strategic report for amgen, inc. - economics...

Strategic Report for Amgen, Inc.

Harkness Consulting Innovation through Collaboration

Matthew Burrows Jason Cincotta

Rosanna Smart

April 14, 2008

Table of Contents

Executive Summary ………………………………………………..2 Company History ………………………………….………………...3 Competitive Analysis ………………………………………………8 Internal Rivalry …………………………………………………………. 9

Entry ………………………………………………………………………… 10

Substitutes and Complements …………………………………….. 10

Supplier Power ………………………………………………………….. 11

Buyer Power …………………………………………………............... 11

Financial Analysis ………………………………………………….12 SWOT Analysis ………………………………………………………16 Strategic Issues and Recommendations …………………..18 Appendix ………………………………………………………………22

Harkness Consulting 1

Executive Summary

After a difficult 2007 fiscal year, CEO Kevin Sharer retained Harkness Consulting to provide

strategic advice for Amgen Inc. The company currently faces a number of problems, including

stagnant revenues and earnings, and anticipated problems with a number of its main drugs.

Harkness assigned the project to its biotechnology team, including Matthew Burrows (project

leader), Jason Cincotta and Rosanna Smart. The company researched Amgen’s history, and

provided competitive analysis, financial analysis, and SWOT analysis. After gaining a better

understanding of the company and the competitive landscape of the industry, Harkness

identified key issues and made a number of strategic recommendations. The following

summarizes Harkness’s findings and recommendations:

Amgen Inc. is a biotechnology company headquartered in Thousand Oaks, California. Amgen

uses molecular biology and recombinant DNA technology to develop therapeutics. The

company has more than 14,000 employees, including top research scientists, who develop

innovative, high-revenue drugs.

Amgen has a number of highly profitable drugs. Its first big product, anemia drug Epogen, at

one point accounted for 25% of the entire biotechnology industry’s revenues. Since then, the

company has developed a wide variety of different products. Aranesp, like Epogen, treats

anemia. Neupogen and Neulasta treat neutropenia. Enbrel treats arthritis. Other products, with

substantially lower revenues, include Kepivance and Sensipar.1

Amgen is a leader within the biotechnology industry. Competitors include Genentech,

Genzyme, UCB, and Gilead Sciences. Amgen’s 2007 revenue, $14.7 billion, and net income, $3.2

billion, outdistanced all other biotech firms. The nearest competitor, Genentech, posted $11.7

billion in revenue and $2.8 billion in net income.2 Total industry revenues were approximately

$50 billion dollars in 2007.3

Analysis of Amgen’s financial ratios shows that the company performs comparably to other

firms in its industry. Its gross profit margin and net profit margin, 83% and 21%, respectively,

are slightly above the biotechnology industry averages of 69% and 14%.4 However, the stock


has performed poorly of late, with shares falling from a high of $85 in 2005 to just over $40 in

recent weeks.5

Amgen’s declining stock price is due primarily to threats to its highly profitable ESA drugs,

Epogen and Aranesp. Recent research has suggests that these drugs may promote tumor

growth for as much as 10% of patients. If demand for these drugs decreases, the company’s

profitability and value will decline significantly. Another significant problem is that the

company’s revenues have grown much more slowly than the revenues of its peers. On the cost

side, Amgen spends a tremendous of money on research and development, which adversely

affects the company’s bottom line..

Despite recent stock price declines, Harkness Consulting’s biotechnology consulting division

feels confident about Amgen’s future prospects, assuming Amgen adequately addresses the key

strategic issues facing their business. In order to maintain revenues, Amgen needs to place most

of its short-term focus on ESA litigation and labeling, as it will be critical to the company’s

success to maintain the success of Aranesp and Epogen. If further research confirms the drugs’

safety, then Amgen should fight to maintain market share. However, if the drugs are truly

dangerous, then Amgen should consider long-term brand value and patient health by being

more cautious in marketing the drugs.

Amgen also has cost issues to address as well. Manufacturing can be done at a much lower cost

in places such as southeastern Asian and eastern Europe. Similarly, research and development

can be conducted more cheaply in India, with highly capable, low-cost research scientists.

Revenue growth can be maintained by continued patent protection and increased international

sales.

Company History

Biotechnology: Birth of an Industry

In the early 1970’s, biochemist Dr. Herbert Boyer and geneticist Stanley Cohen invented

recombinant DNA technology.5 Venture capitalist Robert Swanson, excited by this new


development, teamed with Boyer in founding the world’s first biotechnology firm, Genetech

Inc. In 1978, the company cloned human insulin, and in 1979, it cloned the human growth

hormone. The following year, the company raised $35 million in a well-received initial public

offering. Since then, biotechnology has grown significantly, with multiple companies worth

billions of dollars, including Genentech ($80.1 billion), Amgen ($46.8 billion), and Genzyme

($19.6 billion).6 Biotechnology has been established as successful and highly profitable, and thus

is now being used by pharmaceutical companies as well. Biotech companies now must compete

directly with pharmaceutical companies, yet are well-poised to continue growing in the future.

Amgen’s Foundation

In 1980, four years after Genentech’s birth had spawned the new biotechnology industry, a

group of scientists and venture capitalists formed Applied Molecular Genetics (later Amgen)

with a $19 million private-equity placement from venture capital firms and two major

corporations. Amgen began operations in Thousand Oaks, California as a development

company for health care products based on molecular biology research.8 The former vice

president for research and development in the diagnostics division of Abbott Laboratories,

George Rathmann, served as the company’s CEO until 1986, when he was named chairman of

Amgen’s Board of Directors.

Under Rathmann, Amgen initially operated under the strategy of creating a few potentially

profitable products rather than conducting extensive research. The company operated near

bankruptcy until 1983, when Amgen scientist Fu-Kuen Lin cloned erythropoietin (EPO), a

human protein that stimulates red blood cell production in the human body. Amgen went

public the same year under the NASDAQ ticker AMGN with an IPO of 2,350,000 shares. The

company then formed a joint venture with Kirin Brewery in 1984 to develop and market Lin’s

discovery and another protein (G-CSF) that stimulates the immune system.

In 1989, the FDA approved Epogen (under brand name EPO) for the treatment of anemia. By

the end of June, it had sold nearly $17 million worth of the drug--its first product after nine

years in business. Legal battles with Genetics Institute (GI) over patent rights for EPO ensued,

but Amgen had the market to itself as GI's version of EPO awaited FDA approval.


Meanwhile, as CEO Rathmann passed his title to CFO Gordon M. Binder, expectations soared

for Amgen's new drug, Neupogen (using G-CSF). In clinical studies, G-CSF performed well,

and the initial market for Neupogen was calculated to be twice that of Epogen. The hope was

that the drug's use would extend beyond chemotherapy patients to include others who would

benefit from increased immunization. Amgen received the first U.S. patent on recombinant G-

CSF in 1989, and the FDA issued approval for Neupogen in February 1991. Amgen retained full

domestic marketing rights to the drug, while Kirin Brewery had exclusive license for sales of G-

CSF in Japan, Korea, and Taiwan.

In March 1991, Amgen received more good news: A federal court of appeals issued the final

verdict favoring Amgen in the company’s ongoing struggle with Genetics Institute over EPO.

The judge blocked GI from selling its version of the anti-anemia drug, ruling that GI had failed

to demonstrate just how it made the purified form of EPO from human urine--the factor by

which GI's product differed from Amgen's. Thus, Amgen was given a legal monopoly over

domestic EPO sales, and Amgen stepped into the new decade with two heavy-hitting drugs in

its arsenal.

Amgen closed 1992 as the first biotech company to top $1 billion in sales and the only one to

near the status of independent global pharmaceutical company. In the fall of 1992, Amgen

tapped Kevin W. Sharer, president of the telephone giant MCI Communications Corporation, to

fill the post of president and COO, and in 1993, Amgen announced an expansion of its research

and development investment to nearly double what its 1992 expenditure had been. New

research focused on blood-cell growth factors, soft-tissue growth factors, and inflammation,

neurobiology, and nucleic acid therapeutics. The company also began exploring growth factors

to help heal burns, bone damage, and other injuries. As of early 1993, Amgen had more than 90

percent of the white blood cell stimulator market in the United States and no competition in the

red blood cell stimulator market. Neupogen's growth potential remained considerable. That

year, Amgen's revenues reached $1.4 billion, with Neupogen sales comprising 52 percent of this

figure.


Throughout 1994, while the growth rate of Amgen's products continued to increase, the

company joined with Amcell Corp. in commercializing certain cell separation products

developed by Amcell in an extension of Amgen's clinical research with stem cell factor and

Neupogen. In December of 1994, Amgen also purchased Synergen, acquiring that company's

product pipeline, and was awarded a national medal of technology for development of Epogen,

the first biotechnology company and only one of five corporations ever to receive this highest

presidential tribute for the commercial application of technology.

Throughout this period of growth, Amgen's legal battles continued. In 1991, Amgen was

ordered to pay Johnson & Johnson's subsidiary, Ortho Pharmaceutical Corporation, $164

million in damages for selling Epogen in violation of their 1985 EPO marketing agreement

during the 19 months it took for Ortho to bring its product to the market.

However, in a turnaround case in 1992 Johnson & Johnson was ordered to pay Amgen $90

million for failing to comply with another aspect of the same 1985 agreement that stipulated

Johnson & Johnson was to develop two products from which Amgen was to receive royalties.

Another dispute with Johnson & Johnson over Amgen's 1985 licensing agreement with Ortho

Pharmaceutical ended when an arbiter ordered Amgen to pay about $200 million. Later,

however, Amgen won a legal battle with J&J over the rights to a promising anemia drug.

Recent Years

Work on Amgen’s product pipeline continued in 1999: The company ended development of

obesity and Parkinson's disease drugs after clinical trials produced discouraging results, but at

the same time it began human tests with partner Guilford Pharmaceuticals on a drug designed

to regenerate damaged nerve cells in the brain in Parkinson's disease patients. (Guildford and

Amgen ended the collaboration in 2001.)

In 2000 the firm resumed its battle to keep its stranglehold on the Epogen market: It sued

Transkaryotic Therapies and Aventis (presently Sanofi-Aventis) for alleged patent violations

over its Epogen product in both the US and the UK. Although it initially won its case in the UK,

that verdict was overturned in 2002, making Amgen vulnerable to competition before Epogen's


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patent expired in 2004. That year it won EU and US approval for Aranesp, an updated version

of Epogen.

Despite continued legal battles throughout the beginning of the decade, Amgen continued to

make acquisitions. In 2000, the company absorbed Kintex Pharmaceuticals Inc., and in 2002, the

company bought leukemia and rheumatoid arthritis drugs maker Immunex. In 2004, Amgen

bought Tularik Inc., a company involved in the discovery and development of oral medicines to

treat cancer, immunology and metabolic diseases; and in 2006 Amgen acquired Abgenix, a

manufacturer of human therapeutic antibodies. The company also bought private company

Avidia, a developer of treatments for inflammation and autoimmune diseases. Furthering its

acquisitive phase in 2007, Amgen privately bought Ilypsa, a biotech working in renal disease

care, and Alantos, which worked on therapies for rheumatoid arthritis and Type II Diabetes.

Unfortunately, Amgen’s acquisitive phase came to a halt in 2007, when the company disclosed a

study of patients who had cancer and anemia but were not undergoing chemotherapy showed

an increased risk of death on Aranesp.8 These results imply that Aranesp can actually cause

cancer in some patients, a damaging blow to one of Amgen’s most profitable products. Epogen

also took a significant hit in the world marketplace following reports the drug’s adverse effects

on the heart.9 As a result, Medicare restricted EPO’s use in chemotherapy patients, and the FDA

has requested changes in the drugs' warning labels. Those two drugs account for about half of

Amgen’s sales and more than half their profits, and the FDA’s actions pushed the stock to a

four-year low. After trading above $85 per share in 2005, Amgen has now sunk below $50.

The company has since announced restructuring plans in hopes of absorbing sales losses. While

Amgen has continued increasing investment in its manufacturing and research and

development operations and extending its sales reach in Europe and South America, the

company is scaling back on its expansion plans as part of the 2007 restructuring. In addition to

cutting its workforce by 12% to 14%, the company plans to rationalize its manufacturing

facilities, reduce R&D efforts, and lower capital expenditures by nearly $2 billion. It has also

delayed the development of a manufacturing plant in Ireland.


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As Democrats attempt to pass legislation helping generic drug firms create cheaper knockoffs of

Amgen’s products, and as the biotech industry becomes increasingly competitive, Amgen

strives to employ a broad range of technologies in developing new approaches to multiple

therapeutic systems. The company’s pipeline currently contains denosumab, an osteoporosis

drug they hope will contend with Merck’s Fosamax (losing patent protection on February 6,

2008).10 Study results from January show Denosumab to be more effective than Fosamax in

treating bone disease in the hips. Bret Holley, analyst for Oppenheimer and Co., projects $2

billion in annual peak sales for the drug. Stockholders seem to hold the same optimistic view as

Amgen’s stock has risen 4% since it released a strong earnings report on January 24.11

Overview

Over the course of its history, Amgen has grown from having no products (for its first seven

years) to being among the top biotechnology companies in the world. It has shown the ability

to grow both organically and inorganically. Amgen has developed highly successful drugs,

such as Epogen and Neupogen, in house. It has also been able to purchase other drugs, most

notably Enbrel, and leverage its marketing and distribution power to justify high purchase

prices. Once drugs have established market share, Amgen also devotes significant efforts and

resources to protecting such intellectual property. Litigation is standard within the

biotechnology industry, and Amgen is no exception. Its wins in major lawsuits against the

Genetics Institute and Johnson and Johnson, among others, allowed its drugs to maintain

market dominance.

Competitive Analysis

Amgen operates in the Biological Products industry, often referred to simply as “biotech,” and

coded SIC 2836 with the official title of “Biological Products (No Diagnostic Substances).” 12 The

industry is defined by the technology used to make the products, described in several U.S.

government publications as, “techniques that use organisms or their cellular, sub-cellular, or

molecular components to make products or modify plants, animals, and micro-organisms to

carry desired traits.” This microenvironment encompasses more than 1,300 domestic biotech

firms and many more international ones. Few of these firms can match the size of Amgen and


its closest competitors. The companies in this space with 2006 revenues of over $1bn include

Genentech Inc., Genzyme Corporation, UCB (Belgium), Gilead Sciences, Serono (Switzerland),

Biogen Idec Inc., CSL Limited (Australia), Cephalon Inc., and MedImmune Inc.

Although Amgen is strictly a biotechnology firm, it also competes directly with firms in the

pharmaceutical industry, whose industry revenues, $140 billion, far exceed biotechnology

revenues, $50 billion.13 However, biotechnology industry is considered to have higher growth

prospects than the pharmaceutical industry, as reflected in the industry price-to-equity ratios,

28.6 and 24.1, respectively.14 Since pharmaceuticals are increasingly utilizing biotechnology to

develop new products, from a competitive standpoint, it is most accurate to define

biotechnology as a subset of the pharmaceutical industry. Pharmaceutical and biotechnology

firms that compete directly with Amgen include Johnson & Johnson, Hospira Enterprise B.V.,

Arzneimittel AG, Sandoz GmbH, Hexal Biotech Forschungs GmbH, Medice Arzneimittel Pütter

GmbH & Co. KG, Bayer HealthCare Pharmaceuticals, MedImmune Oncology, Inc., Chugai

Pharmaceuticals Co., Ltd., Sanofi-Aventis Novartis AG, Kyowa Hakko Kogyo Co., Ltd., Shire

Pharmaceutical Group Plc, Roche, Janssen-Cilag, Abbott Laboratories, and Genzyme

Corporation. Amgen shares a similar position with Genentech and Genzyme, which can be

considered its closest competitors in terms of size and structure. Amgen focuses primarily on

products for the treatment of cancer, inflammatory disorders, and metabolic and

neurodegenerative diseases. The industry is becoming increasingly international due to three

primary factors. First, there is a global market for the technologies developed by biotech firms.

Second, many countries, particularly in the European Union and Asia, are coordinating strong

governmentally supported biotech infrastructure. Third, all firms are subject to the international

environment with respect to regulation and intellectual property laws.

Internal Rivalry

Internal rivalry in the biotechnology industry is severely limited by the presence of strong

patents on developed technology. As such, one firm’s product will often be differentiated from

its competitors’ products. Amgen faces less internal rivalry than the vast majority of biotech

firms due to its size, which provides it increased purchasing power and a more global reach.

While there are more than 1,300 firms in the larger market space, there are perhaps as few as


three that can be considered direct competitors. For many smaller firms, the process of capital

formation presents a significant hurdle to successfully competing in the space. At the other end

of the spectrum, Amgen competes with other biotech and pharma firms to acquire the most

promising small firms and technologies. Another aspect of internal rivalry is competition with

other firms for the right to develop products of NIH and other federally funded research when

the technological knowledge is brought to the private sector. Finally, non-price competition

exists through the development of new and superior products.

Entry

Entry into the biotech industry is facilitated through grants and venture capital. While entry on

a small scale is available to enterprising individuals, the risk of entry of an equivalently-sized

competitor is much less likely for a firm as large as Amgen. One potential risk is entry by large

pharmaceutical companies. This will become increasingly more popular as pharma experiences

reduced revenues and contracting margins in the future. An example of this crossover entry is

the recent expansion into agricultural biotech by Pfizer, Inc. The cost of developing new

technologies and the presence of patented technology limits the entry of firms from related

industries, even those that are well capitalized. Other barriers include prior technological know-

how, which is a stronger factor in more specialized fields, and relationships with biotech

researchers.

Substitutes and Complements

Direct substitutes are generally prevented by process and product patents for drugs. However,

one long-term threat biotechnology companies face is the development of cheaper generic

versions of their products. Patents last only twenty years, after which biosimilar generic drugs

enter the market and drive down profit margins substantially. Amgen’s products are highly

competitive, and are at a competitive advantage because of Amgen’s brand name and

marketing. However, close substitutes exist for most of Amgen’s drugs. Domestically,

substitutes include Johnson and Johnson’s Procrit (biosimilar to Aranesp) and Abott Labs’

Humira (Enbrel), as well as others that compete with Amgen’s low-revenue drugs.

Internationally, Roche, Janssen-Cliag, and Sandoz produce substitutes for Aranesp, and foreign

substitutes exist for Amgen’s low-revenue drugs.15 Amgen is in the strong position of having no


direct substitutes in any market for two of its four high-revenue drugs: Epogen and Neupogen,

which comprise 17.4% and 30.0% of the company’s revenue, respectively.

Supplier Power

Supplier power is mostly felt in the market for labor. Competition between firms for the best

scientists and the right to develop their research presents an instance where supplier power can

be exerted. One development in supplier power will be a movement of production overseas by

some biotech firms, which will allow them to hire in a different market. On the materials side,

supply can be affected by other firms' patents, such as the patenting of a specific genome or

germ line, and through governmental regulation. A clear example of this is the U.S. regulation

of stem-cell based research. As such, supply is susceptible to the political situation of the

countries in which firms operate. This will almost certainly become a more prevalent issue as

the industry’s research becomes more politicized. Short-term supply of certain materials can

present difficulties as well. Some raw materials, medical devices, and components are

proprietary products of third parties. Finally, many smaller biotech companies do not possess

the distribution and marking capabilities necessary to bring their product to market, forcing

them to license it to a firm with better capabilities.

Buyer Power

Direct buyer power for the patient is curtailed by the nature of the U.S. healthcare industry.

Instead, buyer power is held by hospitals, doctors, HMOs, and governments, with their social

healthcare programs. The availability of a product to a patient is circumscribed by the decision-

making of these agents. Medicaid and Medicare make decisions about the safety and efficacy of

biotech products that can significantly affect demand. One example of this is recent studies on

the use of ESAs which have impacted the policy of these social medicine bodies. Even though

some of Amgen’s products do not suffer much substitute competition, the challenge of selling to

these groups can be difficult and comprises buyer power through the collective bargaining

aspect to the groups that are making purchasing decisions. As such, Amgen is well positioned

because it has established relationships and marketing experience that positions it well in

selling its products.


Financial Analysis

Financial Overview

Amgen has been the top revenue-grossing firm in the biotechnology industry, and had revenue

of $14.7 billion in 2007. Net income for the past year was $3.2 billion. The stock price has slid in

recent months, but its market capitalization, $45 billion, is still among the top in the industry.

Like most biotechnology and pharmaceutical companies, Amgen’s financial outcome hinges on

the success of a few drugs. As seen in Table 1, ninety-five percent of Amgen’s revenues come

from merely four of its drugs. Amgen spends more than $3 billion on research and development

every year, as the development of a pipeline of possible future drugs is essential to a biotech

company’s future success. Amgen’s research and development expenditures are consistent with

the industry average of 20% of revenues.

Table 1

Source: Amgen 2007 10-K


Financial Statement Analysis

Figure 1

Amgen Revenue and Income

$0.0

$2.0

$4.0

$6.0

$8.0

$10.0

$12.0

$14.0

$16.0

2003 2004 2005 2006 2007 2008E

(bill

ions

)

RevenueNet Income

Amgen maintained double-digit growth in revenues from the beginning of the decade until the

end of 2005, but revenues have stagnated since and are expected to decrease in coming years.

Robust revenue and income growth in first half of the decade were due to two primary causes.

One was strong growth in Amgen’s ESA drugs, Aranesp and Epogen. The second was that

Amgen was able to leverage its marketing strength and brand name to increase sales of Enbrel,

the primary drug received in the 2001 takeover of Immunex. Net income has stayed relatively

steady within a range of $2 to $4 billion per year. Company estimates for 2008 may prove to be

overly optimistic, as revenues may drop dramatically due to problems with ESA drugs. The

estimate of a sharp increase in net income may also fail to come to fruition, unless the company

cuts expenses significantly. Recent expense reductions have been achieved primarily by cutting

research and development costs, but this may backfire in the long term.


Figure 2

Biotech Profitability Ratios

0%10%20%30%40%50%60%70%80%90%

Amgen Genentech Genzyme GileadSciences

Industry

Per

cent

age Gross Profit Margin

Operating MarginNet Profit Margin

Amgen’s profitability ratios are similar to those of most of the other top biotechnology firms.

Amgen’s gross profit margin for 2007, 82.75%, is much higher than the S+P 500 average, 43.92%,

but is average within the biotech industry. For biotech firms, the actual cost of manufacturing is

relatively small, whereas research and development and marketing costs predominate. For

Amgen’s fiscal year 2007, the Cost of Goods Sold, 17.3% of revenues, was exceeded by its

Research and Development expense, 22.1% of revenues, and its Selling, General and

Administrative expense, 22.8% of revenues.

Amgen’s Balance Sheet is fairly standard for a biotech firm, closely resembling rivals such as

Genentech in most respects. The company has much financial flexibility, with a combined $7.1

billion in the highly liquid assets Cash and Cash Equivalents and Marketable Securities. This

gives Amgen the ability to acquire competitor firms and products. Amgen’s Goodwill, at $11.2

billion, is 7 times greater than Genentech’s. This is due to Amgen’s 2001 acquisition of Immunix

for $16 billion, when the company booked $9.8 billion in Goodwill.16. With more than $9 billion

in debt, and a debt to equity ratio of 0.51, Amgen is among the most levered biotech firms.

However, such figures do not indicate that the company is risk-taking, since Amgen currently

holds $7.1 billion in highly liquid assets, and another $5.9 billion in other current assets, and

thus can easily pay back its creditors. The ability to raise fund in credit markets is reflective of


creditors’ confidence in Amgen, which is one of the only biotech firms to consistently generate

positive earnings.

Analysis of Amgen’s Statements of Cash Flows shows that the company has been quite effective

in generating cash from its operating activities. The company’s cash flows from operations in

2005, 2006, and 2007 were $4.9 billion, $5.4 billion, and $5.4 billion, respectively, and

corresponding free cash flows were $4.0 billion, $4.2 billion, and $4.1 billion. Net changes in

cash were approximately zero in recent years, as the company made billions of dollars in stock

repurchases. The company’s ability to generate cash from its business operations is clearly a

positive sign. Furthermore, manipulation of profits through accounting sleight of hand is highly

unlikely, as consistent, positive cash flows indicate that the company is in good financial health

and is economically viable.

Stock Price Analysis

Figure 3

Source: Google Finance

(IBB=NASDAQ Biotechnology Index, AMGN=Amgen)

Despite strong financial data, Amgen’s stock has floundered in recent years, especially in 2007.

Amgen’s stock sunk in early 2002 after the acquisition of Immunix for $16 billion, although part

of this decline may have been due to the market’s post-9/11 downturn. Amgen shares rose

sharply in mid-2005, coinciding with much-improved Enbrel sales, and continued EPO success.

However, 2007 proved a down year for the stock, driven by research showing that two of its top


products, ESA drugs Epogen and Aranesp, may actually cause increased tumor growth and

earlier death for cancer patients. The FDA has announced that the two drugs will henceforth

have “black box” labeling. In addition, the United States government is considering reducing

Medicare subsidies for these products.

Figure 4

Source: Google Finance

(AMGN=Amgen, DNA=Genentech, GENZ=Genzyme, GILD=Gilead Sciences)

Investors’ bearishness concerning Amgen stock is evident in the company’s price-to-earnings

ratio, 14, which is half the industry average, 28. The reason for this is that investors are not

confident in Amgen’s earnings growth. Wall Street’s views of Amgen’s future are evident when

one notes that the Gilead Science’s market capitalization, $47 billion, exceeds Amgen’s market

capitalization, $44 billion, even though Amgen revenues were three times greater in 2007. As

shown in Figure 4, in the past year, Amgen’s stock has been outperformed by stock of

competitors Genentech, Genzyme, and Gilead Sciences. Analysts and investors feel that

Amgen’s uncertain future make it a risky purchase, as reflected in the company’s relatively low

stock price, which is now barely over $40 per share, down more than fifty percent from its $85

peak in 2005.

SWOT Analysis

Strengths

• Biotech industry leader, and large revenues give them market power


• Strong brand name and marketing provide competitive advantage in selling drugs

• Established distributional relationships with healthcare providers allow for consistent

revenue

• Consistent ability to generate income and positive cash flows

• Large, promising pipeline of potential drugs

• Flexibility provided by liquid assets

• Perceived stability enables access to debt markets

o Unusual for a biotech firm

Weaknesses

• Revenue growth slowing

• ESA drug problems

• High research and development costs

• High cost of equity financing due to low stock price

• Direct substitutes for high revenue drugs

Opportunities

• Possibility of lower costs through research and manufacturing partnerships with East

Asian firms

• Room for international growth

o Foreign sales comprise only 20% of revenues, but are growing 17% annually

• More marketing and sales partnerships with foreign firms

o Current partnerships, such as with Japan’s Daiichi Sankyo, have proven highly

successful

Threats

• Possible changes to the U.S. healthcare system with political regime change

• Pharmaceutical industry concentrating more on biotech

• Studies revealing dangers of drugs

o “Black box” labeling and decreased Medicare and Medicaid funding are

legitimate possibilities


• FDA denial of pipeline drugs

• Increased competition from foreign competitors, especially from Japanese and European

firms

• Circumvention or invalidation of patents

Strategic Issues and Recommendations

If Amgen places attention on a few key areas, it should be able to maintain its position as leader

of the biotechnology industry for many years to come. Most important will be to maintain

current revenues, especially for its ESA drugs. It can also increase its long-term future revenues

by expanding internationally and by maintaining a strong pipeline of potential drugs. Finally, it

can reduce costs by conducting more research and development in countries with lower labor

costs.

The company’s most pressing near-term issue is the safety of its ESA drugs, Epogen and

Aranesp. As the two drugs comprised $6.1 billion of Amgen’s $14.3 billion in revenue in 2007, a

drop-off in the drugs’ revenue would significantly impact the company’s financial health.

Harkness recommends that Amgen conduct further research on the two drugs. If concerns that

Epogen and Aranesp promote tumor growth are unfounded, then Amgen should fight

vigorously to maintain the drugs’ market share. The company should continue to lobby

Congress and the FDA. Much of Amgen’s revenue comes from Medicare and Medicaid

programs, so Congressional support of the drugs is important. FDA support is equally

important since “black box” labeling could prove costly. Amgen should not be miserly in its

lobbying and litigation expenditures, a possible yearly loss of one or two billion dollars in

revenues hinge upon the perception of toxicity of its ESA drugs.

However, if the drugs truly do promote tumor growth, Amgen would be best served to take a

cautious approach in marketing and distributing the drugs. On its website, the company notes

that it follows the noble mission of “us[ing] science and innovation to dramatically improve

people’s lives.” Much of Amgen’s value and competitive advantage is derived from its brand

name and prestige. If the drugs have harmful effects, then such information should be made


known to prescribing doctors, who can determine on a case by case basis whether benefits

exceed the risks for their patients. Such policies, while financially hurtful in the short-run,

would allow the company to maintain its important distribution relationships with the medical

community and allow it to continue to leverage its greatest intangible asset, the Amgen brand

name. Continued use of a dangerous product would risk the public relations fiasco that Merrell-

Dow Pharmaceutical endured when it was revealed that the company had continued to sell its

Bendectin drug despite awareness that the product caused serious birth defects.

After resolving its ESA litigation, Amgen should consider external avenues for growth. Amgen

has a large amount of highly liquid assets at its disposal, including $2.0 billion in cash and cash

equivalents and $5.1 billion in marketable securities. Amgen should use this to purchase drugs

from other companies, or to purchase other biotech firms outright. This occurred in 2002 when

Amgen bought Immunix. The purchase was $19 billion, and Immunix shares, which had been

trading between $12 and $20 for much of the year, were acquired for $30 per share. While this

acquisition could be considered costly, it allowed Amgen to leverage its brand name and

distribution channels to significantly increase the revenues of its flagship arthritis drug, Enbrel,

from a few hundred million dollars in 2001, while part of Immunix, to $3.2 billion, as a top

Amgen drug, in 2007. Amgen has held more than $7 billion in highly liquid, non-core assets for

the past few years. As credit markets have soured, it appears that it is a buyer’s market for

acquisitions. Amgen should try to add another $3 billion revenue drug to its portfolio of major

drugs. After considering the premium paid for such a drug, such a purchase could add $500

million to $1.5 billion in net income per year in the long-run. In order to maximize shareholder

value, Amgen should either purchase high-potential drugs and companies or distribute cash to

shareholders through increased dividends or more stock buybacks.

Amgen should actively work to protect existing patents, and to secure patents for its pipeline

drugs. The company’s value is derived primarily from its proprietary technology, including its

products and processes. Amgen lists the value of its intangible assets, primarily patents, at a

book value of $4 billion, but the actual value to the company is even higher. Amgen has been

mostly successful in patent litigation in the past. Amgen would do well to continue vigorously


fighting possible instances of patent infringement, such as the entry Roche’s anemia drug,

Mircera (biosimilar to Epogen), to maintain the market shares of its products.

Amgen would also do well to increase its international exposure. In 2007, only $2.9 billion of its

$14.3 billion in revenues came from non-U.S. markets. Although its primary potential markets,

the developed economies of western Europe and Canada, have socialized medical systems and

entrenched local firms, such as Roche, Janssen-Cliag, and Sandoz, Amgen still has untapped

revenue potential abroad. Amgen should obtain approval and patents for its drugs from more

foreign regulatory agencies, increase global sales staff, and actively initiate distribution to

foreign doctors and healthcare systems. Upside for potential foreign growth is limited by

preference towards local firms by European medicare systems, but expanded sales efforts

should allow Amgen to increase its non-U.S. revenues by approximately 20-25% in the near

future.

A more international approach to would also benefit Amgen in its manufacturing and research

and development by allowing the company to reduce costs. Amgen currently operates

manufacturing facilities in the United States, Puerto Rico, and the Netherlands. It might be

beneficial to move manufacturing to countries with lower labor costs, including eastern

European and southeastern Asian countries. Amgen might also benefit from outsourcing some

of its research and development processes to India, where scientists are well-educated but

command much lower salaries. There are relatively limited but positive gains to moving

manufacturing abroad, as cost of goods sold is a mere 17% of revenues, and much

manufacturing is already done in low-cost Puerto Rico. However, moving research and

development could allow Amgen to reduce its high research and development costs, over $3

billion annually, by up to $1 billion per year.

Overall, Amgen is a financially robust, innovative company that will likely continue to be an

industry leader for years to come. The company’s short term success hinges greatly on how

dangerous its high revenue ESA drugs, Aranesp and Epogen truly are. However, the company

should maintain a long-term perspective, and can maximize brand value and distribution lines

if it stays true to its objective of being a patient-oriented company. By expanding internationally


and protecting patents, the company can maintain revenue growth and further increase its

bottom line by outsourcing production and research and development to low-cost countries. If

Amgen implements the aforementioned suggestions and mitigates its ESA problems, it will

continue to be an industry leader and should see a significant resurgence in stock price.



Appendix Amgen Balance Sheets (in millions) 2007 2006 2005 2004 2003

Cash and cash equivalents $ 2,024 $ 1,283 $ 1,840 $ 1,526 $ 837 Marketable securities 5,127 4,994 3,415 4,282 4286 Trade receivables, net doubtful accounts 2,101 2,124 1,769 1,461 1008 Inventories 2,091 1,903 1,258 888 713 Other current assets 1,698 1,408 953 1,013 558 Total current assets 13,041 11,712 9,235 9,170 7,402 Property, plant and equipment 5,941 5,921 5,038 4,712 3799 Intangible assets, net 3,332 3,747 3,742 4,033 4288 Goodwill1 11,240 11,302 10,495 10,525 9820

Other assets 1,085 1,106 787 781 804 Total assets $ 34,639 $ 33,788 $ 29,297 $29,221 $ 26,113 Accounts Payable 378 555 596 507 327 Accrued Liabilities 3,801 4,589 2,999 2,477 2129 Convertible Notes 1,778 ‐ 1,173 ‐ Other short‐term liabilities 2,000 100 ‐ ‐ ‐

Total current liabilities 6,179 7,022 3,595 4,157 2,456 Deferred tax liabilities 480 367 1,163 1,294 1146 Convertible Notes 5,080 5,000 1,759 1,739 2880 Other long‐term debt 4,097 2,134 2,198 2,198 200 Other non‐current liabilities 934 301 131 128 42 Commitments and contingencies ‐ ‐ ‐ ‐ ‐ Total liabilities 16,770 14,824 8,846 9,516 6,724 Preferred stock ‐ ‐ ‐ ‐ Common stock and additional paid‐in capital 24,976 24,155 23,561 22,078 19995 Accumulated deficit (7,160) (5,203) (3,132) (2,376) (667) Accumulated other comprehensive income 53 12 22 3 61 Total shareholdersʹ equity 17,869 18,964 20,451 19,705 19,389

Total liabilities and shareholders equity $ 34,639 $ 33,788 $ 29,297 $29,221 $ 26,113 Amgen Balance Sheets Vertical Common Size 2007 2006 2005 2004 2003 Cash and cash equivalents 5.8% 3.8% 6.3% 5.2% 3.2% Marketable securities 14.8% 14.8% 11.7% 14.7% 16.4% Trade receivables, net doubtful accounts 6.1% 6.3% 6.0% 5.0% 3.9% Inventories 6.0% 5.6% 4.3% 3.0% 2.7% Other current assets 4.9% 4.2% 3.3% 3.5% 2.1% Total current assets 37.6% 34.7% 31.5% 31.4% 28.3% Property, plant and equipment 17.2% 17.5% 17.2% 16.1% 14.5% Intangible assets, net 9.6% 11.1% 12.8% 13.8% 16.4% Goodwill 32.4% 33.4% 35.8% 36.0% 37.6% Other assets 3.1% 3.3% 2.7% 2.7% 3.1% Total assets 100.0% 100.0% 100.0% 100.0% 100.0%


Accounts Payable 1.1% 1.6% 2.0% 1.7% 1.3% Accrued Liabilities 11.0% 13.6% 10.2% 8.5% 8.2% Convertible Notes 0.0% 5.3% 0.0% 4.0% 0.0% Total current liabilities 17.8% 20.8% 12.3% 14.2% 9.4% Deferred tax liabilities 1.4% 1.1% 4.0% 4.4% 4.4% Convertible Notes 14.7% 14.8% 6.0% 6.0% 11.0% Other long‐term debt 11.8% 6.3% 7.5% 7.5% 0.8% Other non‐current liabilities 2.7% 0.9% 0.4% 0.4% 0.2% Commitments and contingencies 0.0% 0.0% 0.0% 0.0% 0.0% Total liabilities 48.4% 43.9% 30.2% 32.6% 25.7% Preferred stock 0.0% 0.0% 0.0% 0.0% 0.0% Common stock 72.1% 71.5% 80.4% 75.6% 76.6% Accumulated deficit ‐20.7% ‐15.4% ‐10.7% ‐8.1% ‐2.6% Accumulated other comprehensive income 0.2% 0.0% 0.1% 0.0% 0.2% Total shareholdersʹ equity 51.6% 56.1% 69.8% 67.4% 74.3% Total liabilities and shareholders equity 100.0% 100.0% 100.0% 100.0% 100.0% Amgen Balance Sheets Financial Ratios 2007 2006 2005 2004 2003 AR Turn 7 7 8 9 17 Days AR 52 50 47 43 22 AP Turn 5 4 4 4 8 Days AP 67 100 97 88 45 Inv. Turn 1 1 2 2 4 Day Inv. 286 275 188 169 97 Net Cash Conversion Cycle 271 225 139 124 75 ROE 17.19% 14.97% 18.30% 12.09% 23.31% Growth in Book Value ‐15.79% ‐37.00% 20.73% ‐2.54% Book value 3,297 3,915 6,214 5,147 5,281 Debt to EBITDA 2.16 1.88 0.70 1.25 0.82 Notes [1] Goodwill increased from 97.2 to 9871 in 2002 with $9.7 billion purchase of Immunex for Enbrel arthritis drug.

Amgen Income Statement (in millions) 2007 2006 2005 2004 2003 2002 Sales revenues $14,771 $14,268 $12,430 $10,550 $8,356 $5,523 Cost of goods sold 2,548 2,095 2,082 1,731 1,341 736 Research and Development 3,266 3,366 2,314 2,028 1,655 1,117 Write‐off of acquired‐in process R+D 590 1,231 ‐ 554 ‐ 2,992 Selling, general and administrative expenses 3,361 3,366 2,790 2,556 1,953 1,462 Amortization of acquired intangible assets 298 370 347 333 336 155 Loss (earnings) of affiliates, net 4 (13) Other 728 ‐ 49 ‐ (24) (141)


Total operating expenses 10,791 10,428 7,582 7,202 5,265 6,307

Operating income 3,980 3,840 4,848 3,348 3,091 (784) Interest and other income, net 309 309 119 85 113 144 Interest expense, net (328) (129) (99) (38) (32) (44)

Other non‐operating (income), net (19) 180 20 47 82 100

Income before income taxes 3,961 4,020 4,868 3,395 3,173 (684) Tax expense 795 1,070 1,194 1,032 914 707 Net income $ 3,166 $ 2,950 $ 3,674 $ 2,363 $2,260 $

(1,392) Earnings per share: Basic EPS $ 2.83 $ 2.51 $ 2.97 $ 1.86 $ 1.75 $

(1.21) Diluted EPS $ 2.82 $ 2.48 $ 2.92 $ 1.79 $ 1.68 $

(1.21) Shares used in calculation of EPS: Basic 1,117 1,176 1,236 1,271 1,288 1,154 Diluted 1,123 1,190 1,258 1,320 1,346 1,154 Amgen Income Statements Vertical Common Size 2007 2006 2005 2004 2003 Sales revenues 3.5% 14.8% 17.8% 26.3% 51.3% Cost of goods sold 17.3% 14.7% 16.7% 16.4% 16.0% Gross Profit 82.7% 85.3% 83.3% 83.6% 84.0% Research and Development 22.1% 23.6% 18.6% 19.2% 19.8% Write‐off of acquired‐in process R+D 4.0% 8.6% 0.0% 5.3% 0.0% Selling, general and administrative expenses 22.8% 23.6% 22.4% 24.2% 23.4% Amortization of acquired intangible assets 2.0% 2.6% 2.8% 3.2% 4.0% Loss (earnings) of affiliates, net 0.0% 0.0% 0.0% 0.0% 0.1% Other 4.9% 0.0% 0.4% 0.0% ‐0.3% Total operating expenses 73.1% 73.1% 61.0% 68.3% 63.0% Operating income 26.9% 26.9% 39.0% 31.7% 37.0% Interest and other income, net 2.1% 2.2% 1.0% 0.8% 1.4% Interest expense, net ‐2.2% ‐0.9% ‐0.8% ‐0.4% ‐0.4% Other non‐operating (income), net ‐0.1% 1.3% 0.2% 0.4% 1.0% Income before income taxes 26.8% 28.2% 39.2% 32.2% 38.0% Tax expense 5.4% 7.5% 9.6% 9.8% 10.9% Net income 21.4% 20.7% 29.6% 22.4% 27.0% Amgen Income Statements Compound Annual Growth Rate 2007 2006 2005 2004 Sales revenues 9.01% 16.29% 21.97% 38.21% Cost of goods sold 10.63% 10.01% 24.62% 53.39% Research and Development 18.80% 28.83% 18.23% 34.77% Selling, general and administrative expenses 9.76% 14.76% 19.54% 32.22% Amortization of acquired intangible assets ‐7.33% 5.41% 1.65% 46.48%


Total operating expenses 19.30% 20.33% 20.01% 6.86% Operating income ‐9.39% 7.10% 25.23% Interest and other income, net 61.14% 90.66% 2.44% ‐23.22% Interest expense, net 82.02% 84.25% 77.28% ‐7.28% Other non‐operating (income), net ‐ 95.70% ‐50.58% ‐31.44% Income before income taxes ‐9.80% 8.82% 23.86% Tax expense ‐18.40% 1.82% 14.32% 20.78% Net income ‐7.17% 11.73% 27.52% Earnings per share: Basic EPS 16.16% 30.19% Diluted EPS 17.68% 31.90%

Consolidated Statement of Cash Flows Amgen (in millions of dollars) 2007 2006 2005 2004 2003 2002 Operating: Net income (loss) $ 3,166 $ 2,950 $ 3,674 $ 2,363 $2,260 $(1,392) Depreciation and Amortization 1,202 963 841 734 687 447 Write‐off of acquired R+D 590 1,231 ‐ 554 0 $ 2,992 Stock‐based compensation expense 263 403 106 45 0 ‐ Tax benefits of employee stock plans ‐ 315 203 287 252 Deferred income taxes 136 (540) (95) 57 (190) 175 Property, plant, and equipment impairments 404 Other non‐cash expenses 81 (81) 60 116 99 25 Cash provided by (used in) changes in assets and liabilities: Trade Receivables, net 38 (355) (308) (453) (256) (122) Inventories (109) (561) (370) (175) (168) (102) Other current assets (119) (6) (47) (85) (33) (5) Accounts payable (181) (24) 72 179 74 11 Other accrued liabilities (70) 1,409 663 159 825 (32)

Cash generated by operating activities $ 5,401 $ 5,389 $ 4,911 $ 3,697 $ 3,585 $ 2,249 Investing: Cash paid for acquisitions $ (697) $(2,167) $ ‐ $ 115 $(2,037) Cash received for product sales $ 390 Purchases of property, plant, and equipment (1,267) (1,218) (867) (1,336) (1,357) (659) Purchases of marketable securities (5,579) (5,386) (9,597) (6,869) (5,320) (2,953) Proceeds from sales of marketable securities 5,073 3,065 9,835 6,606 3,339 1,622 Proceeds from maturities of marketable securities 454 785 603 208 371 778 Other 24 (210) (33) (123) (243) (6)

Net cash used for investing activities $(1,992) $(5,131) $ (59) $(1,399) $(3,210) $(2,864) Financing: Repurchases of common stock $(5,100) $(2,000) $(4,430) $(4,072) Issuance of debt 3982 Repayment of debt $(1,840) (653) (1,175) ‐ (123)


Issuance of notes payable 439 ‐ 1,989 2,765 Repurchase of notes payable ‐ ‐

Issuance of common stock 277 528 1,087 453 529 428 Repurchase of common stock (1,801) (1,420)

Issuance of preferred stock ‐ Issuance of warrents 774 ‐ ‐ Other 13 97 (20) 21 24 6

Net cash generated by financing activities (2,668) (815) (4,538) (1,609) (1,372) 1,778 Total cash generated (used) $ 741 $ (557) $ 314 $ 689 $ (997) $ 1,163 Cash and cash equiv., beginning of year $ 1,283 $ 1,840 $ 1,526 $ 837 $1,852 689.1 Cash and cash equivalents, end of year $ 2,024 $ 1,283 $ 1,840 $ 1,526 $855 $1,852 Cash Flow Ratios Free cash flow $ 4,134 $ 4,171 $ 4,044 $ 2,361 $ 2,228 $ 1,590 Cash flow return on assets 16% 17% 17% 13% 14% Cash flow return on sales 37% 38% 40% 35% 43% 41% Cash Flows excluding Stock Repurchases $ 5,841 $ 1,443 $ 4,744 $ 4,761 $ (997) $ 1,163

Endnotes _____________________ 1 Amgen FY 2007 10-K. 2 http://finance.google.com/finance?q=amgn&btnG=Search 3 http://premium.hoovers.com/subscribe/ind/fr/profile/basic.xhtml?ID=174 4 http://stocks.us.reuters.com/stocks/ratios.asp?rpc=66&symbol=AMGN.O 5 http://www.gene.com/gene/about/corporate/history 6 http://finance.google.com/finance 7 http://finance.google.com/finance 8 http://premium.hoovers.com/subscribe/co/history.xhtml?ID=ffffrtjtyfysskjrsj 9 http://www.forbes.com/2007/02/16/amgen-cancer-pharmacuticals-biz_cx_mh_0216amgen.html 10 Smith, Aaron. “Big Pharma’s Leaky Pipeline.” CNNMoney.com. 1 February 2008. 11 Aenlle, Conrad. “Amgen Finds Growing Up Isn’t So Easy.” New York Times. 18 August 2007. 12 http://premium.hoovers.com/subscribe/co/factsheet.xhtml?ID=12623 13 http://finance.google.com/finance?q=amgn&btnG=Search 14 http://stocks.us.reuters.com/stocks/ratios.asp?rpc=66&symbol=AMGN.O 15 Amgen FY 2007 10-K. 16 “Amgen to Buy Immunex.” CNNMoney.com. 17 December 2001.


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