By Ryan Barnes. Edited by Douglas A. McIntyre
Big Pharma is notoriously hard to value, as the strength of the pipeline and product mix tends to determine future earnings power, and nobody ever knows for sure what will be approved, what will be a blockbuster, and for how long. Schering has already suffered through a dried-up pipeline and plummeting net income, and the stock has since rebounded some to trade nearly in-line with peers like Pfizer and Merck.
The company has three operating segments – Global Pharma, Consumer Health, and Animal Health – but Global Pharmaceuticals dominates the revenue figures, providing over 80% of the total company mix. The Consumer Health group doesn’t seem to be getting any attention from management; sales growth has been non-existent for several years, and the unit might benefit from being spun off or sold to someone like JNJ or PG. The unit has decent operating margins, but still deserves a low multiple in our analysis – we’ll value it at 10x segment earnings to account for the steady cash flow and 20% margins, which comes to $2 billion in breakup value.
It’s almost the same story for Animal Health, which consists mainly of vaccination drugs that are chiefly sold overseas. The unit has shown some decent top-line growth (high single digits) and expanding margins, but is probably too small to exist as a spin-off and would be instead sold off; we will give it a low-range pharmaceuticals multiple of 12x operating earnings to arrive at a value of $1.5 billion.
That leaves Ole’ Pharma and all of its valuation difficulties, plus the added trick of valuing the 50/50 cholesterol joint venture with Merck. The joint venture is currently adding about $1.6b in annual operating income to SGP in while still growing at over a 50% clip. However, considering all of the R&D effort put into cholesterol drugs worldwide, it’s only a matter of time before someone comes along and invades their space. For the sake of analysis we’ve calculated a 7 year “usable life” of the partnership at current revenue rates; it could last longer but when factoring in competition and generics a conservative estimate is the most prudent. This values the partnership at $11 billion, and leaves us with the remaining pharmaceutical business – known around Wall Street as one of the weaker pipelines amongst the big boys. To account for this we’ve applied an industry multiple on the very low end amounting to 3x sales, bringing the value of this segment to just north of $25 billion. Adding in the net of current accounts and subtracting long-term debt gives us a total breakup value of over $29.50 per share and highlights surprising value given all of our conservative assumptions.
Ryan Barnes
Ryan Barnes has over 10 years’ experience in portfolio management and investment research, covering equities, fixed income, and derivative products. Ryan spent the past 5 years working as an institutional trader & manager for high-net worth investors, working with Merrill Lynch, Charles Schwab, Morgan Stanley, and many others. Ryan is currently working as a writer and financial modeling consultant on hedging and capital appreciation strategies, and does not own securities in the companies being covered.
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