ARB. Bystolic achieved a
4% share among specialists several months ago, and weekly national share among all prescribers
is now consistently above 4%.
Interestingly, younger patients comprise a higher percentage of Bystolic’s patient base than they
do for other beta blockers and other antihypertensive agents in general. 56% of Bystolic's
patients are younger than 65 compared to 46% for other beta blockers and 52% for the general
antihypertensive market.
In quarter 4, days of therapy increased 20% over quarter 3 to reach approximately 120,000 days
of therapy in the quarter. Teflaro has a strong user base, with over 3,000 hospitals purchasing,
which is almost 50% of the entire hospital universe. The number of new and repeat accounts is
also climbing and significantly exceeds CUBICIN's launch-aligned user base count. Quarter-
over-quarter, we've seen an increase of 13% in total accounts purchasing Teflaro, and 83% of
hospitals have purchased Teflaro multiple times.
Formulary acceptance continues to advance with the majority now of target hospitals, 56%,
granting Teflaro unrestricted access. Overall, we had 80 formulary wins since December, and 17
have been in the top 250 hospitals, where days of therapy growth continues to outpace growth in
the overall market. In addition, over time, the gap in days of therapy between unrestricted access
versus non-formulary access continues to widen.
Share of the ABSSI market in January was 1.26% versus 0.89% in December, a 0.37-point
increase in one month. Forest Labs CAP market share jumped to 0.42% in January, versus 0.25%
in December and more remarkably, from 0.1% at the beginning of the respiratory season.
Namenda is and remains an important product for Forest. Sales for Namenda were $393.1
million in the quarter with growth of 19.5% year-on-year, which contains consistent, single-digit
real growth 8 years post-launch. We expect Namenda to continue to be a growth product for
Forest as we continue to support it. Furthermore, the launch of an XR product that has a higher
dose, a once-a-day formulation and also has been studied in combination with all
acetylcholinesterase inhibitor should propel future growth for this important product.
Savella sales in the current quarter were $25.3 million, growth of 6.5% year-on-year compared to
sales of $23.7 million last year. Overall, the fibromyalgia market has grown more modestly than
anticipated and has proven itself to be a more specialty-driven market than a broad-based
primary care category. Savella's share among specialists is comparable to that of Cymbalta and
Lyrica.
Lexapro's patent exclusivity ended this past March. Substitution rates for Lexapro quickly grew
to greater than 80% in just 6 weeks. Consequently, wholesalers rapidly drew down their
inventories. Sales of Lexapro were $355.8 million versus $594.8 million the same quarter a year
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ago. Only 2 generic products, Mylan's and Teva's, will be in the market until mid-September
2012, when the 180-day Hatch Waxman exclusivity period ends.
Overall, fourth quarter fiscal 2012 was a good quarter for Forest Labs promoted products. Sales
of Forest Labs newest products were up: Daliresp increased 56%; Viibryd, 32%; Teflaro, 22%
over the previous quarter. Forest Labs more established products, Bystolic and Namenda,
continue to enjoy real unit growth several years post-launch. As we prepare for another round of
important launches, Forest Labs is very encouraged by these results.
Forest Laboratories Outlook
The ever-present concern about Forest Labs is whether the company can continue to recharge its
product portfolio with lucrative new drugs. Forest does no in-house new drug research, instead it
focuses all of its future toward acquiring, developing and exploiting other companies'
compounds. It has been a very successful model throughout Forest's history. Overall through this
Forest is a competitive leader in its niche of dealing with pharmaceuticals in this way and does
just as Merck (NYSE:MRK), Pfizer (NYSE:PFE) and Novartis (NYSE:NVS) in converting
revenue to free cash flow.
The geography of big-cap pharmaceutical companies has changed a lot over recent years due to
regulation, more frequent patent cliffs, reform and the maturation of the Alheimer’s
pharmaceutical market. Companies like Pfizer, Merck, and Glaxo (NYSE:GSK) have reduced
their headcount in R&D and are currently aggressively seeking wider use of licensing
agreements and acquisitions. This is similar to Forest’s approach. AstraZeneca (NYSE:AZN)
and Lilly (NYSE:LLY) is currently dealing with pipeline failures and patent cliffs more than
ever. There is a stronger interest due to the success of Forest that the exploitation of in-licensing
and acquisition.
In other words, Forest Labs has more and more competition when it comes to striking profitable
bargains for small companies' pipeline candidates in their quest for attaining compound rights.
In respect to Forest Labs’s pipeline, the company has Teflaro for infections, two COPD drugs
and a promising candidate in late-stage testing for irritable bowel syndrome and chronic
constipation. Beyond that they are doing what they do best and are utilizing additional
compounds. In this case it is being tested for depression; these are compounds which would be
natural extensions of Forest's long-held franchise in psychiatric medication.
P a g e | 16
1. Patent Expiration
Forest Laboratories faces expiration of two of its blockbuster drugs in 2012. As you can see from
current drugs portfolio below, Namenda and Lexapro which represent 85% of their current
revenue of that fiscal year are going to experience patent expiration. And this patent cliff has
become the major concern for the investors. This report also aims to explore whether the Forest
Labs’ newly launched drugs and drugs in the pipeline would have the potential to cover the
revenue loss due to the patent expiration of Namenda and Lexapro.
Patent of drugs in the United States expires every fifteen years. As soon as the patent expires,
generic versions of the drug are allowed to enter the market, bringing the once brand name drug
dramatic competition. However, it does not mean that the revenue that the drug was gaining
would vanish right after the patent expires. Firstly, it takes time for the generic version of the
drugs to come into the market. Secondly, the drug’s brand equity and customer loyalty over the
last fifteen years should still help to keep parts of its revenue. And it is likely the same for Forest
Lab’s two drugs: Namenda and Lexapro.
Current Drugs for fiscal year ended March 2011.
P a g e | 17
2. Prospects of New Launches
As investors, we are all concerned about whether Forest Lab’s Newly Launched drugs would be
successful enough to cover the revenue loss due to patent expiration. Below we examined the
performance of four of its recently launched drugs and one old drug in the second quarter of fical
year 2012.
According to Forbes new release, Bystolic, Forest Labs’ beta-blocker for the treatment of
hypertension, posted revenues of 82.3 million, up 29.2% for the second quarter of fiscal year
2012. Savella, which is approved for the management of fibromyalgia, posted revenues of $25.5
million, up 19.1% from the year-ago period.
Forest Labs’ new product, Teflaro, posted revenues of 5.3 million, up from $2.7 million in the
first quarter of fiscal 2012. The FDA granted approval to Teflaro for the treatment of patients
suffering from acute bacterial skin and skin structure infection and community acquired bacterial
pneumonia in October 2010. Forest Labs launched the product in March. The company is
targeting 2,200 key hospitals and hospital systems. The Center for Medicaid and Medicare
Services (CMS) has added Teflaro to the Specifications Manual for National Hospital Inpatient
Quality Measures as a recommended initial antibiotic (applicable to hospital discharges on or
after January 1, 2012). This should increase the use of Teflaro as a first-line agent, particularly in
community-acquired bacterial pneumonia.
Two other products, Daliresp and Viibryd, were launched in August. While Daliresp, which is
approved for the treatment of chronic obstructive pulmonary disease (COPD), recorded revenues
of 1.2 million, Viibryd (vilazodone HCl), approved for the treatment of major depressive
disorder (MDD) recorded revenues of $5.3 million.
Q2 FY 2012 Performance of the New Launches
P a g e | 18
3. Broad Pipeline
From the pipeline taken from Forest Labs’ official website, it is quite observant that Forest Labs
has a variety of drugs in its pipeline. Two of its drugs have filed for NDA. Five of its drugs are in
their phase three of development. In comparison, as shown in the table below, Valent
Pharmaceutical only has one drug filed for NDA. One drug in its third phase of development and
the rest of the drugs in its pipeline are still in the preliminary development phase.
Pipeline from Forest Labs
P a g e | 19
Pipeline from Valent Phamaceutical International. Inc
Main Points
Forest Labs faces a sharp fall-off in sales and cash flow in just a couple of years due to the
development of new product revenue streams.
Overall Forest Labs needs to continue to develop its pipeline to maintain competitive leadership
and market share in its industry. With the expiration of patents of flagship brands (Lexapro and
Namenda) Forest Labs is at risk of not executing sales at the same caliber as its push in these
launches. Forest Labs is in a unique stage of development and with the post-submission stage
completed for their new emerging brands it can prove to be a leader in the pharmaceutical
industry.
P a g e | 20
IV. Ratio Analysis
Profitability Ratios
Notes: Forest Labs fiscal year is in March, while its competitors’ are all in December. We want
the calendar time periods to overlap as much as possible, so we line up FOREST LABS March
2012 number with its competitors’ December 2011 numbers through all the ratio analysis part.
Sales
From the chart, you can see that Pfizer and GlaxoSmithKline get the highest revenue and are far
above its peers. Lily is hovering around the industry average. Forest Lab’s revenue size is closer
to Watson, especially in year 2011, when Forest Labs was 4565.7 million and Watson was
4584.4 million. Valeant has the lowest revenue among all the competitors through 2002 to 2011.
When we look at the sales growth rate chart below, we can see that Forest labs’ growth rate is
neither under- nor out-performing its competitors.
P a g e | 21
Net Income
Because net income shows a company’s total profits, it is an important measure in analysis.
Forest Labs’ net income is almost at the bottom due to the size of the company being
comparatively small. We can see on the chart that the blue line of Forest Labs only surpassed
Valeant and Watson. But the average annual growth rate from 2006-2011 is the second highest
among those comparable. In March 2012, Forest Labs’ Net Income was 979.1 million; compared
with Pfizer’s 8697.0 million there’s a huge gap in between. But actually the net income of
FOREST LABS is gradually increasing.
P a g e | 22
Cash Flow Operations
The cash flow from operations number for Forest Labs( March 2011) is almost four times the
number of Valeant ( December 2010). Their cash flow from operation is comparatively flat
among its competitors. And FOREST LABS stays above 1000 million since 2007 (March 2008).
Due to the March 2012 cash flow from operations is not avaialble ,we only calcuated the the
average annual growth rate from 2006 to 2010. As we can see their average annual growth rate
of 6.65% is the second highest, and the average industry growth rate is -1.28%.
P a g e | 23
Net Profit Margin
Net Profit Margin is the ratio of net profits to revenues for a company that shows how much of
each dollar earned by the company is translated into profits. From the chart we can see that
Forest labs’ net Margin is comparatively healthy than the industry average. That means Forest
Labs’ ability of translated revenues into profits is more efficient than its competitors. Also,
compared with WPI, VRX and LLY’s net profit margins are more volatile than FOREST
LABS’s. Starting in 2009, the custom industry’s average net margin is gradually decreasing, but
it picks up in 2010. FOREST LABS shows an upward trend from 2009 to 2010, and then goes
down in 2011.
P a g e | 24
Gross Margin
Forest Labs is comparatively stable among its competitors; the highest ratio was 79.229% in
March 2003, and the lowest ratio was 77.832% in March 2010. It floated within a pretty narrow
range. Also, on the chart, Forest Labs surpassed the custom industry average from 2004 to 2010,
and surpassed GlaxoSmithKline a little bit in 2010.
P a g e | 25
ROE and DuPont Analysis
Return on Equity represents how much profit a company generates with money its shareholders
have invested. On the chart, Forest labs’ ratio is higher than Pfizer since 2003. Also, Forest Labs
comparatively stays on a stable level. By using the DuPont analysis to break down the
composition of ROE into three parts, we can see that financial leverage and asset turnover did
not change that much, it is the floating net profit margin cause the change in ROE ratio.
P a g e | 26
ROA
ROA is measured as income dollars generated per dollar of assets and shows how profitable a
company is relative to its assets. ROA represents how efficient management is at using its assets
to generate earnings. Overall, Forest Labs was on the top, except in the years 2006, 2009 and
2010. Also, we can see that FOREST LABS is higher than its competitors and industry averages
throughout the years 2002 to 2011. But the decrease of the ROA ratio starting in 2007 is due to
the gradual increase of the average assets, and that means Forest Labs’ ability to use assets to
generate earning decreased.
P a g e | 27
Liquidity Ratios
Quick Ratio 1
The quick ratio measures a company’s ability to meet its short-term obligations with its most
liquid assets, excluding inventory. The Forest Labs’ line is far above its competitors and
industry average. In year 2010 the quick ratio of FOREST LABS reached the peak of 5.13, while
custom industry average was only 2.04, so there is a 3.94 gap in between. In 2006, the cause of
Forest Labs’Quick ratio’s upward trend and industry average’s downward trends is because
FOREST LABS decreased its inventory from 610.2 in year 2003 to 451.4 million in year 2010,
but other competitor’s inventory all increased during this period.
P a g e | 28
Current Ratio
The current ratio gives an idea of the company’s ability to pay back its short-term liabilities with
short-term assets. The pattern of Current ratio is similar to the Quick Ratio. In March 2011
Forest Labs reached it’s peak of 5.61, while industry average was still at a low level.
Current Ratio
FRX
LLY
GSK
WPI
VRX
PFE
Industry Avg
P a g e | 29
Efficiency Ratio
Asset Turnover
Asset turnover measures the amount of sales generated for every dollar’s worth of assets. Forest
Labs’ asset turnover ratio is hovering around the top 2 in the past 8 years. And during 2006 to
2008, its ratio was even better than GlaxoSmithKline’s. Forest Labs’ ratio is far above Valeant’s,
which is the most similar company to Forest Labs. But since 2006 FOREST LABS’s asset
turnover has been trending downward to 0.641 from 0.940, and became the third highest among
those competitors. It is the growth of average asset outpacing the growth of sales that caused this
downward trend.
P a g e | 30
Inventory Turnover
Inventory Turnover shows how many times a company’s inventory is sold and replaced over a
period of time. At the beginning, Forest’s ratio started out near the lowest among this peer group
, but its COGS (excluding depreciation and amortization) increased from 458.4 million in 2002
(March 2003) to 891.0 million in 2010 (March 2011), which is almost double the number of
COGS; meanwhile the Average Inventory number is hovering around $450 million. It caused the
Forest Labs’ inventory turnover ratio to spike to 2.01 in year 2009. And it has stayed among the
top 3 since the year 2007.
P a g e | 31
Receivables Turnover
Receivable turnover ratio measures the number of times, on average, accounts receivables are
collected during the period. Forest Labs receivables turnover declined from 13.75 in March 2003
to 8.10 for their March 2006 year, and it has remained between 8 and 8.5, and above this peer
group, since then.
P a g e | 32
Asset Turnover
Asset turnover measures the amount of sales generated for every dollar’s worth of assets. Forest
Labs’ asset turnover ratio is hovering around the top 2 in the past 8 years. And during 2006 to
2008, its ratio was even better than GlaxoSmithKline’s. FOREST LABS’s ratio is far above
Valeant’s, which is the most similar company to FOREST LABS. But since 2006 FOREST
LABS’s asset turnover has been trending downward to 0.641 from 0.940, and became the third
highest among those competitors. It is the growth of average asset outpacing the growth of sales
that caused this downward trend.
P a g e | 33
Solvency
Financial Leverage Ratio
Financial leverage is calculated as total assets divided by total shareholder’s equity. It is a
measure of total borrowing and use of leverage in their capital structure. Forest Labs do not have
debt, so they have the lowest financial leverage which makes it less exposed to failure risk.
P a g e | 34
IV. Pro Forma Income Statement
One of the most important stepping stones to analyze while valuing a company is the income
statement. The components contribute to each other and allow you to make future estimates and
construct earnings per share estimate. The Pro Forma Income Statement includes industry
revenues, yearly share, total revenue, depreciation, amortization, cost of goods sold, operating
expenses, average diluted shares, and earnings per share. The values are represented in
thousands.
Industry Revenues
Projection: 314.704
Based on FactSet estimates, there could be a prediction on industry revenues. This was done by
constructing a graph with FRX’s top competitors (LLY, GSK, WPI, VRX, and PFE) as well as
comparing it to our ten custom firms (including MRK,JNJ,ABT, and BMY). Actual revenue
numbers were used for each company from 2002-2012, and forecasted the revenue values for
2013.
Revenues
0.0
10,000.0
20,000.0
30,000.0
40,000.0
50,000.0
60,000.0
70,000.0
80,000.0
LLY
WPI
FRX
GSK
PFE
VRX
Industry Avg
P a g e | 35
Yearly Share
Projection: 1.305%
Yearly share has been around the 1.3 to 1.4 range fluctuating up and down for the past seven
years relative to our custom industry. It had been growing steadily from 2006-2010 then took a
slight dive in 2011 to 1.381 and rebounded in 2012 to 1.424. There will be a decrease to 1.305 in
the yearly share for 2013 as by calculating the eleven and ten year averages. This decline is
mainly due to delay in the pipeline for the new drug linaclotide, which is used for the treatment
of irritable bowel syndrome as well as the expiration of one of their heavy hitter patents,
Lexapro, which is a treatment for depression. There are also generic brands of Lexapro that have
been produced by Teva (TEVA) as well as Mylan (MYL) marketing an authorized generic
version of the product.
FRX Yearly Share
P a g e | 36
Total Revenue
Projection: 4,106.90
The estimate for total revenue was calculated by taking the yearly share estimate for 2013, and
multiplying it by the industry revenue for the same year, then multiplying that by a thousand. A
decrease in total revenue from 2012 from 4,565.7 million to 4,106.90 for 2013 is projected due to
the loss of patent for Lexapro.
Revenue Comparison
The pie chart below compares FRX’s revenue size with regards to that of other similar
companies in the industry. The 2011 sales revenue for LLY, GSK, WPI, VRX, and PFE was
used as well as the March 2012 fiscal year for FRX as our input data to create the chart below.
Sales Revenue
Dec 2011
FRX 4,565.7 LLY 24,286.5 GSK 44,091.2 WPI 4,584.4 VRX 2,463.5 PFE 67,425.0
P a g e | 37
Depreciation
Projection: 43.97
The five year average was used for depreciation arriving at 43.97 million for the 2013 estimate.
It has remained in the 40.0 to 50.0 (thousands) range for the past six years.
Depreciation
Amortization
Projection: 70.74
Amortization rises from 65.4 million in 2012 to the highest it has been at 70.74 for 2013 as it is
estimated on the company’s 10K for 2013.
Cost of Goods Sold
Projection: 987.63
Cost of Goods Sold excluding Depreciation and Amortization was taken as a percentage of
revenue by using COGS excluding D&A and dividing it by total revenue. For the 2013 estimate,
the average over the ten years as well as the year to date for 2011 was taken. The estimate for
COGS excluding D&A in 2013 came by taking total revenue and multiplying it by the COGS
P a g e | 38
percentage of revenue estimate which was $872.91 (thousands). Depreciation was averaged for
the past 5 years and Amortization was taken as an estimate from the 10K. Adding these three
arrived at the total COGS estimate for 2013. It has been growing since 2006 but is due for an
expected decrease since revenues have declined.
Operating Expenses
Projection: 2217.26
This was recorded by taking SGA Operating Expenses and then splitting it into R&D and other
SGA. For 2013 the estimate for R&D was found in the 10K, $850.00 (thousands) also
calculating the 2013 Other SGA expense estimate by finding other SGA as a percentage of
revenue (33.29%), which was the average of the past eleven years, then multiplying it by
revenue. Then adding R&D and SGA to get the total operating expense. This has been going
steady around the 30.0 to 40.0% range since 2002.
Operating Expenses as % of Revenue
P a g e | 39
Provision for Legal Judgment/Other Extraordinary Expense
Projection: 0
FRX shows no signs of any of these expenses.
Interest Income: 23.8
The interest income forecast for 2013 comes from the calculation of the projected interest yield
of 8% for 2012 multiplied by adding cash and s/t investments as well as total investments and
advances for 2012. It is expected to stay around the 20.0 to 30.0 (thousands) range as it has for
the past couple of years.
Interest Income
Interest Expense
Projection: 0
FRX has no debt and shows no signs of it.
P a g e | 40
Contract Revenue and Other Income
Projection: 191.3
This was done by taking an average over the past seven years to come up with an estimate for
2013. It has stayed put in the high 100.0 (thousands) for the past two years.
Contract Revenue and Other Income
P a g e | 41
Average Weighted Diluted Shares
Projection: 268000
This is a slight drop from the year before. The expiration of the patent for Lexapro remains a
contributor to this. The number was obtained from the 10K report.
Earnings Per Share
Projection: 3.068
EPS has been growing for FRX during the past two years. But as the patent for Lexapro expires
the EPS will drop a slight bit. However, FRX has added two other new products, Viibryd and
Daliresp, to keep themselves from falling out of the market.
EPS
P a g e | 42
V. Relative Valuation
The following charts indicate the trailing P/E for Forest Lab’s Comparables pharmaceutical
stocks Eli Lilly (LLY), Watson Pharmaceuticals (WPI), Johnson & Johnson (JNJ),
GlaxoSmithKline (GSK), Pfizer (PFE), Merck & Co., Inc (MRK), Abbott Laboratories (ABT),
Valeant Pharmaceuticals (VRX), and Bristol Myers Squibb Co. (BMY). Due to the fiscal year of
Forest Labs being different from the other comparables, we use the subbed methodology to get
their P/E from the Factset. This way, we can line up Forest Labs numbers with other
comparables in the Decembers through 2002-2011.
Company Trailing P/Es
As we can see from this chart, Merck P/E of 128.71 for 2010 and Valeant P/E of 89.79 for 2011
are so significantly high among their historical P/E ratio, and we think they will pollute our later
calculation of mean and median, and future price estimate. So, in this case we decided to exclude
Merck P/E, and for Valeant P/E we leave it there, but we decided to raise our adjustment factor
later a little bit.
The historical relative proportion between Forest Labs and the benchmark P/E ratios will be used
in forecasting the future relationship between Forest Labs and its competitors. As shown in the
table below, we divided Forest Labs P/E by the P/E of comparables, P/E of custom industry’s
average, as well as the S&P500 healthcare sector. We did this for each year and calculated both
the average and median to form our adjustment factors.
P a g e | 43
P/E Ratio Relationships
In 2011, the relationships were all below 1, and the last two years P/E relationships are
significantly different from the mean and the median’s column. In this case our group decided to
use the adjustment factors, that we felt were most accurate and resembled the most recent trends.
Also, the lower adjustment factor we use the more conservative price estimate we can get.
Since we want to estimate March 2013 for Forest Labs, we use three-fourths of 2012 forward
P/E and one-fourth of 2013 forward P/E ratio to get the 2013 weighted average number. Also, in
order to figure out the left hand side forward P/E for 2013, we use the price from 4/27/2012
divided by the Non-GAAP expected 2013 EPS for FOREST LABS’s comparables. By using the
formula and the expected EPS of Forest Labs for 2013, which we got from our assignment 3, we
can see the green part is our estimate for the Forest Labs future Price and Current Price. And the
average price estimates are hovering around 36 dollars. Compared with the price 34.92 last
Friday April 27, Forest Labs is fair valued.
P a g e | 44
VI. Absolute Valuation
Since Forest Laboratories has no debt or dividends, the Free Cash Flow to Firm model is
applied for our absolute evaluation. The Free Cash Flow to Firm refers to cash flow available to
all providers of capital (equity & debt) after operating expenses are deducted and investments in
fixed (Capex) and/or working capital are made.
Cost of Capital
We used two different methods to calculate possible cost of capital: the CAPM and Bond
yield + Equity premium method.
CAPM (Capital Asset Pricing Model)
The cost of capital (k) calculated by CAPM, equals beta of FOREST LABS multiplied by
the market risk premium plus a risk free rate of return. The market risk premium equals the
expected market return minus the risk free rate. The calculation is shown in the table below.
10 Yr 30 Yr
Treasury Strip 2.186% 3.38%
Risk Premium (MR-RF) 8.58% 7.39%
Expected Market Return (MR) 10.77%
Beta 0.785
P a g e | 45
Calculation RF+Beta(MR-RF)=K
K1 K2
Results 0.089 0.092
In the tables below, we show groups of treasury rates and betas we have looked at and
our rationale behind choosing the ones to be put into the CAPM calculation.
Treasury Rates (as of 4/18)
10 Year 30 Year
T-bond 1.98% 3.13%
Strip 2.186% 3.38%
Beta 5yr (3/30/2007-3/30/2012) Beta 10yr(3/29/2002-3/30/2012)
Raw Adj Raw Adj
0.678 0.785 0.623 0.749
The risk free rates used here are the STRIP numbers for both 10 Year and 30 Year rate.
The market expected return used here is the US market return ratio as of 4/17/2012 from
Bloomberg. The 5- year adjusted beta is used because we want to be conservative in our
evaluation by inserting the highest beta.
Bond Yield + Equity Premium Method
The method that is demonstrated in the Utendahl analysis is utilized to get to our third
possible cost of capital here. We firstly selected Valeant Pharmaceutical, which is a company
very similar to Forest Laboratories as our comparable. We then found that its most recently
issued 10-year bond has a yield to maturity of 7.335% as of 4/26/2012. Then an equity premium
is applied to this yield to get to our third cost capital as it was the case in the Utendahl example.
The equity premium refers to the return difference between equity and bond. The equity
premium applied in Utendahl case was 3%, which is ten years ago. We believe that a 10%
increase in that number is reasonable with regards to the current economic condition. This will
lead our equity premium to be 3.5%. Therefore, through the Bond yield + Equity premium
method, our K3 amounts to roughly 11% (7.335%+3.5%=10.84%).
Cost of Capital (k) Used
P a g e | 46
We felt that k1 and k2 from the CAPM calculation failed to capture the additional risk
corporate bond brings over. Additionally, we also want to keep taking a conservative position by
taking the highest k to prevent from inflating our price estimates. Therefore, the k3 cost of
capital of 10.64% is used throughout the absolute valuation.
Near Term Growth Rate for FCF
Next, we looked at the historical free cash flows of FOREST LABS over the last ten
years as shown above. We calculated the geometric average growth rate of the FCF over three
periods. From the results, we concluded that FOREST LABS’s free cash flow has experienced
significant growth from 2002 to 2008. And the growth trends continued from 2008 onwards
excerpt a slight drop in 2009 and 2010. However, the growth rate over the last four years has
been a lot more moderate. Therefore, we decided to take 2.65% as our near-term growth rate for
free cash flow.
Near-Term and Long-Term Growth Rate Matrix
In order to be more conservative and comprehensive in our evaluation, we choose to do
two streams of scenario analysis. We created a matrix shown as below using near-term growth
rate (g1) ranging from -3% to 9% and long-term growth rate (g2) ranging from -3% to 5% to
estimate the current intrinsic value of Forest Laboratories by following the steps below.
1. Estimate the future free cash flow for Forest Laboratories from 2012 to 2018 using g1.
2. Discount all the 2012 to 2018 FCF estimates using k3 and sum them up to get total PV
for 2012 to 2018.
3. Use the FCF for 2018 calculated from step 1 and multiply by g2 to get to estimate FCF
for 2019
4. Calculate Estimate of intrinsic value of FCF for 2018 onwards in with the formula below:
P a g e | 47
Est (IV 2018) = FCF 2019/ (k3-g2)
5. Discount the result from step 2 to 2012 to get the PV for 2018 onwards.
6. Add up the PV for 2012 to 2018 and PV for 2018 onwards to get the total PV.
7. Divide the PV with the Weighted Average Diluted Shares of 268 Million for Forest
Laboratories to get to the estimate of intrinsic value for FOREST LABS now.
Growth Rate from 2018 Onwards (g2)
Near-Term Growth Rate (g1) -3% -2% -1% 1% 2% 3% 4% 5%
-3% 33.22 34.52 36.04 39.99 42.63 45.92 50.15 55.79
-2% 34.76 36.15 37.76 41.96 44.76 48.26 52.76 58.77
-1% 36.37 37.84 39.56 44.02 47.00 50.72 55.50 61.88
1% 39.80 41.46 43.39 48.43 51.78 55.98 61.37 68.56
2% 41.62 43.39 45.44 50.78 54.34 58.79 64.51 72.14
2.65% 42.85 44.68 46.82 52.37 56.06 60.69 66.63 74.56
3% 43.53 45.40 47.58 53.24 57.01 61.73 67.80 75.89
4% 45.52 47.50 49.81 55.81 59.81 64.81 71.24 79.81
5% 47.59 49.69 52.13 58.49 62.72 68.02 74.83 83.91
6% 49.75 51.97 54.56 61.29 65.77 71.38 78.58 88.19
7% 52.01 54.35 57.09 64.21 68.95 74.88 82.51 92.67
8% 54.35 56.83 59.73 67.25 72.27 78.54 86.60 97.36
9% 56.80 59.42 62.48 70.43 75.73 82.36 90.88 102.24
The chart above is telling us that with the worst case scenario, a negative three percent
near-term and long-term growth rate will only lead Forest Laboratories to be fairly valued (The
price as of 4/30/2012 is $34.83). If Forest Laboratories continues its recent five year growth rate
of 2.65% in the near-term, even a negative three percent long-term growth rate will lead Forest
Laboratories to be undervalued. However, looking from another perspective, the result might
also be signifying that the market is currently expecting Forest Labs to have negative growth rate
for a long time. However, according to our company and industry research, we believe even if it
is the case, the market should be having overly low expectation for Forest Labs providing that it
has great cash position and broad pipeline.
P a g e | 48
Along with results from company and industry analysis conducted above, we conclude
that Forest Laboratories is likely to be undervalued.
VII. Recommendation
Overall by using a three-legged approach in our valuation of Forest Labs including ratio analysis
in a custom and relative industry, cash flow analysis and absolute/relative valuation we conclude
forest is undervalued even within a scenario analysis framework at a 3 percent growth rate. After
extensively observing the growth and position of Forest Labs, the Forest Laboratories analyst
team considers Forest Labs as an emerging leader in the near future bringing great potential
value to the SMIF.
Our absolute valuation calculation shows that Forest Labs is highly undervalued however using
the highest cost of capital and negative growths this shows the valuable position of Forest Labs
for purchase. Our relative valuation calculation shows that Forest Labs is fairly valued.
Recommendation: Purchase 150 share at $30 limit buy order
P a g e | 49
References
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"Company Profile for Forest Laboratories Inc (FRX)." Bloomberg. 30 Apr. 2012.
<http://www.bloomberg.com/quote/FRX:US/profile>.
"Ironwood Pharmaceuticals Provides First Quarter 2012 Investor Update." Bloomberg. 1 May
2012. Business Wire. <http://www.bloomberg.com/apps/news?pid=conewsstory>.
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"Development Pipeline." Development Pipeline. Web. 08 May 2012.
<http://www.valeant.com/products/pipeline.aspx>.
"FOREST LABS INC (NYSE: FRX) | Buy/Hold/Sell Analysis." FRX. Web. 08 May 2012.
<http://finapps.forbes.com/finapps/BuyHoldSellAnalysis.do?tkr=FRX>.
P a g e | 50
"Forest Laboratories Management Discusses Q1 2012 Results - Earnings Call Transcript -
Seeking Alpha." Forest Laboratories Management Discusses Q1 2012 Results - Earnings Call
Transcript - Seeking Alpha. Web. 08 May 2012. <http://seekingalpha.com/article/280330-forest-
laboratories-management-discusses-q1-2012-results-earnings-call-transcript>.
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