Pharma_Valuation_ETH

Pharmaceutical Valuation Methodology & Case Studies Karl Heinz Koch European Pharmaceuticals

21 February 2008

Slide 2

Content Valuation Methodologies - An Overview Static Valuation Methodologies (Pros and Cons) Dynamic Valuation Methodologies (Pros and Cons) Vontobel Pharma Valuation ("Net Portfolio Add-On Potential")

3 4-8 9 10-21

Case Studies: - Special Situations (i.e. Roche, Novartis)

22-39

- Nycomed - "Life Beyond Pantoprazole"

40-44

21 February 2008

Valuation Overview Static

Geared De-Geared (e.g. P/E, (e.g. EV/x) P/CF)

P/E rel., PEG

EV/x rel., EV/x/g

Dynamic

Discounted Cash Flow (DCF)

Economic Value Added (EVA)

Slide 3

21 February 2008

Static "Geared" Valuation Methods (1)
Price per share relative to Earnings per share, the so-called "PER"
Pros: "Simple" (no adjustments needed)
Widely used because they are "simple"
Cons:
Misleading due to lack of comparability
Different accounting philosophies (shareholder focus versus tax authorities)
Different balance sheet structures ("Gearing")

Slide 4

21 February 2008

Gearing affects P/E ratios (PER)

USD million Market Capitalisation Level of debt Cost of debt (interest rate p.a.) Earnings before interests and taxes (EBIT) Net interest Pre-tax profit (PTP) Taxes (@ 35%) Net profit PER

Company A 100 0 12%

Company B 50 50 12%

10 0 10 3.5 6.5

10 6 4 1.4 2.6

15.4x

19.2x

Slide 5

21 February 2008

Static "Geared" Valuation Methods (2)
Price per share relative to Cash Flow per share, so-called "P/CF"
Pros: More accurate cross-company comparability within a sector (assuming similar capital structures)
More accurate assessment of "cash" operating performance
Cons:
Not as widely used due to lack of information that spots "cash" from "non-cash" items
Insufficiently accounts for minority interests, capital requirements and is even more sensitive to "gearing" than a PER

Slide 6

21 February 2008

Static "De-Geared" Valuation Methods (1)
Enterprise Value (EV) relative to "Revenues" per share
Pros: Values assets of a company by looking at the whole enterprise (hence the term "enterprise value") independent of the capital structure of the company (which is different from just looking at "equity" in the case of geared valuation methods); (known as Proposition 1 by Miller and Modigliani)
Allows for a distinction between a company's "core" and "non-core" assets (widely used by so-called "company raiders")
Cons:
Imperfections of markets mean that companies are not always able to restructure their balance sheet at will or at negligible cost
Strong assumptions built into EV methodology: tax neutrality between equity and debt,

Slide 7

21 February 2008

Static "De-Geared" Valuation Methods (2)
Enterprise Value (EV) = Market Capitalisation + Value of net debt (average for the year) - Estimated Value of "non-core" assets
Pros: Removes the often significant distortion due to different capital structures
Allows to value individual businesses
Cons:
Not as widely used due to adjustments needed ("can not be easily commanded on traditional financial services such as Bloomberg")
Sometimes difficult assumptions needed to value non-core businesses and impact of tax wedges due to imperfect capital markets

Slide 8

21 February 2008

Dynamic Valuation Method - DCF
Discounted Cash Flow Model
Pros: Allows valuation of companies with no near-term sustainable cash flow streams (or even loss making companies, i.e. biotechnology)
Appropriate for businesses with discretionary cost structures and long product cycles, such as pharmaceuticals
Cons:
A large part of the NPV is driven by the growth rates in the terminal value which are difficult to predict
Many businesses do not lend themselves to the long-term predictions needed for a DCF model (though pharmaceutical and biotechnology companies do)

Slide 9

21 February 2008

Vontobel Pharmaceutical Valuation Model based on

"Net Portfolio Add-On Potential"

Slide 10

21 February 2008

Slide 11

Relative Valuation Multiples for Pharmaceuticals

25

+10x 15

PER Median 12.2x -4x

10 5

PER 2008

EV/EBITDA 2008

EV/Sales 2008

Novo

Abbott

Roche

JNJ

Merck KGaA

SGP

Merck Inc.

Lilly

BMS

Novartis

Wyeth

GSK

Lundbeck

Pfizer

Sanofi

0 AZN

Multiple (x)

20

21 February 2008

Large Variances in Relative Valuation Multiples

12 10

6 4 2 0 -2 -4

PER '08E vs median

EV/EBITDA '08E vs median

EV/Sales '08E vs median

Novo

Abbott

Roche

JNJ

Merck KGaA

SGP

Merck Inc.

Lilly

BMS

Novartis

Wyeth

GSK

Lundbeck

Pfizer

Sanofi

-6 AZN

Multiple (x)

8

Slide 12

21 February 2008

Slide 13

Why Has Valuation Analysis Been Poor in the Past?
Relative Earnings Multiples (geared or de-geared) Can Be Misleading because:
Much of a stock's value is driven by future drug revenues, which are difficult to predict accurately
A. they tend to penalize innovative companies since they are the ones that have to absorb the high cost of large-scale clinical studies and market introduction;
B. they favor companies that lack new product flow, not least as profitability measures tend to rise in the short term due to a lack of (product) investment opportunities
Furthermore, relative valuation multiples do not take into account important quality differences because "growth is not simply growth" and only sustainable growth driven by new products determines valuations in the sector.

Ro ch e(

AZ N

DN A) Ba ye r SG Ab P bo tt W M e ye rck th & Co No . No v vo arti No s rd isk Eli Lil ly

c. pr op .

GS K BM S Sa P no f fi- iz er Av en tis JN J

in

generic exposure as % of sales

21 February 2008

Patent losses - The Only Certainty

60%

50%

40%

30%

20%

10%

0%

Slide 14

Ro ch e(

AZ N

DN A) Ba ye r SG Ab P bo tt Wy Me e rck th & Co No . No v vo arti No s rd isk Eli Lil ly

c. pr op .

Pf iz e r JN J

BM S

Sa no G fi- SK Av en tis

in

generic exposure vs pipeline potential (as % of sales)

21 February 2008

The Difference is in The Balance

80%

60%

40%

20%

0%

Slide 15

21 February 2008

Winners And Losers ... Broadly Speaking (Phase 1-3)

50% 40%

20% 10% 0% -10% -20%

Net portfolio "add-on" potential (pipeline potential - generic exposure)

Pf iz e r

JN J

Ab bo Sa tt no fiAv en t is

il l y Eli L

BM S

AZ N

Wy et h o No rd isk No v

&

Co .

SG P Me rck

Ba ye r

GS K

e(

in

No va c. rti pr s op .D NA )

-30%

Ro ch

% of 2006 sales

30%

Slide 16

21 February 2008

Winners And Losers ... Strictly Speaking (Phase 3)

40% 30%

10% 0% -10% -20% -30%

Net portfolio "add-on" potential (pipeline potential - generic exposure)

r Pf iz e

Sa JN no J fiav en tis

AZ N

Wy et h Ab bo tt Eli Lil ly

BM S

Ba ye r rck & Co No . vo No rd isk Me

SG P

GS K

DN A)

Pr op

e(

in

cl .

No v

ar tis

-40%

Ro ch

% of 2006 sales

20%

Slide 17

21 February 2008

Big Pharmaceuticals - An Industry Fallen From Grace

18% 16% 14% 12% 10% 8% 6% 4% 2% 0% 1996

1998

2000

2002

2004

2006

2008E

US/EU Big Pharma Rx sales growth (l.c.)

2010E

Slide 18

21 February 2008

3-Phase DCF Model - FCF Growth EU Universe

8.0% 6% 6.0% 4.0% 2.0%

3%

4% 3%3%

3%

2%

3% 2%

3%

0% 0.0% 0%

0%

-2.0%

-2% -4.0% -5%

-6.0% Novartis

Roche

Sanofi-aventis 1st phase

2nd phase

GlaxoSmithKline terminal

AstraZeneca

Slide 19

21 February 2008

Healthcare Continuum - Risk Perceptions Big Pharma

BioPharma

Biotech

Slide 20

21 February 2008

Assessing Quality of Growth - Appropriate Discount Rate Low risk (++)/High risk (--) Premium/Discount per quality characteristic

++

+

0

-

--

-0.40%

-0.20%

0.00%

0.20%

0.40%

++ (significantly better than sector) Pipeline Potential or Portfolio Replacement Rate (Sum of probabilityw eighted peak sales of all pipeline projects expressed as % of current sales) Generic Exposure or Portfolio Rate at Risk (Sum of all sales losing patent protection in the coming 5 years expressed as % of sales) Incremental potential of base portfolio (Sales of the underlying base portfolio - not new , not at generic risk - as % of current sales) Therapeutic Leadership (Franchise strengths indicating high sustainability of future cash flow s - Minimum 10% in USD 10 bn+ market segment) Geographical Exposure (% of revenues in the profitable and higher grow th US market) Business Diversification (% of revenues derived from prescription medicines (not vaccines, not blood plasma) TOTAL COMPANY-SPECIFIC RISK (PREMIUM (-)/ DISCOUNT (+) (Negative risk premium is a bonus and increases the value by low ering the overall discount rate (Rf + Rm). Positive risk premium low ers the value by raising the overall discount rate)

+ (better than sector - (w orse than sector 0 (sector average) average) average)

-- (significantly w orse than sector)

> 50%

40% - 50%

30% - 40%

20% - 30%

0% - 20%

10%

10% - 20%

20% - 30%

30% - 50%

above 50%

> 36%

26% - 35%

16% - 25%

0% - 15%

< 0%

No leadership according to LODH No notable definition, but among therapeutic franchise top 5 in 2 or more strength areas

3 leadership positions

2 leadership positions

1 leadership position

> 60% US revenues

US revenues of 45% - 60%

US revenues of 30% - 45%

US revenues of 15% - 30%

US revenues of 0% - 15%

100% Rx revenues

75% - 99% Rx revenues

50% - 74% Rx revenues

25% - 49% Rx revenues

< 25% Rx revenues

-1.2%

Aggregate of average quality on discount rate 0%

1.2%

Aggregate of discount quality characteristics on discount rate 2.4%

Aggregate of premium quality characteristics on discount rate -2.4%

Slide 21

21 February 2008

Slide 22

Special Situation - Novartis "Structurally Flawed" (Buy - PT: CHF 68)

21 February 2008

Slide 23

Novartis relative to MSCI Euro Pharma Index 27/2/08 80

75

70

-20% 65

60

55

-30%

50

45 2000

2001

2002

2003

2004

2005

2006

2007

2008

NOVARTIS 'R' REL.PERF. TO DRUGS EURO

-10% Source: DATASTREAM

21 February 2008

Novartis Branded Rx Outperforms a Declining Industry

18% 16% 14% 12% 10% 8% 6% 4% 2% 0% 1996

1998

2000

2002

2004

Novartis Branded Rx sales growth (l.c.)

2006

2008E

2010E

US/EU Big Pharma Rx sales growth (l.c.)

Slide 24

21 February 2008

A Bird's View Cash Cows

New Drugs Growth

Stars Lucentis Gleevec

Femara Diovan

Exjade Exforge

Certican Enablex Sebivo

Exelon

Zometa

Myfortic

Elidel Aclast Xolair Stalevo Foradil Sandostatin LAR a Tasigna Tekturna Lescol Neoral AGO Optaflu LBH Tegretol RAD Miacalcic Tekt. QAB FTY720 Clozaril Menveo FDC 149 (MS) AS Lamisil Lotrel Voltaren QAB Men B SOM LBQ Visudyne Zelnorm EPO FDC albuf Famvir NVA Trileptal Mycograb

Pipeline Drugs

Eucreas

?

ACZ AEB071 Cost Phase

Aurograb

Dogs Return Phase

Market Share

Slide 25

21 February 2008

Structurally Sound ... 100% 90% 80% 70% 60%

Others

50% 40% 30% 20% 10% 0%

FTY720 QAB149 agomelatine Lotrel Lucentis Exforge Diovan Eucreas (G) Femara Tekturna Lamisil Tasigna Trileptal agomelatine Zometa Aclasta Risk adjusted pipeline Generic risk as % of 2007 Incremental potential of potential as % of 2007 sales base portfolio as % of sales 2007 sales (2007-12)

Slide 26

21 February 2008

New Product Cycle - "Show Me The Money"

Sales in USD mn

20,000 15,000 10,000 5,000 0 2002

2004

2006

2008E

2010E

Annual sales of drugs losing patents Annual sales of new drugs Annual sales of base portfolio (not new, not generic)

2012E

Slide 27

21 February 2008

Valuation And Earnings Discrepancy

100% 90% EBIT vs EV contribution

80%

1013

16357

1253 22320

70% 60% 50% 40%

7217

30%

55896

20% 10% 0% EBIT Pharmaceuticals & Vaccines

EV Sandoz

Consumer Health

Slide 28

21 February 2008

Back-Integrated Sum-of-Parts (SOP) Valuation in million USD Novartis share price (in CHF) Novartis share price in USD (Fx: 1.0) Number of shares (diluted) * Market Capitalisation

2007 50.8 50 2330 116500

2008E 50.8 50 2287 114350

7400

11457

Cash value of Roche equity holding (in USD) Roche bearer share price (in CHF) Nbe of Roche bearer shares owned by Novartis

11193 210 53.3

11193 210 53.3

Enterprise Value (EV)

97907

91700

Sandoz (generics) sales Mean peer EV/Sales multiple Implied EV (Sandoz)

7169 2.8x 20073

7972 2.6x 20726

Consumer Health (OTC, animal, vision) sales Mean peer EV/Sales multiple Implied EV (Consumer Health)

5426 3.2x 17363

5842 3.0x 17526

Corporate overhead EBITDA Mean peer EV/cost Implied EV (Corporate overhead)

>638 5.0x >3190

>468 5.0x >2340

Implied EV of Pharmaceuticals & Vaccines

63661

55788

Pharmaceutical sales Vaccines (& Diagnostics) sales Total Pharmaceuticals & Vaccines/Dx sales

24025 1452 25477

25277 1646 26923

Pharmaceutical EBITDA Vaccine (& Diagnostics) EBITDA Total Pharmaceutical and Vaccine/Dx EBITDA

7688 448 8136

8368 485 8853

Implied Pharmaceuticals & Vaccine/Dx EV/Sales (x) Mean peer sector EV/Sales multiple Discount Novartis versus peers Implied Pharmaceuticals & Vaccine EV/EBITDA (x) Mean peer sector EV/EBITDA multiple Discount Novartis versus peers

2.5x 3.5x 828% 7.8x 11.5x 832%

2.1x 2.8x 826% 6.3x 8.5x 826%

Net Cash *

Slide 29

21 February 2008

Novartis - A Takeover Target?

50

44

40 30 20 6.5x

6.3x

10 0 -10 -20

-24

-30 Novartis

Pfizer Net add-on potential (%)

EV/EBITDA (x)

Slide 30

21 February 2008

Big Pharma's Pain is Generic's Gain

25%

20%

15%

10%

5%

0% 1996

1998

2000

2002

2004

US/EU Big Pharma Rx sales growth (l.c.)

2006

2008E

2010E

US/EU Generic (Gx) sales growth (l.c.)

Slide 31

21 February 2008

Market Does Not Appear to Value Sandoz (Generics) Due To Potential "Conflict of Interest"

25% 20% 15% 10% 5% 0% -5% 1996

1998

2000

2002

2004

US/EU Generic (Gx) sales growth (l.c.)

2006

2008E

2010E

Novartis Generic sales growth (l.c.)

Slide 32

21 February 2008

Special Situation - Roche "High on DNA" (Buy - PT: CHF 235)

Slide 33

21 February 2008

Roche NVES relative to MSCI European Pharmaceuticals 260

240

220

200

180

160

140

120

100

80

60 2002

2003

2004

2005

2006

2007

2008

ROCHE HOLDINGS GSH. Rel to MSCI Pharma Source: DATASTREAM

Slide 34

21 February 2008

Roche Rx Substantially Outperforms Peers

30% 25% 20% 15% 10% 5% 0% 1996

1998

2000

2002

2004

US/EU Big Pharma Rx sales growth (l.c.)

2006

2008E

2010E

Roche Pharmaceutical Sales

Slide 35

21 February 2008

Substantially Scalable... "Cash Cows"

Growth

"Stars"

Tarceva (ex.-US)

Bonviva

Avastin (ex.-US/Jap)

New Drugs Pipeline Drugs

Herceptin (ex-US)/Jap) Xeloda Mabthera (ex-US/Jap) Bondronat Fuzeon

Actemra (RA)

Mircera

"Pipeline"

Pegasys

CellCept Tamiflu Dilatrend

ocrelizumab (ex-US)

Pertuzumab (ex-US) R1583 (diabetes)

Valcyte

HPV16

Xenical

Kytril

EPO (ex-US)

Viracept/ Fortovase

Rocephin

R1626 (HepC)

Accutane

R1658 (dyslipidemia) Cost Phase

"Dogs" Return Phase

Market Share

Slide 36

21 February 2008

Structurally Sound ...

100% 90% 80% 70% 60%

DNA

50% 40%

Other

30% 20%

Mircera M/ocralizum ab Actem ra

10%

Avastin

0% Risk adjusted pipeline potential as % of 2007 sales

CellCept NeoRecorm on DNA Dilatrend Roche

Generic risk as % of 2007 sales

Increm ental potential of base portfolio as % of 2007 sales (2007-12)

Slide 37

21 February 2008

New Product Cycle - "Show Me The Money"

20,000

Sales in CHF mn

15,000 10,000 5,000 0 2002

2003E

2004

2005

2006E

2007E

2008E

-5,000 Annual sales of drugs losing patents Annual sales of new drugs Annual sales of base portfolio (not new, not generic)

2009E

2010E

Slide 38

21 February 2008

Back-Integrated Sum-of-Parts (SOP) Valuation Price Roche NVES + Bearer NVES Bearer Total in CHF mn Genentech (DNA) (in USD) FX DNA in CHF mn Roche ownership (56%) Chugai (Japan) Fx Chugai in CHF mn Roche ownership (51%)

Nbe of shares

Market Cap

191 210

699 160

133509 33616 167125

81

1070

86670 1.0 86670 48535

1087

551

598937 1.01 5930 3024

"Equity value" of underlying Roche (CHF mn)

115566

115566

115566

115566

Net cash owned by Roche (90% of total) Enterprise value (EV; CHF mn)

2005 8163 107403

2006 12286 103279

2007 15041 100525

2008E 18619 96946

Roche Rx and Dx Sales Implied sales multiples Global sector mean Premium (Discount)

2005 23,962 4.5x 3.8x 18%

2006 28,101 3.7x 3.6x 2%

2007 30,918 3.3x 3.5x 87%

2008E 32,331 3.0x 2.8x 7%

7796 13.8x 12.6x 9%

9035 11.4x 11.5x 81%

10569 9.5x 10.5x 89%

11513 8.4x 8.5x 81%

Roche Rx and Dx EBITDA Implied EBITDA multiple Global sector mean Premium (Discount)

Slide 39

21 February 2008

Nycomed "Life After Pantoprazole"

Slide 40

21 February 2008

Preparing for Life Beyond Pantoprazole... Cash Cow s

Pipeline drugs

New drugs

Growth

Stars

Alvesc

Preotac

Bradley Pharm a

Tachosil Om naris Angiom ax Instanyl ZyCom b

Im agify

Protonix TransMID

Alvesco + LABA FDC Dogs Cost Phase

Return Phase

Market Share

Slide 41

21 February 2008

Overcoming the Pantoprazole Patent Overhang...

100% 90% 80% 70% 60% 50% 40% 30%

Others

20%

Alvesco + FDC

10%

Om naris

Protonix/ pantoprazole

?

0% Risk adjusted pipeline potential as % of 2007 sales

Generic risk as % of 2007 sales

Increm ental potential of base portfolio as % of 2007 sales (2007-12)

Slide 42

21 February 2008

Risk Profiling of Nycomed Risk Grade

5 (low risk)

4

3

2

1 (high risk)

50% or more

>= 30% - 50%

>= 15% - 30%

0 to 15%

0

(Sum of probability weighted value of pipeline projects / current sales base)

-0.40%

-0.20%

0.00%

0.20%

0.40%

Generic Risk (Portfolio rate at risk)

= 10% - 20%

>= 20% - 30%

>= 30% - 50%

above 50%

(Sales at risk of losing patents in coming 5 years at 100% / current sales base)

-0.40%

-0.20%

0.00%

0.20%

0.40%

Incremtental potential of underlying portfolio

> 36%

26% - 35%

16% - 25%

0% - 15%

< 0%

(Sales of the underlying product portfolio not new, not at risk of patent loss - as % of current sales)

-0.40%

-0.20%

0.00%

0.20%

0.40%

No leadership + among top 10 in 3 therapeutic groups

No leadership and not among top 10 in 3 therapeutic groups at least

Pipeline Potential (Portfolio replacement rate)

Therapeutic Leadership

(Based on world market shares and serves as an indicator of a company's success in franchise building, ie., knowledge building)

Geographical Exposure

(% of sales (direct and indirect sales) in the fast growing "free" US market)

Business Diversification

(% of sales derived from prescription drugs)

3 leaderships in 2 leaderships in 1 leaderships in therapeutic groups of therapeutic groups of therapeutic groups of average size $10bn+ average size $10bn+ average size $10bn+

-0.40%

-0.20%

0.00%

0.20%

0.40%

US sales of 60% or more

US sales of > 45%

US sales of > 30%

US sales of > 15%

US sales of < 15%

-0.40%

-0.20%

0.00%

0.20%

0.40%

100% of sales from prescription drugs

> 75% of sales from prescription drugs

> 50% of sales from prescription drugs

> 25% of sales from prescription drugs

< 25% of sales from prescription drugs

-0.40%

-0.20%

0.00%

0.20%

0.40%

Slide 43

21 February 2008

What Would an Appropriate Discount Rate for Nycomed Be?

12.0% 10.0% 8.0% 6.0%

0.56%

0.50%

0.50%

0.75%

0.75%

0.75% 0.8%

4.0%

4.0%

4.0%

4.0%

4.0%

4%

4.5%

4.5%

4.5%

4.5%

4.5%

4.50%

-1.0%

-0.7%

-0.2%

-0.3%

-0.2%

Novartis (8.8%)

GSK (8.95%)

Sanofiaventis (8.3%)

4.0% 2.0% 0.0% -2.0% Roche (7.5%) AZN (8.3%)

Risk free

Market risk premium

Company spec. Risk premium

Nycomed (~10%)

Pipeline risk premium

Slide 44

21 February 2008

Slide 45

Remember ... Valuation is Not Strictly a Science But More Like an Art !

"Not everything that can be counted counts and not everything that counts can be counted" (Albert Einstein)