A Financial Review: Pharmaceuticals Industry

A Financial Review: Pharmaceuticals Industry GSK, Merck & Co, Novartis !Hangzhou- Team 12 Birdman Sachs

�1BIRDMAN SACHSGSK, MERCK & CO, NOVARTIS

Presented to: Bill Carlile Prepared by: Dušan Nešic, Didem Gürbüz, Errin Verani, Graeme Wilson, Roby Camagong

Financial Review This Financial Review discusses the in-depth analysis of the operating and financial performance of the three companies in the Pharmaceutical Industry, namely- GlaxoSmithKline, Merck & Co, and Novartis. It compares the results of the companies from the past 5 FYE in relation to the financial ratios, industry economic indicators, company trends, business strengths and weaknesses, and management strategies.

Industry Overview In a competitive globalized economy, the pharmaceutical industry is one of the most influential movers in the developed

and developing nations. The business of the pharmaceutical industry is highly dependent on the company’s application for patents. The patent will grant the company exclusive manufacturing rights by which the drug developer can recover their investment costs from. Last year, the pharmaceutical industry has stumbled upon major patent conflicts and stricter measures in product development imposed by FDA . Despite these hurdles, the market players in the pharmaceutical 1

industry still posted relatively impressive growth figures. Moreover, Moody’s has furthered that the outlook of the industry will remain stable for the next 12 months with the possibility of being rated as “positive” if the companies maintain higher profit margins . 2!

Aside from the application for patents, the business of the industry inordinately relies also on the legislation direction of the government. The “Obamacare” health law that will bring millions of uninsured Americans health benefits which began in January 2014 can be a critical factor in boosting the sales and balance sheet of the pharmaceutical companies in the US. Global Data of London forecasts the pharmaceutical market value to climb from $359 billion in 2012 to $476 billion in 2020, posting a 33% increase over an eight-year period that can create the largest market of the industry . Like many other countries, U.S. is 3

expected to experience growth in its elderly population, which can be a factor to the corresponding increase in healthcare demand. The data posted by Moody’s and the legislation of Obamacare indicates that the pharmaceutical industry still has a great deal of growth potential. !GlaxoSmithKline (NYSE:GSK)!Company Overview !

GSK was founded in 1924 and headquartered in UK. The company operates on a wide array of pharmaceutical businesses from manufacturing, distributing, and trading globally. Its considered an influential player in three major business namely- pharmaceuticals, vaccines, and consumer healthcare. (Exhibit 1 for GSK’s Stock Performance and Exhibit 2 for the breakdown of GSK's three core businesses) Moreover, GSK also operates as a science-backed global healthcare corporation that researches and develops innovative products and medicines. The company has successfully diversified its lines of businesses through aggressive acquisitions and internal growth strategy. It also offers prescription medicines that span across different therapeutic areas. With its vast geographical reach of 115 countries of sales offices and research centers, the company was able to distribute almost 4 billion packs of products to 150 countries every year . 4

!Corporate Governance

The top institutional stockholders of GSK comes mostly from big institutions with 11.06% ownership and big hedge funds with 4.24%. After analyzing the executive committee and board’s backgrounds, it is safe to say that there is no apparent conflict of interest. None of the corporate executive management team is a sizeable owner of the business which opens little possibility of the agency dilemma. The company tries avoids this dilemma through compensating their employees by 56% in bonuses on average. (Exhibit 3 for the List of Top Stockholders, Board Member’s Background, Corporate Governance Framework, Executive Compensation Plan) In terms of corporate governance, GSK has elected a diverse board of members carefully avoiding conflict of interests for the executive directors and non-executive directors. The percentage of insider trading buying and selling stocks is relatively minute which has least effect on the company market performance . 5

GSK maintains its social image as a company that improves the quality of life by enabling people to do more, feel better and live longer. They’ve done it through a series of corporate social responsibility programs and partnerships. Recently, they partnered with Pfizer to deliver massive healthcare treatments for HIV patients. !!


Industry Market Value!

$476B (up 33%)!by 2020

Offices in115

countries

$44.4Bn Revenues

!$128.41B

Market Cap

Business Trend Analysis and Financial Highlights Quality of Sales (2009-2013)

GSK’s sales has increased by 0.28% for FY2013. This has been brought by the growth in the US across the three different businesses of the company while Europe sales is on a continuous decline (Exhibit 4 for GSK’s Sales by Segment). The Pharmaceuticals and Vaccines business units benefited heavily from sales in the US, Immuno-Inflammation Products grew more than 100%, and Anti-Bacterial Vaccines grew 30%. (Exhibit 5 for GSK’s Complete Pharmaceuticals and Vaccines Turnover). Unfortunately, the decrease in their Healthcare business has offset the entire sales growth of the company especially with their product Combivir down by 36%. (Exhibit 6 for the GSK’s Complete ViiV Healthcare Turnover) GSK has a consistent increase in its sales for the past 5 years. !Operating Profit and Cost Analysis (2009-2013)

In the most recent earnings results, GSK has managed to cap the year off by having a 19.08% increase in Net Income and a 1% increase in Core Operating Profit. (Exhibit 7 for GSK’s Income Statement). The flat result in the operating profit has been brought by the currency effects and operating margin declines. The negative impact of an expected 1.6% increase in COGS offset the impressive 26.4% increase royalty income and lower R&D expense . In addition, for an industry that is heavily 6

reliant on research, GSK’s R&D expenditures was managed properly which in turn boosted GSK’s rate of return in its investments from 13% to 14% . (Exhibit 8 for the Notes on R&D Expense of GSK). With this, investors received £1.12 GBP 7

earnings per share for FY2013. Historically, GSK’s gross margin is at a steady decline for 5 years with a CAGR of 0.1%. !Cash and Free Cash Flow Analysis (2009-2013)

In terms of cash, GSK has spent £1.19 billion GBP in Capital Expenditures. As part of their strategic plan to grow, the company is focusing on organic growth by investing steadily in their assets and being not as aggressive as before in acquisitions. GSK’s free cash flow (FCF) stands at £1.66Bn as of the end of FY2013. This is a good indicator as the company can fund its future growth without a large need for outside financing and can also stand as a risk buffer for legal settlements. In order to stay afloat in the pharmaceuticals business, a company needs to have a lot of cash. !Financial Structure

The company is financed by 24.5% of Equity and 75.5% of Debt. The equity is composed of all common stock with no preferred stock. (Exhibit 9 for GSK’s Balance Sheet)

In the latest fiscal year, GSK has decided to lower down its long-term loans from £4.43 billion to £1.91 billion GBP. This move will save the company interest expenses and preserve most of its operating profit to pay preferred and common stockholders. (Exhibit 10 for GSK’s Reconciliation of Cash Flow to Movements in Net Debt). GSK is still currently properly leveraged relative to its size and business due to a very high short and long-term net debt compared to its equity. From fiscal year 2012 to 2013, GSK's accounts payable increased from $2.6 billion to $7.8 billion. This was due to GSK changing their policy of payments to their suppliers, increasing the time from 60 days to 90 days, more in some cases . This action has led to 8

great criticism, with allegations of "corporate greed.” !Dividend Policy

GSK is a relatively mature company that regularly pays out quarterly dividends to its stockholders. This strategy has helped the movement of their stock price for the past 5 years. (Exhibit 11 of GSK’s Stock Price Movement in relation to Dividend Announcements) The stock has a 5.67% dividend yield with 2.43 billion shares outstanding with a payout of 101%. Considering their Operating profits and Net income, it is safe to say that GSK has a fair and generous dividend policy historically. The company should continue with their cyclical quarterly payments but should be careful and leave enough money for reinvestments as patents are crucial in this industry. !Trends and Future Growth

In 2014, GSK expects their earnings-per-share growth to be within the range of 4% to 8% on a constant exchange rate. The sales from new pharmaceutical and vaccine launches look promising for the next years to come. In a product life-cycle angle, this growth expectation is reasonable because it is safe to assume that these launches are still in their early stages. (Exhibit 12 for Sales from New Pharmaceutical and Vaccine Launches) In addition, the management is confident that their 5 new approved medicines can strengthen the growth of their pharmaceuticals business . This paper advises the management to 9

focus on their growth products and focus their distribution in emerging markets.


Merck & Co (NYSE:MRK)!Company Overview

Merck & Co is one of the biggest pharmaceutical companies in the world. The company is recently headquartered in New Jersey, USA. It was founded in 1891 as a subsidiary of a German company named Merck KgaA. Since then, Merck has transformed to be one of the leading players in the pharmaceutical industry in terms of revenue and market capitalization. Its main business comes from discovering, developing and manufacturing human and animal health products. Like GSK, this company also offers medicines, vaccines and services to cover broad ranges of health complications and infectious serious diseases. The company focuses on its four core operating segments: Pharmaceutical, Animal Health, Consumer Care and Alliances . 10!Corporate Governance

The top institutional stockholders of MRK comes mostly from big financial institutions and private equity firms e.g. Blackrock. The top institutional investors own 76.15% of the company. By examining the backgrounds of the executive and non-executive directors, conflict of interest has been carefully avoided despite the big share of ownership of institutions. Also, none of the corporate executive management team is a sizeable owner of the business which opens the possibility of the agency dilemma. The company avoids this by compensating the high-level executives via stock options. (Exhibit 13 for the MRK’s List of Top Stockholders, Board Member’s Background and Current Board Memberships) MRK declares their commitment to make difference in the lives of people globally through their products and services. The company publicly supports policies that push for the advancement of public health and universal access to medicines and healthcare . Like GSK, the percentage of insider 11

trading buying and selling stocks is relatively minute which has least effect on the company market performance . 12!Business Trend Analysis and Financial Highlights Quality of Sales (2009-2013)

MRK’s total sales for FY2013 is down by 7% due to the decline of their pharmaceutical (-8%) and consumer care (-3%) businesses. In the pharmaceuticals business, the increased sales of Gardasil and Janumet failed to offset the decline in Januvia- that being the greatest component of the company’s revenue. Geographically, the emerging market sales grew by 2% attributed to the great demand in vaccines, acute care and diabetes products. However, it was partially offset due to the negative impact of currency exchange . (Exhibit 14 for MRK’s Revenue Breakdown) The company’s current sales have been unsatisfactory 13

when compared to the 14.3% 5-year CAGR from FY2012. Among the three companies, MRK is the only one that posted a decline in its sales. !Operating Profits and Cost Analysis (2009-2013)

In terms of cost analysis, MRK has produced a lower gross margin of 61.5% for FY2013 compared to 65.2% last fiscal year due to the expected increase in COGS across the industry. There was also a decrease of $700M in marketing and administrative expenses which is contradictory from the management’s aggressive stance of pushing new and existing products and services . FY2013 was a tough year for the company as it is its first time in five years to have a decline in their margin 14

(Gross Profit CAGR of 9.2% for the past 5 years). We believe that this decrease was a result of the company’s lower levels of productivity in terms of sales and distribution activities. MRK’s R&D expenses had decline which was expected due to targeted spending reductions and intensified focus on the company’s stronger businesses . Next, MRK suffered from a 28.6% decline of 15

net income brought by the $2.3Bn acquistion-related and restructuring costs of the firm. (Exhibit 15 for MRK’s Income Statement and Detailed Acquisition-related and Restructuring costs) It is important to know that these costs are not recurrent because it is not part of their core operating business. Nonetheless, MRK’s management has been lenient in terms of cost-cutting and poor in managing costs of post-acquisition integrations. !Cash and Free Cash Flow Analysis (2009-2013) ! In terms of cash, the company spent $1.89Bn in capital expenditures which is lower compared to last year’s $1.95Bn. MRK also has a FCF of $8.5Bn at their expense which represents 19.21% of their sales. Their high cash level reflects the management’s efforts on targeted spending while investing only on assets that can generate substantial amount of revenues. !!!


89,000 Employees

$44.03B Revenue

$160.38B Market Cap

Financial Structure MRK is financed by 64% of Equity and 36% of Debt. The equity is composed of all common stock with no preferred

stock. (Exhibit 16 for MRK’s Capital Structure). Compared to GSK, MRK has a significantly lower level of debt despite its increasing long term investments, primarily focused on expanding in China and India, but also having a significant presence in South East Asia. From 2009, long term investment totaled $1.3 billion, and grew each year to $9.2 billion in 2013. Likewise, long term debt increased dramatically from 2008 to 2009, ($3.9B - $16.1B), and remained high through to 2013, ending at $22.7 billion . This indicates that much of the investments were financed through long term loans. 16!Dividend Policy MRK has consistently paid generous dividends to its shareholders even while their earnings have been depressed. The company has returned $11Bn to the shareholders through strategic stock purchases and dividends. In comparison to GSK, MRK has a lower dividend yield of 3.22% but a higher payout ratio of 118% .(Exhibit 17 of MRK’s Stock Price Movement in 17

relation to Dividend Announcements) MRK should continue its recurrent dividend payments which satisfies their clientele who prefer a stable dividend policy. !Trends and Future Growth With MRK’s ongoing divestments, we can expect to see a decent increase in the firm’s efficiency and profitability. The company should be able to use their assets more efficiently by selling their non-core businesses. However, one ongoing concern is the recurrent restructuring cost of the firm. MRK decided to buy AZ Electronic Materials (AZEM) last year to boost its offering of specialty chemicals to strengthen their industrial-material unit. It raises concerns for investors as it reflects the management’s judgement in M&A activities. The market was optimistic as the stock price rose 4.9%. However, if they keep losing money for this fiscal year, the company will suffer poor margins that might significantly affect their stock price. In terms of product development and R&D rate of return, MRK is still waiting for 3 drug patent application . Uncertainty increases the risk of the MRK’s inability to 18

augment sales and recover costs. This review advises the management of MRK to focus on delivering its sales in their core businesses and emphasise efforts on the post-merger integration with AZEM. !Novartis (NYSE:NVS)!Company Overview !

Novartis, founded in 1996, is a world leading pharmaceuticals company based in Switzerland. It is a major research company that focuses on developing, manufacturing, sales and marketing of diverse products. Similar to the other two aforementioned companies, Novartis offers a wide range of healthcare products and medicines. But unlike the other two, this company also offer eye care services, diagnostic tools and generic pharmaceuticals. This company operates on five key business segments: Pharmaceuticals, Alcon, Sandoz, Vaccines, and Diagnosis and Consumer Health. Its ability to produce lives up to its reputation as one of the the top-performing pharmaceutical companies worldwide with sales of $57.9Bn last FYE. !Corporate Governances The top institutional owners constitute 10.35% while the funds control 4.6%. Like the two other companies, NVS was careful in electing their board of directors. The pharmaceutical companies seem to have a bias on the diversity of their non-executive directors. After careful examination and analysis on the current board memberships of the directors, it is safe to assume that they represent the true interests of the majority owners of NVS. (Exhibit 18 for NVS’ Background of Board Members and Exhibit 19 for the list of top stockholders) Novartis’ responsible business practices, like launching new CR newsletter 2014, have earned its place in top 100 most sustainable companies in Corporate Knights Global . 19!Business Trend Analysis and Financial Highlights Quality of Sales (2009-2013)

At the end of FY2013, NVS has managed to increase their net sales by 4% ($57B) with constant exchange rates even with constant pressure from generic drug competitors. The growth can be attributed to the strong upward momentum in their new products in strategic geographic performances. First, new drug launches and approvals in 2013 has boosted the sales of NVS. Sales of Zometa and Diovan grew by 7% despite the impact of the generic competition of almost $400M. The growth


#2 Sales Worldwide

$57.9B Revenue

$217.32B Market Cap

products of NVS added $4.8B in their total sales. Second, the company’s sales in the US and emerging markets are continually improving in the span of the past 5 FYE. This past fiscal year, their products grew by 15% in the US and 10% in the emerging markets. These are good performance indicators for NVS, as it shows that their sales are not tied into few several products in selected geographies. In a risk standpoint, the company’s sales is sustainable as their core business of pharmaceuticals remains strong and their growth products complement the growth. (Exhibit 20 for NVS’ detailed financial performance) !Operating Profits and Cost Analysis (2009-2013)

NVS boasted a $10.9B operating income this recent fiscal year end which is a 5% increase from last year with constant exchange rates. This result is impressive for the company despite of the industry-wide increase in COGS. NVS is the only one among the three companies to produce an increase in their margin. This was due to the management’s effective R&D cost management, lowered portion of LT debts, and focused innovation strategy . 20!Cash and Free Cash Flow Analysis (2009-2013)

Currently, NVS has a FCF of $9.98B which is 13% lower compared to last year. But this is not something that investors should be concerned about as the FCF got lowered because of the slight increase in receivables and higher investments in manufacturing and research facilities. Unlike MRK which focuses on investing in very specific assets, NVS is more aggressive in its capital expenditures and R&D expenses ( net -9.38%) . In the past 5 FYEs, NVS has shown strong operating cash flows of 21

7.34% growth average due to their stronger sales performance and adept capital budgeting decisions. In analysing the financial performance of a firm, it is always considered that cash is king. With this in mind, NVS can be considered to be a very valuable stock if we take the present value of its strong future cash flows. (Exhibit 21 for for NVS’ Cash flow statement) !Financial Structure

NVS is financed by 59% of Equity and 41% of Debt. The equity is composed of all common stock with no preferred stock. The firm has a 0.15X debt-to-equity ratio. Based on this, NVS might be missing on opportunities to improve their profitability by adding debt to their balance sheet like most of its competitors. It seems to be a very defensive strategy for an established global pharmaceutical company with strong sales growth and healthy margins. Nonetheless, its strong capital structure of just 20% debt still managed to provide attractive return to their shareholders. No significant financing made during the past three years. (Exhibit 22 for NVS’ Balance Sheet). !Dividend Policy NVS offers a dividend yield of 3.13% back to the shareholders. Recently, the board proposed an increased dividend payment of $ 2.45 per share for 2013 which is up 7% from the past fiscal year . Also, the payout ratio is also expected to increase from 22

66% to 74%. This is an attractive policy for the shareholders and investors. If this pushes through, NVS will be the most generous in terms of payment dividend against the other two companies. (Exhibit 23 for the effect of dividend in NVS’ stock price) This analysis supports the proposal of the board to change the dividend policy. !Trends and Future Growth For 2014, NVS sees their pharmaceuticals with mid-high single digit growth. The new growth products support this forecast especially with their oral type 2 diabetes treatment reaching a $1.2B in full sales. As long as NVS can keep their strong commercial execution it will strengthen their portfolio across a span of diseases in different geographies. Aside from that, NVS’ market share acquisition strategy in China and Russia paid off with double-digit growth rates. It is safe to expect the same line of growth from these markets for the next few years. This report advises NVS to pursue more market acquisition strategies in emerging markets. !Financial Statement and Ratio Analysis Liquidity

!

GSK MRK NVS Industry Average

Current Ratio 1.1X 2.1X 1.2X 1.7X

Quick Ratio 0.7X 1.4X 0.7X 1.2X


In a liquidity standpoint, MRK appears to be the most liquid among the three companies. MRK’s current liabilities only stand at 17% of the assets compared to GSK’s 31% and NVS’ 20.88%. Next, MRK’s cash and short-term investments represent 17.07% of the total assets which is substantially higher than that of GSK’s 8.07% and NVS’ 7.30%. MRK appears to be safe from its obligations compared to the other two companies. As of FY2013, the inventory level of MRK, GSK, and NVS— 6.33%, 10.14%, and 5.76% respectively. Our analysis shows the inventory management expertise and adept demand forecasting of MRK’s management by keeping just the sufficient level of inventory relative to the size of its business. Compared to the industry however, it can be seen that Merck is a bit above the industry ratios, while GSK and Novartis are significantly below the averages. This can partially be explained through the build-up of high inventory levels relative to sales for GSK and NVS which in turn might indicate obsolescence of inventory or unnecessary write-offs. !Asset Management

In terms of efficiency, NVS shows the best inventory management in comparison to the other two companies. NVS on the other hand seems to be lacking a stricter credit policy in their pharmaceuticals and vaccines business, since it's AR Turnover is below the average and the other two competitors. However, GSK’s total assets were able to produce more sales compared to the other two. However, averages in industry show that GSK is on the industry average with the TA Turnover, but is significantly below it when it comes to Inventory Turnover. This can be explained by them having efficient management of fixed assets, but not of their working capital. !Debt Management

Among the three companies, NVS has the lowest risk of liquidity crisis and solvency problems. The pharmaceutical companies on average look like they have significant amounts of debt in their balance sheets to finance their capital investments. However, it is really only a few companies, GSK included, that raise the average through the roof. The 90% trimmed mean of the top 10 companies in the industry for D/E is 41%, much closer to MRK and NVS values. GSK has by far the most highly leveraged capital, but their TIE is still reasonably high, so it can be assumed that their solvency risk is not high as their operations continue to pay for their expenses. According to the analysis done in this paper, the three companies are in no danger of defaulting on their obligations assuming that sales remain flat or growing because their products offer high return of investments. !Profitability

GSK’s ability to generate revenue by using their assets efficiently was translated to its ROA of 11.7% for FY2013 and 13.4% on average for the past 5 FYEs. The results of GSK are superior compared to MRK and NVS. This is due to the strength


Total Assets Turnover 0.6X 0.4X 0.5X 0.6X

Fixed Assets Turnover 3.0X 2.8X 3.4X 5.8X

AR Turnover 4.9X 5.7X 5.9X 2.9X

Inventory Turnover 1.9X 2.4X 2.8X N/A


Total D/E 2.7X 0.4X 0.3X 0.8X

Total D/C 0.7X 0.3X 0.2X 0.4X

EBIT/ Interest Exp 10.4X 15X 22X 13.4X


ROA 11.7% 6.3% 8.0% 8.6%

ROE 60.9% 11.2% 14.3% 26.1%

Basic-Earning-Power 16.7% 8.4% 8.6% N/A

EBIT Margin 29.3% 22.6% 17.5% 23.6%


of the new product launches of GSK and their 5 new patented drugs. ROE is also dramatically higher because of their low equity capital structure. These numbers are impressive considering that the company’s assets are also growing at a flat rate. NVS and MRK are significantly below the industry average in ROE only because of the few companies that have high debt leverage, GSK included. The strength of its profitability will remain strong in FY2014 as the projections of their revenues from their innovative products and services continue to remain bullish, when compared to MRK’s uncertainty in their patent applications and NVS’ almost flat sales growth. GSK is the most profitable among the three companies as of now but in serious threat because NVS has recently got their 18 new drug patent applications approved. !Industry Specific Numbers

GSK has the highest number of pipeline products. This explains MRK’s highest dividend payout compared to the other two companies because of few investment opportunities and project developments. (*Please see Exhibit 24 for the definitions of the different phases)

Market Performance In terms of price movement, NVS gives 98.42% return in 5 years which is higher than GSK’s 55.45% and MRK’s 78.75%. Historically, the stock prices of these companies are in a steady incline after the financial crisis. It is also worth noting that the increase in prices is confirmed by the volume which can mean that the stock price is not manipulated by a small group of investors. Moreover, the three pharmaceutical companies performed weaker compared to DJIA and S&P500. This particular industry takes a longer time to recover from the effects of the 2008 financial crisis when compared against the market. MRK has a high P/E ratio of 37.81X compared to GSK’s 15.65X and NVS’ 21.88X (Exhibit 25 Market Performance of the three companies) This ratio indicates that MRK might be overvalued by the market already.

Risk Analysis Regulation and Currency Exchanges The most prevalent and pressing issue to the industry as a whole, is the continuous trend of increases in legislative regulations and political action/intervention on operations. This includes regulations on product quality, clinical trials, reporting methods, and compliance; pharmaceutical companies must make enormous effort to remain within the legal operating zone, which is constantly changing. This rapid upswing in regulation and accountability has caught many by surprise, as the traditional way of doing business in China, i.e. “corrupt” from the Western perspective, has suddenly become corrupt in China as well. Next, currency exchanges can severely depress and inflate the earnings of pharmaceutical companies due to global scale of research, development, manufacturing and distribution. Intellectual Property and Production Pharmaceutical companies rely very heavily on their patents, and protecting their intellectual property. These large pharmaceutical companies spend millions of dollars developing and researching their products. When a smaller firm copies and starts selling the same drug for a drastically reduced price, often without license to do so, the large company has no way to recoup the costs incurred developing the drug to begin with. This means a huge financial hit to their budget. Merck has had extensive issues with patents theft and intellectual property rights loss, especially in the asian and Indian markets. The Indian government has made policy that encourages local companies to produce low cost versions of popular western medicines and drugs, in order to increase availability. Many pharmaceutical companies have complained, but enforcement is extremely weak. Reputation Thirdly, are issues that damage the future potential of the company to sell its products. A tarnished reputation can mean greatly diminished profits or even the death of the organization. In the event that a product turns out to have negative side effects, or is show to be dangerous for patients during clinical trials, there is always a very long and costly litigation process. Lawsuits are filed, settlements are reached. Despite the fact that many pharmaceutical companies build the expected lawsuit costs into their pricing structures, hundreds of millions in fines and multi billion dollar settlements add very obvious strain on the company’s financial health. Not even to mention the public awareness and outcry over “dangerous drugs,” or “corrupt businesses.” The

GSK MRK NVS

Phase I* 27 N/A 4

Phase II* 46 19 27

Phase III* 31 16 23

Registration* 11 4 7

Approved* 8 3 2


current headlining of GSK in the news is proof of this. Their company is being publicly called out by the government of China, long well-known for its corruption, for its corrupt business practices. It would be hard to get consumers buy drugs from a company that was kicked out of a country for being too corrupt. !!!Summary of Investment Considerations! NYSE:GSK!! ! ! ! NYSE:MRK!!

Recommendation:BUY Recommendation: HOLD

NYSE:NVS! ! ! ! ! Key Takeaways!

! Recommendation: BUY


Industry Specific: -Pharmaceuticals industry spends aggressively in R&D -Product development is of paramount importance !Finance Class: -Numbers tell the stories inside the companies -Dynamic analysis of qualitative and quantitative data -Due diligence is crucial in financial analysis -Benchmark is important in ratio analysis

!-R&D Cost

Management!-Strong Profitability

-High amounts of debt!-Weak Europe Sales!

-High P/E (GSK might be overvalued already)

Pros Cons

Shor

t -Te

rm

-Strong Pipeline Products!

-Strong US Sales!-High Dividend Yield

-High amounts of LT debt!

-Pricing Pressure from Generic Competition

Long

-Ter

m

-Posti-integration acquisition potential

-Lower Margins!-Decline in Sales!

-Lower FCF

Pros Cons

Shor

t -Te

rm-Increasing Demand in Emerging Markets!

-High Dividend Payout Ratio

-Weak Product Dev!-High COGS!-Poor Cost

Management!-Pricing Pressure from Generic CompetitionLo

ng -T

erm

-Strong Price Momentum!

-Increase in Sales!-Good Inventory

Management

-Lower FCF!-Under Leveraged!

-High P/E (GSK might be overvalued already)!!

Pros Cons

Shor

t -Te

rm

-Better Capital Structure!

-Better Debt Management!

-Strong Operating Profit

!-High COGS!

-Pricing Pressure from Generic Competition

Long

-Ter

m

APPENDIX !Exhibit 1 GSK Stock Performance Compared to DJIA and S&P500

source: http://quotes.wsj.com/GSK/interactive-chart !Exhibit 2 GSK’s Core Business

source: http://www.gsk.com/about-us/what-we-do.html !!!!

Pharmaceuticals GSK makes medicines available in these areas:

Vaccines GSK produces pediatric and adult vaccines to prevent a range of infectious diseases including:

Consumer Healthcare GSK have leading positions in these

Infectious diseases Hepatitis A and B Oral Care

Cancer Diptheria, tetanus, and whooping cough

Nutrition

Epilepsy Measles, mumps and rubella Total wellness

Heart diseases Polio Skin health

Asthma and Chronic OPD Typhoid

HIV/AIDS Influenza

Bacterial Meningitis


!Exhibit 3A List of GSK’s Top Stockholders

Exhibit 3B Board Member’s Background

Institutional Holders Shares Percentage Mutual Fund

Holders Shares Percentage

Dodge & Cox Inc 61,290,600 2.52 Dodge & Cox

Stock Fund 24,703,400 1.02

Royal Bank of Canada 18,024,481 0.74

Dodge & Cox a International Stock Fund

19,853,749 0.82

Fisher Asset Management, LLC

11,110,909 0.46 Vanguard/Primecap Fund 5,121,200 0.21

State Street Corporation 10,921,623 0.45 Dodge & Cox a

Balanced Fund 4,910,600 0.2

FMR, LLC 10,332,168 0.43 FMI Large Cap Fund 3,169,000 0.13

Primecap Management Company

10,078,655 0.42

Price (T.Rowe) International Growth and Income Fund

3,004,371 0.12

Bank of New York Mellon Corporation

8,412,337 0.35Price (T.Rowe) Overseas Stock a Fund

2,700,713 0.11

Wells Fargo & Company 8,122,652 0.33 Invesco

Comstock Fd 2,015,222 0.08

Price (T.Rowe) Associates Inc 6,934,811 0.29

Columbia Fds Ser Tr II-Columbia Dividend Opportunity Fd

1,493,656 0.06

Fiduciary Management, Inc.

6,137,991 0.25Fidelity Series Growth & Income Fund

1,441,400 0.06


Exhibit 3C Corporate Governance Framework

!!Exhibit 3D Executive Compensation Plan

source: Annual Report 2013 !!!!


Exhibit 4 GSK’s Sales by Segment

Exhibit 5 GSK’s Pharmaceuticals and Vaccines Turnover !!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!

source: 4th Quarter Financial Results, 2013


Exhibit 6 GSK’s Complete ViiV Healthcare Turnover !!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!source: 4th Quarter Financial Results, 2013 !!!!!!!!!!


Exhibit 7 GSK’s Income Statement

!source: 4th Quarter Financial Results, 2013 !!!!!!!!!!!!


Exhibit 8 GSK’s Notes on R&D Expense

!source: 4th Quarter Financial Results, 2013 !Exhibit 9 GSK’s Balance Sheet !!!

!!!!!!!!!! !!source: 4th Quarter Financial Results, 2013


75%

25%

Equity Debt

!Exhibit 10 GSK’s Reconciliation of Cash Flow to Movement in Debt

source: 4th Quarter Financial Results, 2013 !Exhibit 11 GSK’s Stock movement in relation to dividends announcement

source: Wall Street Journal !!!!!!!!!


Exhibit 12 Sales from New Pharmaceutical and Vaccine Launches

source: 4th Quarter Financial Results, 2013 !Exhibit 13A MRK’s Board Member Profiles !Posi%on Board of Directors Current Board Membership

Chairman & Chief Execu0ve Officer Kenneth C. Frazier, 59

Pennsylvania State University, Cornerstone Chris0an Academy, Merck & Co., Inc., Exxon Mobil Corp., Pharmaceu0cal Research & Manufacturers of America

Lead Independent Director William B. Harrison, 70

Central Park Conservancy, Inc., The Partnership for New York City, Cadence Bancorp LLC, Merck & Co., Inc., RecoverCare LLC, University of North Carolina Endowment, Lincoln Center for the Performing Arts, Inc.

Independent Director Thomas Robert Cech, 66 Merck & Co., Inc., Grinnell College

Independent Director Thomas Henry Glocer, 54

Merck & Co., Inc., The Partnership for New York City, The Interna0onal Business Council, The Cleveland Clinic Founda0on, K2 Global Consul0ng, Inc., Morgan Stanley, Council on Foreign Rela0ons, Inc.


source: Wall Street Journal """"""""""""""""

Independent Director Rochelle B. Lazarus, 66

Merck & Co., Inc., General Electric Co., The Blackstone Group LP, World Wildlife Fund, Inc., Blackstone Group Management LLC, Ogilvy & Mather Worldwide, Inc., American Museum of Natural History, NewYork-Presbyterian Hospital, The Partnership for New York City, Lincoln Center for the Performing Arts, Inc.

Independent Director Leslie A. Brun, 62

NXT Capital LLC, SARR Group LLC, Merck & Co., Inc., Broadridge Financial Solutions, Inc., Automatic Data Processing, Inc.

Independent Director Charles Robert Kidder, 69

Merck & Co., Inc., Gulf Coast Analytical Laboratories, Inc., 3Stone Advisors LLC, Microvi Biotech, Inc., Morgan Stanley, Wildcat Discovery Technologies, Inc., The Ohio University, Wexner Foundation, Nationwide Children's Hospital, The Columbus Foundation, Inc.

Independent Director Carlos Eduardo Represas de Almeida, 69

Swiss Re AG, National Institute of Genomic Medicine, Bombardier, Inc., Merck & Co., Inc., The Mexican Health Foundation, Swiss Reinsurance Co. Ltd.

Independent Director Patricia F. Russo, 61

Merck & Co., Inc., Hewlett-Packard Co., The Partnership for a Drug-Free America, Inc., General Motors Co., Alcoa, Inc., KKR Management LLC, KKR & Co. LP

Independent Director Craig B. Thompson, 60

Charles River Laboratories, Inc., Charles River Laboratories International, Inc., American Association for Cancer Research, Merck & Co., Inc.

Independent Director Wendell P. Weeks, 54

Corning, Inc. Foundation, Lehigh University, Corning, Inc., The Corning Museum of Glass, Merck & Co., Inc.

Independent Director Peter C. Wendell, 63 Princeton University, Merck & Co., Inc., ARTstor, Inc.

Posi%on Board of Directors Current Board Membership


Exhibit 13B MRK’s Top Stockholders "

""source: Wall Street Journal """""""""""""""""""

Institutional Holders Shares Percentage Mutual Fund

Holders Shares Percentage

Capital World Investors 157,254,204 5.38

Washington Mutual Investors Fund

49,295,000 1.69

Wellington Management Company, LLP

144,476,462 4.94 Income Fund of America Inc 44,980,440 1.54

Vanguard Group, Inc (The)

141,364,251 4.84Vanguard Total Stock Market Index Fund

42,592,587 1.46

State Street Corporation 132,101,295 4.52

Vanguard Specialized-Health Care Fund

36,561,348 1.25

Franklin Resources, Inc 87,625,703 3 Dodge & Cox

Stock Fund 29,748,700 1.02

BlackRock Institutional Trust Company, N.A.

77,640,502 2.66

Vanguard Institutional Index Fund-Institutional Index

28,629,117 0.98

FMR, LLC 61,321,068 2.1 Vanguard 500 Index Fund 28,011,922 0.96

Bank of New York Mellon Corporation

51,789,064 1.77Vanguard/Wellington Fund Inc.

27,713,952 0.95

Dodge & Cox Inc 50,137,596 1.72 SPRD S&P

500 ETF Trust 27,539,624 0.94

Price (T.Rowe) Associates Inc 45,266,271 1.55

American Balanced Fund

25,730,000 0.88


Exhibit 14 MRK’s Sales Breakdown

source: Merck’s Full Year Results 2013 """""""""""""""""""""""


"Exhibit 15A MRK’s Income Statement

source: Merck’s Full Year Results 2013 """""""""""


Exhibit 15B MRK’s Detailed Acquisition and Restructuring Costs """"""""""""""""""""source: Merck’s Full Year Results 2013 ""Exhibit 16 MRK’s Capital Structure """""""""""""""""""""source: Merck’s Full Year Results 2013 """"


36%

64%

Equity Debt

Exhibit 17 MRK’s Stock movement in relation to dividends announcement

source: Wall Street Journal "Exhibit 18 NVS’ Board Member Profiles Position Name Current Board MembershipChairman Jörg Reinhardt, 58 Novartis AG

Independent Non-Executive Director Dimitri Azar, 55Association for Research in Vision & Ophthalmology, Chicago Ophthalmological Society, Novartis AG

Independent Non-Executive Director Andreas von Planta, 59

Clinique Générale Beaulieu SA, Novartis AG, Swiss National Insurance Co., Holcim Ltd., Raymond Weil SA, HSBC Private Banking Holdings (Suisse) SA, Socotab Frana SA

Vice Chairman Ulrich Lehner, 68

E.ON SE, HSBC Trinkaus & Burkhardt AG, Porsche Automobil Holding SE, ThyssenKrupp AG, Deutsche Telekom AG, Novartis AG, Henkel Management AG, Henkel AG & Co. KGaA,

Independent Non-Executive Director Rolf M. Zinkernagel, 70 The Genomics Institute of the Novartis Research Foundation, Novartis AG

Independent Non-Executive Director Wendelin Wiedeking, 62 Novartis AG

Independent Non-Executive Director Pierre Landolt, 65

Sandoz Family Foundation, Vaucher Manufacture Fleurier SA, Parmigiani Fleurier SA, Eco-Carbone SAS, Amazentis SA, Syngenta Foundation For Sustainable Agriculture, Emasan AG, Novartis AG, Montreux Jazz Festival Foundation, Axial Participações e Projetos Ltda.

Independent Non-Executive Director Srikant Madhav Datar, 61HCL Technologies Ltd., Novartis AG, ICF International, Inc., T-Mobile US, Inc., T-Mobile USA, Inc., Stryker Corp.


source: Wall Street Journal """"""""""""""""""

Independent Non-Executive Director Mun Tak Yang, 61

Asia Business Council, Hong Kong-United States Business Council, Esquel Enterprises Ltd., The HongKong & Shanghai Banking Corp. Ltd., Swire Pacific Ltd., Seoul International Business Advisory Council, Novartis AG

Vice Chairman Enrico Cipro Vanni, 63Denzler & Partners, Eclosion2, Advanced Oncotherapy Plc, Novartis AG, Banque Privee BCP (Suisse) SA

Independent Non-Executive Director Ann Marie Fudge, 62

General Electric Co., Novartis AG, The Rockefeller Foundation, Simmons College (Massachusetts), Infosys Ltd., Council on Foreign Relations, Inc., The Brookings Institution, Unilever NV, Unilever Plc

Independent Non-Executive Director William R. Brody, 70

Novartis AG, The Salk Institute for Biological Studies, International Business Machines Corp., T. Rowe Price Mutual Funds, Stanford University, Baltimore Community Foundation, T. Rowe Price International, Inc., BioMed Realty Trust, Inc., The Genomics Institute of the Novartis Research Foundation, T. Rowe Price New America Growth Fund, Novartis, Inc., T. Rowe Price Real Assets Fund, Inc., T. Rowe Price GNMA Fund

Independent Non-Executive Director Bill T. Winters, 52

The Institute of International Finance, Inc., Renshaw Bay LLP, International Rescue Committee, Inc., Novartis AG, Pension Corp. LLP

Independent Non-Executive Director Charles Sawyers, 55 Novartis AG, Cold Spring Harbor Laboratory, Inc.

Independent Non-Executive Director Verena A. Briner, 63 Novartis AG

Position Name Current Board Membership


Exhibit 19 NVS’ List of Top Stockholders

" """""""""""""""""""


Institutional Holders Shares Percentage Mutual Fund Holders Shares Percen

tage

Dodge & Cox Inc 46,862,302 1.93 Dodge & Cox Stock Fund 18,750,400 0.77

Primecap Management Company

26,850,538 1.11Dodge & Cox International Stock Fund

16,305,000 0.67

Brown Brother Harriman & Co 13,205,757 0.54 Vanguard/Primecap

Fund 14,529,969 0.6

Wells Fargo & Company 7,111,751 0.29

Vanguard International Stock Index-Vanguard MSCI Europe ETF

4,780,935 0.2

Neuberger Berman Group, LLC 5,982,915 0.25 Dodge & Cox Balanced

Fund 3,374,900 0.14

Fisher Asset Management, LLC 5,781,623 0.24 BBH Core Select Fund 3,387,124 0.14

Franklin Resources, Inc 4,038,055 0.17

Vanguard Horizon Fund-Capital Opportunity Portfolio

3,131,000 0.3

Invesco ltd. 3,755,075 0.15 American Mutual Fund Inc 3,014,000 0.12

Managed Account Advisors, LLC 3,705,273 0.15

Franklin Mutual Series Fund-Mutual Global Discovery Fund

2,692,791 0.11

UBS AG 3,698,961 0.15 Vanguard Fenway Fds-Primecap Core Fund 2,200,605 0.09

"Exhibit 20 NVS’ Detailed Financial Performance " """""""""""""""""""""""""""""""""""""""source: Company Financial Results 2013 """"""""


Exhibit 21 NVS’ Cash Flow Statement

source: NVS Annual Report 2013 """"""""""""""""�28BIRDMAN SACHSGSK, MERCK & CO, NOVARTIS

Exhibit 22 NVS’ Balance Sheet """

""""""""source: NVS Annual Report 2013 """"""""""""""""


41%

59%

Equity Debt

Exhibit 23 NVS’ Stock movement in relation to dividends announcement

source: Wall Street Journal ""Exhibit 24 Definition of Product Phases for the Pharmaceutical Industry

Source: Novartis Company Site """""""


Exhibit 25 Stock Price Movement of GSK, MRK, NVS

"source: Wall Street Journal """"""""""""""""""""""""""


ENDNOTE CITATIONS


! FDA. FDA’s stricter measures in product development. N.p.: n.p., n.d. Web. 7 Feb. 2014. <www.fda.gov/1

Drugs/DevelopmentApprovalProcess/default.htm>

! Moody's. Outlook for Global Pharmacy. N.p.: Moody's, n.d. Web. 7 Feb. 2014. <www.moodys.com/2

research/Moodys-Stable-outlook-for-global-pharmaceuti>

! Global Data of London. Healthcare Global Data. N.p.: n.p., n.d. Web. 7 Feb. 2014. 3

<healthcare.globaldata.com/pressreleasedetails.aspx?prid=863>

! GlaxoSmithKline. About Us. N.p., n.d. Web. 10 Feb. 2014. <http://www.gsk.com/about-us/what-we-4

do.html>.

! Financial Visualization. GSK's Insider Trading Percentage. N.p., n.d. Web. 19 Feb. 2014. <http://5

finviz.com/insidertrading.ashx?oc=1131399&tc=7&b=2>

! GlaxoSmithKline. 2013 Fourth Quarter Results. N.p., n.d. Web. 10 Feb. 2014. <http://www.gsk.com/media/6

press-releases/2014/results-announcement-for-the-fourth-quarter-2013.html>



! Merck & Co. Merck & Co's Financial Results. N.p., n.d. Web. 15 Feb. 2014. <http://www.telegraph.co.uk/8

finance/newsbysector/pharmaceuticalsandchemicals/9798947/Glaxo-disregards-suppliers-with-90-day-payment-terms.html>.



! WSJ. Wall Street Journal. N.p., n.d. Web. 10 Feb. 2014. <http://quotes.wsj.com/MRK/company-people>10

! Merck & Co. Merck & Co's Views and Positions. N.p., n.d. Web. 11 Feb. 2014. <http://www.merck.com/11

about/views-and-positions/home.html>

! NASDAQ. N.p., n.d. Web. 19 Feb. 2014. <http://www.nasdaq.com/symbol/mrk/insider-trades/buys>12

! Merck & Co. Merck & Co's Financial Results. N.p., n.d. Web. 11 Feb. 2014. <http://13

www.mercknewsroom.com/news-release/corporate-news/merck-announces-fourth-quarter-and-full-year-2013-financial-results>





! Pharmafile. Pharmafile News. N.p., n.d. Web. 16 Feb. 2014. <http://www.pharmafile.com/news/169532/16

merck-invest-1billion-singapore-rd-and-manufacturing>

! Wall Street Journal. Wall Street Journal Market Data. N.p., n.d. Web. 11 Feb. 2014. <http://17

quotes.wsj.com/MRK>



! Novartis. N.p., n.d. Web. 13 Feb. 2014. <http://novartis.com>19

! Novartis. Novartis Financial Results. N.p., n.d. Web. 13 Feb. 2014. <http://www.novartis.com/downloads/20

investors/financial-results/quarterly-results/q4-2013-media-release_en.pdf>

! ! Wall Street Journal. Wall Street Journal Market Data. N.p., n.d. Web. 11 Feb. 2014. <http://21 21

quotes.wsj.com/MRK>

! ! Novartis. Novartis Financial Results. N.p., n.d. Web. 13 Feb. 2014. <http://www.novartis.com/22 22

downloads/investors/financial-results/quarterly-results/q4-2013-media-release_en.pdf>

GSK, MERCK & CO, NOVARTIS BIRDMAN SACHS �33

Economy & Finance

A Financial Review: Pharmaceuticals Industry