Yale(merc) sample valuation

Topics: Pharmaceutical industry, Pharmacology, Food and Drug Administration Pages: 20 (6269 words) Published: October 25, 2014
Merck & Co., Inc.
Recommendation: Buy
Target Price
Current Price
Difference

$ 37.09
$ 26.18
41.7%↑

Market Cap.
52 Wk High
52 Wk Low

$ 57.48B
$ 36.26
$ 25.50

Shrs. Out.

2,217.6M

As of October 21, 2005

• Market reaction to Vioxx lawsuits
too extreme
• Cash flow for company strong
enough to absorb potential legal or
competitive challenges
• Potential blockbuster drugs in the
pipeline
• A stable of existing drugs to
continue driving growth
• Aging and growing population
• Medicare Modernization Act of
2003 a boon to drug companies

Bryan Heller and Peter Lavallee, student analysts
Yale School of Management
MGT 948 – Securities Analysis and Valuation

Please see Important Disclaimer at the end of this report

Table of Contents

Investment Thesis………………………………………………….…………………….1 Company Overview…………………………………………………………….………..2 Important Revenue Producing Drugs…...……………………………………………..3 Drugs in the Pipeline……………………………………………………….....................6 Demographic Changes………………………………………………………………….10 Growing Population

Aging Population
Medicare Prescription Drug, Improvement,
& Modernization Act of 2003…………………………………………………..11 Partnerships and Joint Ventures………………………………………………………12 Vioxx Litigation………………………………………………………………………...12 Discounted Cash Flow Analysis………………………………………………………..13 Important Disclaimer …………………………………………………………................18

ii

Investment Thesis
We are initiating our coverage of Merck & Co., Inc. (Merck) with a Buy recommendation, based on an estimated value of $37.09 per share, which is 41.7% above the current price of $26.18. We believe the market is currently undervaluing Merck, primarily due to the existing Vioxx litigation. On September 30, 2004, the day of the announced recall of Vioxx, Merck’s stock dropped $11.48, from $42.84 to $31.36. With diluted shares outstanding of 2.226bn, that indicated a market assumption of earnings and litigation losses of $25.6bn. The market cap of the company dropped another $5.1bn on August 19, 2004, the day a Texas jury awarded a Vioxx plaintiff $253mm. Although the litigation is undoubtedly a drag on the firm, we believe the overall threat to the company is small and bankruptcy or restructuring is unlikely.

Merck is very strong, with free cash flow of over $6 billion from its current stable of drugs on the market. The pharmaceutical market is growing steadily in the US and abroad, and populations in most major pharmaceutical markets are aging. In addition, the Medicare Modernization Act of 2003 (MMA) should provide a boon to brand name drug manufacturers.

The company is facing potential risks to its future cash flows. Vioxx is currently on trial, but there is always the possibility of additional litigation relating to other drugs. The company’s two largest revenue producing drugs have patents expiring in the next few years. This will require new drugs from the pipeline to replace those revenues lost to generic alternatives. Drugs within the pipeline, however promising, are always risky in that they could be stopped at any time by an unsatisfactory trial or ruling by the FDA. And finally, regulatory reforms, including such measures as price caps, could be instituted by the US government. Although it is unlikely such a measure will come to pass in the near future, this could severely limit Merck profits. While there are risks to Merck, we believe them to be small or overstated by the market. In the final analysis, we believe Merck is well positioned to continue producing strong free cash flow in the future. These cash flows more than justify a Buy recommendation for the company.

16

Company Overview
Merck is an international pharmaceutical company with 63,000 employees, about half of them in the United States, that focuses on researching, developing, manufacturing and marketing new drugs, either on its own or through joint ventures. These drugs are created mostly for human use, although a portion of its revenues...
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