Gilead Sciences (NASDAQ:GILD)
Date of Report: June 1, 2010
Recommendation: BUY
Gilead Sciences is a biotechnology firm that develops and manufactures therapies to treat HIV and
other chronic infectious diseases. Through recent acquisitions, the firm has broadened its scope to
include pulmonary and cardiovascular disease. Gilead’s HIV franchise, which leads market sales
worldwide, continues to drive profitability with limited patent expiration exposure. Projected
benefits from the impact of health care legislation, maintenance of forerunner status in HIV
therapy, and diversification into new fields of medicine will ensure strong growth and earnings.
Catalysts
Ohio State University SIM Fund
 Gilead remains undervalued as uncertainty
persists over successful development and sales of
two new blockbuster drugs intended to supplant
sales of Atripla, the market leader for HIV/AIDS
therapy.
 Although uncertainty remains over the impact of
health care legislation, Gilead stands to benefit
from outcomes and has evaded potentially
unfavorable policies.
 Earnings were strong this quarter. Gilead’s
earnings reports have consistently met or
exceeded consensus expectations for the past
several years.
Analyst
Justin Mahida
mahida.1@osu.edu
(513) 207-6346
Fund Manager
Chris Henneforth, CFA
Royce West, CFA
Risks
Market Data
 Gilead has undertaken a series of acquisitions
which have yet to prove their profitability.
 Diversification into unrelated medical conditions
does not seem consistent with Gilead’s overall
strategy and may dilute shareholder value.
 Future value rests on the likelihood of success of
the two HIV/AIDS blockbuster therapies currently
in testing.
52-wk range
Total Enterprise Value
Market Cap.
F.D. Shares Out.
Share price performance chart
49
47
Price (June 1, 2010)
Target Price
% Upside
GICS Sector
GICS Industry
Style
$35.92
$53.00
48%
Health Care
Biotechnology
Large cap, Growth
$35.62 - $50.00
$35.551 billion
$32.197 billion
931 million
Financial Summary
EV/EBITDA
Net Margin
Asset Turnover
ROA
Financial Leverage
ROE
Dividend Yield
8.63X
38.35%
0.83
31.86%
1.46
47.78%
N/A
45
43
Projections
41
39
37
35
5/09
9/09
12/09
3/10
Revenue (bn)
EPS
Consensus
2009
7.011
2.82
2010E
8.203
3.44
3.624
2011E
8.679
3.64
3.931
2012E
9.434
3.95
4.464
Table of Contents
Company overview ................................................................................................................ 1
Management............................................................................................................................................. 1
Recent news .............................................................................................................................................. 2
Strategy overview ................................................................................................................. 3
Competition .............................................................................................................................................. 3
Quantitative Analysis ................................................................................................................................ 4
External Analysis ................................................................................................................... 5
Health care reform .................................................................................................................................... 5
Macroeconomic Exposure ........................................................................................................................ 6
Financial Analysis .................................................................................................................. 6
Profitability Analysis.................................................................................................................................. 6
Efficiency Analysis ..................................................................................................................................... 7
Liquidity Analysis....................................................................................................................................... 8
Volatility .................................................................................................................................................... 8
Financial statement projections ............................................................................................................... 8
Valuation Analysis ................................................................................................................. 9
Equity Valuation: Multiples....................................................................................................................... 9
Equity Valuation: DCF ............................................................................................................................. 10
Equity Valuation: Composite .................................................................................................................. 11
Investment Thesis ............................................................................................................... 11
Catalysts .................................................................................................................................................. 12
Risks ........................................................................................................................................................ 12
Summary ............................................................................................................................. 12
Appendix A: Selected Financial Data .................................................................................... 13
Appendix B: Discounted Cash Flow Valuation ...................................................................... 14
Appendix C: Endnotes.......................................................................................................... 15
Company overview
Gilead Sciences, Inc., which was founded in 1987
and went public in 1992, is a research-based
biopharmaceutical company that discovers,
develops and commercializes medicines.
Gilead’s primary areas of focus include HIV/AIDS,
liver disease and serious cardiovascular and
respiratory conditions. Gilead’s portfolio of
eleven marketed products (Exhibit 1) includes a
number of market leaders such as Atripla, the
first single-tablet regimen for HIV infection. The
company’s first product for HIV infection, Viread,
has also more recently been approved for the
treatment of chronic hepatitis B. Gilead holds a
strong pipeline of future products (Exhibit 2),
positioning the firm well to maintain its status as
the leader in HIV therapy while diversifying into
other medical conditions.i
Exhibit 1: Gilead’s current products. Tamiflu and
Macugen are licensed to other firms and, as such, are
not sold directly by Gilead.
Brand
Name
Indication
AmBisome
fungal
infections
HIV
HIV
pulmonary
hepatitis B
pulmonary
macular
degeneration
influenza
HIV
HIV, Hepatitis
B
CMV retinitis
Atripla
Emtriva
Flolan
Hepsera
Letairis
Macugen
Tamiflu
Truvada
Viread
Vistide
Exhibit 2: Gilead’s pipeline of expected products.
Phase
I
Phase
II
•
•
•
•
•
•
•
•
•
•
•
Phase
III
•
•
•
GS 6201 (pulmonary disease)
GS 9667 (diabetes/dyslipidemia)
GS 9256 (Hepatitis C)
Ranolazine (diastolic heart failure)
Aztreonam – Inhalation (bronchiectasis)
Cicletamine (pulmonary arterial
hypertension)
GS 9190 (Hepatitis C)
GS 9450 (nonalcoholic steatohepatitis)
Cobicistat (HIV/AIDS)
Aztreonam – Inhalation (Cystic Fibrosis)
Integrase Fixed-dose Regimen "Quad"
(HIV/AIDS)
Elvitegravir (HIV/AIDS)
Truvada/TMC278 (HIV/AIDS)
Ambrisentan (Idiopathic Pulmonary
Fibrosis)
% of
Total
Revenue
4.3%
U.S. Patent
Expiration
2016
38.7%
0.4%
NM
3.3%
3.1%
NM
2021
2021
expired
2014
2015
2017
NM
36.8%
10.1%
2016
2021
2017
NM
2010
Management
In general, management has been effective in
stimulating a pipeline of products for Gilead’s
sales. John Martin has served as CEO of the firm
since 1996, and there have been few
management restructuring activities during the
history of the firm. Management has made an
active effort to diversify Gilead’s pipeline from
HIV blockbusters to products in hepatitis, cardiac,
and respiratory care.i
Of notable interest is a series of acquisitions that
have been undertaken by management (Exhibit
3). Gilead entered the cardiovascular arena
primarily through acquisition, which may reflect
overpayment for rights to cardiovascular and
Gilead Sciences
Analyst: Justin Mahida
Page 1
pulmonary drug products.ii
The board is properly incentivized and equipped to complete its fiduciary responsibilities to
shareholders. Gilead has a 13 member board of directors. John Martin, CEO of Gilead Sciences since
April 1996, has served as Chairman of the Board since May 2008. However, beyond this there is little
concern of an insider board being in control of the organization. Board members have a diverse skill set
in science, medicine, and management, and there is no interrelatedness or insider control of the board
that is apparent. Review of the Audit Committee membership also reveals three independent directors
with no apparent insider relations.iii
Insider activity has been favorable. On May 11th, Gilead announced that it had completed a $1 billion
share buyback program and that its board of directors had approved a $5 billion share buyback program.
In 2006, John Martin began prescheduled exercise of 100,000 monthly options, eliminating concern
about timing and size of option exercise. Besides this, there has not been a significant outflux of shares
from insiders.iii
Recent news
Gilead has been successful in advancing its HIV pipeline drugs. On April 27th, Gilead announced that it
had completed bioequivalence testing for a single-pill Truvada and TMC278 regimen, for which it is
Exhibit 3: Acquisitions undertaken by Gilead since 1999.
Year
1999
Company
Nexstar
Pharmaceuticals
Triangle
Pharmaceuticals
Price
$550
million
$464
million
2006
Corus Pharma,
Inc.
$365
million
2006
Myogen, Inc.
$2.5
billion
2006
Raylo Chemicals,
Inc.
$148
million
2007
Nycomed fr.
Altana - Cork
$47
million
2009
CV Therapeutics,
Inc.
$1.4
billion
2003
Notes
Gilead acquired AmBisome as part of this acquisition. Gilead also
acquired a sales force in Europe and Australia.
Acquired emtricitabine, marketed not only as a stand-alone product
(Emtriva) but as a component of the more profitable combination
products Atripla and Truvada.
The acquisition of Corus signaled Gilead's entry into the respiratory
arena. Corus was developing inhalation aztreonam for the treatment of
patients with cystic fibrosis who are infected with Pseudomonas
aeruginosa.
With two bioequivalent drugs in development (ambrisentan and
darusentan), and one marketed product (Flolan) for pulmonary diseases,
the acquisition of Myogen is consistent with Gilead’s entry into
cardiopulmonary care.
This Alberta, Canada site will be used for process research and for
manufacturing compounds for both clinical studies and commercial
products.
This commercial manufacturing site was purchased by Gilead in place of
building a site in Dublin. This site is formerly Altana in Cork which was
purchased by Nycomed.
This acquisition brings Ranexa and Lexiscan as commercial products.
Ranexa is a cardiovascular drug used to treat cardiac chest pain. These
products and pipeline build out Gilead's cardiovascular franchise.
Gilead Sciences
Analyst: Justin Mahida
Page 2
expected to file a new drug application. Also, on April 12th, Gilead initiated Phase III testing of its Quad
regimen single dose pilliv. Both of these products are expected to successfully capture sales from Atripla
before patent expiration occurs, reinforcing Gilead’s position in the HIV/AIDS market. Also, because the
Quad regimen is composed of products fully held by Gilead, Gilead will not be responsible for licensures
or royalties to other firms from sales of the Quad regimen, unlike current sales of Atripla, and will
receive higher margins on sales
Outside of HIV/AIDS, however, Gilead has not been as successful. On April 19th, Gilead announced
termination of Phase II trials for GS 9450, a drug for Hepatitis Cv. Likewise, experimental blood pressure
drug darusentan failed to meet goals for efficacy in a late-stage bioequivalence study.vi
Strategy overview
Gilead has focused on development, marketing, and sales of HIV and AIDS medications, representing a
high-growth and high-margin market. Sales of Atripla, an all-in-one triple combination pill that currently
serves as the only single-pill drug regimen on the market for AIDS, are strong. Clinical data indicates
that patients on single-drug regimens are less likely to miss doses or to develop drug resistancevii.
Gilead’s sales data reveals that 75% of all treated HIV patients in the US use Atripla, Truvada, or
Vireadviii. Gilead continues to focus on HIV and AIDS medication with its two new blockbuster drug
regimens Truvada/TMC278 and the Quad pill, both of which are also single-drug regimens.
Recently, Gilead has attempted growth through acquisition and diversification into other fields of
medicine. To an extent, the logic behind this is based on the technology required with HIV and AIDS
medications; biopharmaceutical techniques to counteract the HIV viral strains can be applied to
Hepatitis C viral strainsix. However, Gilead has moved beyond this simple logic to acquire other drugs
that do not use this same biotechnology, and Gilead’s ability to generate a profit from economies of
scope or of sale is questionable. Gilead has yet to reveal strong sales in these fields of medicine outside
of HIV.
Competition
Gilead competes with both pharmaceutical firms and other biotechnology firms. Gilead is larger than
many biotechnology firms because of its successful sales of HIV drugs; Gilead also does not suffer from
the capital constraints that affect many of these smaller firms. Although Gilead is smaller than many
pharmaceutical firms, it originally did not need a large sales force because its products were focused
around HIV medications, which in suit are sold through distributors and marketed to specific areas
within health care as opposed to blockbusters in Pfizer or Merck’s pipelines that are marketed to the
general medical community. As Gilead enters cardiovascular and pulmonary disease, the firm has met
its need to increase manufacturing and sales resources through acquisition.
Gilead Sciences
Analyst: Justin Mahida
Page 3
Exhibit 4: Growth and profitability metrics for Gilead
as compared to competitors; both metrics are
indexed. Note Gilead’s superior performance in both.
1
0.9
GILD
0.8
0.7
ROE
0.6
0.5
MRK
AZN
0.4
GSK
AMGN
0.3
0.2
Quantitative Analysis
BIIB
SNY
PFE
0.1
0
GENZ
0
Gilead is unique within the competitive landscape
due to its focus on drugs for one disease. Amgen,
Inc., a biotechnology firm with market
capitalization of $50 billion and 2009 sales of $14.3
billion, is different in that it sells drugs marketable
to multiple fields of medicine. Gilead benefits
from lower overhead costs and a clear position of
market leadership, but takes on risk of failure to
diversify.
0.5
1
% Sales Growth over 1 year
Exhibit 4 presents indexed growth and profitability
metrics for Gilead and several competitors, in
which it can be seen that Gilead occupies a unique
position from other firms. Gilead is experiencing
the growth levels of biotechnology firms, but also
exhibits the profitability of mature firms such as
those in pharmaceuticals because of its cash flows
from HIV products.
If we look at management performance, we also see superior performance by Gilead. Gilead
outperforms competitors in asset turnover (Exhibit 12) and in revenue per employee over the past three
yearsx. This is without destruction of long-term profitability; research and development spending as a
percent of revenue is comparable to competitors, and likely understated considering the number of
acquisitions made by Gilead (Exhibits 5 and 6).
Exhibit 5: Revenue per employee for Gilead over the
past three years as compared to competitors, in
millions. Note Gilead’s superior performance.
$1,800
$1,600
$1,400
$1,200
$1,000
$800
$600
$400
$200
$-
Exhibit 6: Research and development spending as
a percent of revenue for Gilead and competitors.
True research investment by Gilead is likely
understated due to investment through
acquisition.
SNY
PFE
MRK
GSK
GILD
GENZ
BIIB
AZN
AMGN
SNY
PFE
MRK
GSK
GILD
GENZ
BIIB
AZN
AMGN
30%
25%
20%
15%
10%
5%
0%
Gilead Sciences
Analyst: Justin Mahida
Page 4
External Analysis
Unlike sectors such as energy, in which commodity prices are tied to profitability; or consumer
discretionary, in which economic metrics such as consumer confidence can be correlated to firm value,
health care sector firms have few economic correlates from which expectations can be derived.
Exhibit 7: The percentage of the US Classically, unemployment was valuable, as employment is
population over age 65 continues to correlated with likelihood of having health care insurance, a
increase and will reach 20% by 2030.
main driver for spending within the sector. However, with the
passage of health care reform in the US, material changes to the
25%
sector make even the few economic variables that were useful
20%
less meaningful.
15%
10%
There are noneconomic variables that speak to potential
outcomes in the health care sector. The percentage of
0%
Americans above age 65 has steadily increased over time. Note
1900 1950 2000 2050
that the first of the baby boomers will reach age 65 by 2011
(Exhibit 7)xi. Seniors are more likely to have multiple chronic
65+
85+
conditions, use the most pharmaceuticals, have the highest
number of physician visits, and require care by a larger variety of
specialists than others in their cohort group.
5%
Health care reform
Most critical to the structure of the biotechnology industry and to the sector as a whole has been health
care reform within the US, passed in late Marchxii. There have been several favorable material changes
to the biotechnology industry:
-
-
-
A tax penalty incentivizes more Americans to carry health insurance. People with health
insurance are more likely to seek medical care for screening of conditions such as HIV. Insured
people are also more likely to use brand-name drugs when they are medically indicated.
Stronger patent protection is applied to biologic products, a class of drugs that Gilead
manufactures. This reduces much of the uncertainty surrounding the patent protection of
Atripla.
Legislation does not contain provisions that would allow the government to negotiate prices
directly with pharmaceutical companies. This was originally of concern to Gilead, since brandname drugs would be the most likely targets to lose purchasing power. However, since this
language was not included, expectations originally priced into Gilead’s market value are now
resolved.
With these points noted, Gilead did revise its product sales forecast for 2010 downward by $200 million.
25% of users of HIV pharmaceutical products receive their drugs through federal assistance programs,
Gilead Sciences
Analyst: Justin Mahida
Page 5
and 35% of US sales go through a federal payerxiii. Health care legislation expanded the size of the
Medicare and Medicaid programs, effectively increasing the percentage of sales to people through these
channels and lowering net revenue for HIV medications; however, health care legislation also appears to
favorably affect the number of patients who will use brand-name HIV medications in the future.
Macroeconomic Exposure
Although the health care sector is typically considered to be defensive, this is questionable for
biotechnology firms. Not so with Gilead, which maintains sufficient cash flows from sales of HIV
pharmaceuticals to override cyclicality, which for other biotech firms is implicitly imposed by debt
markets during recessions.
The biotechnology industry
Exhibit 8: Annual revenue for Gilead, remains a growth industry, with projected CAGR of XXX% from
broken down by country.
2004 to 2009.
2009
2008
2007
USA
51.3%
53.6%
51.2%
UK
5.6%
5.6%
5.3%
Germany
4.2%
4.5%
2.8%
Italy
4.6%
5.2%
4.9%
Spain
6.4%
6.7%
5.8%
France
6.7%
7.4%
8.3%
Switzerland
6.4%
3.6%
10.5%
Other EU
8.6%
6.5%
5.0%
Other
6.2%
6.9%
6.2%
Gilead does have considerable exposure to foreign exchange
rates (Exhibit 8). 43% of sales in 2009 were to Europe. If the
Euro continues to lose value, Gilead stands to lose profitability.
With this noted, Gilead also appropriately uses foreign
exchange derivatives to manage risk. Additionally, with
acquisition of manufacturing capacity in Cork, Ireland, Gilead
generates a considerable hedge in product sales. Although
Gilead does sell considerable volume of drugs to Africa and
Asia, sales outside of North America and Europe only
comprised 6.9% of total revenue in 2009 and exposures to
these areas are not concerning.xiv
Financial Analysis
Profitability Analysis
Profitability margins have steadily decreased from 2005 through 2009 (Exhibit 9), primarily as sales of
Atripla have increased. Because Atripla contains a drug that Gilead licenses from another firm, its
margins are not as high as other products. On the other hand, net profits have continued to increase.
Once Truvada/TMC278 and the Quad regimen enter the market, they can be expected to capture Atripla
sales with higher margins for Gilead.
Gilead Sciences
Analyst: Justin Mahida
Page 6
Comparing margins to competitor
firms (Exhibit 10), Gilead performs
well in comparison. Gross margins are
low in comparison, but Gilead still has
superior operational margins. These
will increase once higher-margin
Truvada/TMC278 and Quad regimen
sales supplant Atripla sales.
Exhibit 9: Profitability metrics for Gilead from 2005 to 2009.
Despite a downward trend in margins, returns on equity and on
invested capital have continued to improve. It is anticipated that,
with the sale of Truvada/TMC278 or the Quad pill, margins should
increase favorably.
2005
2006
2007
2008
2009
Gross Margin
87.2%
85.7%
81.8%
78.9%
77.2%
Operating Margin
54.8%
-25.1%
51.2%
50.2%
50.3%
Net Margin
40.1%
-39.3%
38.2%
37.7%
37.6%
Efficiency Analysis
Return on Assets
53.9%
74.1%
72.5%
76.0%
72.3%
There are no material changes to
efficiency metrics over the past five
years (Exhibit 11), and no reason to
believe that Gilead is unable to control
Return on Equity
8.1%
10.1%
9.5%
10.9%
17.3%
Return on Inv. Cap.
7.3%
9.6%
8.8%
10.0%
15.0%
CFFO/Assets
5.6%
12.1%
12.4%
11.9%
12.6%
Exhibit 10: Comparative profitability metrics for Gilead and its competitors. Notice that, despite having a lower
gross margin, Gilead has higher operating and net margins than competitors.
100%
100%
50%
50%
0%
0%
Average margin over the past 5 years
Gross Margin
Operating Margin
Net Margin
Margin for the past 12 months
Gross Margin
Operating Margin
Net Margin
asset management. This is despite acquisitions that occurred over the past two years to increase
manufacturing capacity, indicating that Gilead has been able to successfully integrate the new facilities
into its operations.
Although inventory turnover is low as compared to competitors (Exhibit 12), this is because of the
nature of the technology used for Gilead’s products; biologic products require more steps for
manufacturing. Inventory turnover is
Exhibit 11: Efficiency metrics for Gilead from 2005 through 2009
comparable to Amgen and Pfizer, two
2005
2006
2007
2008
2009
firms that use equally complex
Inventory turnover
1.200 0.768 1.281 1.215 1.517
technologies in developing products.
A/R
turnover
5.121 4.966 5.320 5.214 5.046
Despite this discrepancy, Gilead has one
A/P turnover
4.262 1.181 2.648 1.875 1.969
of the best asset turnover ratios of its
Asset turnover
0.539 0.741 0.725 0.760 0.723
benchmark group.
Gilead Sciences
Analyst: Justin Mahida
Page 7
Exhibit 12: Comparative efficiency metrics for Gilead and its competitors. Gilead underperforms with accounts
payable and inventory turnover. However, asset turnover is excellent.
Inventory turnover
A/R turnover
A/P turnover
Asset turnover
AMGN
0.964
6.572
2.406
0.370
AZN
3.396
3.015
0.711
0.623
BIIB
1.360
5.809
3.139
0.542
GENZ
2.359
4.912
8.169
0.451
GILD
1.394
5.074
1.798
0.707
GSK
2.864
4.387
1.752
0.676
MRK
1.890
4.463
6.218
0.300
PFE
1.163
3.847
3.893
0.286
SNY
2.468
4.958
4.132
0.373
Liquidity Analysis
Liquidity ratios do show a downward trend from 2005 through 2009 (Exhibit 13), reflective of the
number of acquisitions that Gilead undertook. However, Gilead does not appear to suffer from a
liquidity crunch. Gilead appears to have one of the better liquidity positions in comparison to
competitors (Exhibit 14), and none of the metrics noted indicate concern for financial distress.
Furthermore, the Altman Z-score (Exhibit 15) also does not indicate concern for financial distress.
Volatility
Implied volatility is calculated by applying the Black-Scholes formula to call and put options on Gilead.
Effectively, this allows for an assessment of the market’s projection of Gilead’s volatility; however, the
tool is only as valid as the Black-Scholes formula itself.
Exhibit 13: Liquidity metrics for Gilead from
Accepting this, it can be seen that projected volatility is 2005 through 2009. Although one might
consistent with historical volatility for Gilead.
initially be concerned by the decline in these
In comparing historic volatility to that of Amgen,
Gilead’s closest competitor, it is notable that while
Amgen had a decrease in historic volatility over the past
three years, Gilead did not. I attribute this difference to
Amgen’s more diverse pipeline of products.
Consequently, Gilead has greater potential for upside as
it appears the market has been undervaluing Gilead’s
pipeline, perhaps due to the volatility.
ratios, it is notable that Gilead does not appear
to be facing a liquidity crunch as compared to
competitors (Exhibit 14).
8
6
4
2
0
2005
Financial statement projections
Appendix A presents selected financial statement data
with projections for the next three years.
2006
Current ratio
2007
2008
Quick ratio
2009
Cash ratio
Exhibit 14: Comparative liquidity metrics for Gilead and its competitors.
Inventory turnover
A/R turnover
A/P turnover
Asset turnover
AMGN
0.964
6.572
2.406
0.370
AZN
3.396
3.015
0.711
0.623
BIIB
1.360
5.809
3.139
0.542
GENZ
2.359
4.912
8.169
0.451
GILD
1.394
5.074
1.798
0.707
GSK
2.864
4.387
1.752
0.676
MRK
1.890
4.463
6.218
0.300
PFE
1.163
3.847
3.893
0.286
SNY
2.468
4.958
4.132
0.373
Gilead Sciences
Analyst: Justin Mahida
Page 8
Exhibit 15: Altman Z-score for Gilead for 2005
through 2009. A Z-score above 3.0 indicates that a
firm is safe from financial distress, and a Z score
below 1.8 indicates that a firm is at critical risk of
financial distress. The dip into the grey zone in
2006 is due to impaired margins from the
acquisition of Myogen.
Exhibit 16: Implied volatility for Gilead, calculated
by applying the Black-Scholes formula to call and
put options at varying exercise dates and by noting
the minimum volatility for each set of options at a
given exercise date. Best fit line also noted.
5
4
3
2
1
0
30
28
26
24
22
20
2005
2006
2007
2008
2009
1/10
8/10
2/11
9/11
4/12
Valuation Analysis
Equity Valuation: Multiples
Exhibit 17 presents valuation of Gilead based on absolute multiples. Price/Book is not valuable for
understanding Gilead because of the transition from internally researching drugs to acquiring firms with
drug pipelines; research and development are not capitalized, but goodwill as part of an acquisition is.
However, all other metrics indicate that Gilead is undervalued if we believe that mean reversion theory
holds.
Exhibit 17: Absolute multiples valuation for Gilead, using data from over the past 22 years.
P/Fwd E
P/S
P/B
P/EBITDA
P/CF
High
Low
Median
Current
94.4
425.8
23.6
131.04
135.5
11.2
4.8
1.6
8.38
11.2
26.5
24.3
8.7
25.33
33.8
11.2
4.8
5
8.38
11.2
Target
Multiple
18.9
6.1
4.4
13.57
15.2
Target
Denom.
3.38
8.78
8.12
4.84
3.62
Target Price
63.88
53.55
35.73
65.68
55.02
Exhibit 18: Comparative multiples for Gilead and its competitors. AMGN, BIIB, GENZ, and GILD are biotech firms,
whereas the others are pharmaceutical firms.
EV/Sales
EV/EBITDA
P/Fwd E
P/CF
AMGN
4.124
8.624
9.180
8.120
BIIB
3.359
8.120
9.840
12.390
GENZ
3.260
19.558
12.840
12.980
GILD
4.621
7.992
8.570
10.840
AZN
2.076
4.601
NM
5.400
GSK
2.596
6.737
NM
7.190
MRK
2.910
12.820
8.280
20.990
PFE
2.794
7.953
6.550
16.020
SNY
2.338
5.884
6.360
7.600
Gilead Sciences
Analyst: Justin Mahida
Page 9
Exhibit 18 compares Gilead’s current multiples to competitors in biotechnology and pharmaceuticals.
Gilead is trading at lower multiples than other biotechnology firms, indicating that it is undervalued.
Gilead is also trading at comparable multiples to competitor pharmaceutical firms; however, because
Gilead has higher projected rates of growth, Gilead would have to trade at higher multiples to be
considered comparably priced to competitors.
Equity Valuation: DCF
Appendix B presents a discounted cash flow valuation for Gilead based on expected cash flows. DCF
analysis indicates that Gilead is currently undervalued. DCF carries more importance in determining
target pricing than multiples, because expected information on the various elements of the drug
pipeline can be projected independently. Expected cash flows are based on a weighted average of three
potential outcomes:
-
Bullish (30% likelihood): Gilead maintains 75% market share of HIV drugs, and the Quad pill and
TMC278 capture most of this.
Expected (50% likelihood): Gilead maintains 75% market share of HIV drugs, but the Quad pill
and TMC278 do not capture more than 30% of this.
Bearish (20% likelihood): Gilead is unable to maintain more than 50% of market share of HIV
drugs, as both the Quad Pill and TMC278 are not perceived to be clinically valuable as compared
to Atripla and Truvada.
Growth rates vary from year to year because the DCF model accounts for sales of each individual drug
under patent protection.
A discount rate of 9.5% was applied based on several factors. Health care firms tend to have low
correlation to the overall market. Within this larger view, biotechnology firms will have higher
correlation than other health care firms. Since Gilead sells branded pharmaceuticals, higher correlation
to the overall market can also be expected. The discount rate was found to be consistent with the
Fama-French three factor model (Exhibit 19).xv
Exhibit 19: Application of the Fama-French three factor model to determine an appropriate discount rate. Data
for the three indices from 2007 to 2009 were used for the regression, since Gilead underwent material changes
to its business operations in 2006. Inputs for the model reflect averages of each of the three indices
Intercept
Mkt-RF
SMB
HML
β
0.808
0.442
0.097
-0.607
S.E.
1.158
0.223
0.518
0.425
P-value
0.490
0.056
0.853
0.163
𝟎. 𝟖𝟎𝟖
𝟎. 𝟒𝟒𝟐 × 𝟎. 𝟏𝟔𝟎
𝟎. 𝟎𝟗𝟕 × 𝟎. 𝟐𝟑𝟕
−𝟎. 𝟔𝟎𝟕 × 𝟎. 𝟐𝟗𝟗
+
𝟎. 𝟕𝟐% 𝒑𝒆𝒓 𝒎𝒐𝒏𝒕𝒉
+
=
+ (𝟗. 𝟎% 𝒂𝒏𝒏𝒖𝒂𝒍𝒊𝒛𝒆𝒅)
Gilead Sciences
Analyst: Justin Mahida
Page 10
Exhibit 20: Sensitivity analysis for Gilead, with both
absolute stock price and percent upside noted.
Growth Rate
Terminal Value
3.5%
4.0%
4.5%
5.0%
5.5%
7.5%
8.5%
9.5%
10.5%
11.5%
$66
$72
$80
$91
$108
$54
$58
$62
$67
$75
$46
$48
$51
$54
$58
$41
$42
$44
$46
$48
$36
$37
$38
$40
$41
Growth Rate
Terminal Value
3.5%
4.0%
4.5%
5.0%
5.5%
7.5%
8.5%
9.5%
10.5%
11.5%
85%
101%
123%
153%
199%
51%
61%
73%
88%
108%
29%
35%
42%
51%
61%
13%
17%
21%
27%
33%
1%
3%
7%
10%
14%
A terminal growth rate of 4.5% was applied
based on several factors. Based on population
growth and inflation alone, a 3% rate of growth
can be assumed. HIV and AIDS screening has
been increasing over time, and this increase at
rates above growth rates based on inflation is
expected to remain in place into the distant
future. Populations have also been aging as the
elderly live longer and chronic diseases cost
more to treat. This will also prompt growth
above 3% into the distant future.
Exhibit 20 presents a sensitivity analysis.
Adjustments to the valuation make it clear that
changes in the revenue generated from the HIV
pipeline of products most strongly affect the
value of the firm. Also, it is notable that 52% of
the value of Gilead is explained by the terminal
value.
Equity Valuation: Composite
In valuing Gilead, I made the following assumptions:
-
Because it incorporates information on the pipeline of products, I gave the DCF analysis greater
weight than the multiples analysis in determining the value of Gilead (75% versus 25%).
I did not use the price:book multiple because of the material change in 2006 that affected
accounting for research and development as compared to acquisition. However, I felt that all
other multiples were appropriate and weighted them equally.
Therefore, target price is:
$51.01 × 75% +
$63.88 + $53.55 + $65.68 + $55.02
× 25% ≈ $𝟓𝟑
4
Investment Thesis
The “Buy” recommendation on Gilead is for two reasons. First, both multiples and DCF valuations
indicate that the firm is currently undervalued. This is despite positive earnings report and predictable
cash flows from the HIV franchise that protect Gilead from financial distress. Additionally, concerns
about US health care reform and uncertainty regarding extensibility of Gilead’s pipeline were originally
Gilead Sciences
Analyst: Justin Mahida
Page 11
priced into Gilead’s value. However, since resolution of both of these major pressures to Gilead’s favor,
the market has not reacted accordingly. It is anticipated that another strong earnings report will refocus
investors on Gilead’s solid cash flows through 2017 and away from the uncertainty of health care
legislation.
Catalysts
Gilead is not a typical biotechnology firm in that it derives significant cash flows from Atripla, and sales
are projected to remain strong through patent expiration in 2017. Also, as compared to other
biotechnology and pharmaceutical firms, Gilead faces less exposure to patent expirations. Furthermore,
sales of HIV medications are projected to increase because of CDC recommendations for increased
testing and earlier treatment of HIV, both of which will increase the number of people treated for HIV.
Risks
Gilead’s history of acquisitions is concerning because of their potential to be dilutive to shareholder
value. Because of the firm’s large cash position, it is possible that management will be incentivized to
undertake another acquisition. However, the $5 billion share buyback program signals that Gilead
understands its fiduciary responsibility to return money to shareholders and helps to mitigate likelihood
that management will undertake an acquisition to the detriment of shareholders.
The key risk to Gilead’s core business is likelihood of success of the two new drugs in the HIV franchise,
Truvada/TMC278 and the Quad regimen. For these drugs to be considered successful, they must
demonstrate superior outcomes to Atripla that are material enough to capture 75-80% of the market for
HIV therapy.
Summary
-
-
BUY recommendation with target price of $53, implying 46% upside on closing price of $35.92
from Friday, May 28th 2010.
Gilead should receive favorable outcomes from the impact of US health care legislation, as more
insured people will be able to purchase branded pharmaceuticals.
Gilead remains undervalued as uncertainty persists over successful development and sales of
two new blockbuster drugs intended to supplant sales of Atripla, the market leader for HIV/AIDS
therapy.
Risks include failure to successfully sell one of the two new blockbuster drugs as well as the
ability to realize value from recent acquisitions of non-HIV franchises.
Gilead Sciences
Analyst: Justin Mahida
Page 12
Appendix A: Selected Financial Data
Gilead Sciences (GILD)
('000s, excepting per-share amounts)
Total revenues
Consensus
FY
2012
9,701,956
10,013,000
FY
FY
FY
2011
2010
2009
8,836,025 8,273,432 7,011,383
9,156,000 8,271,000
FY
2008
5,335,750
FY
2007
4,230,045
FY
FY
2006
2005
3,026,139 2,028,400
Cost of goods sold
Gross profit
2,049,663
7,652,293
1,866,724
6,969,301
1,747,869 1,595,558
6,525,563 5,415,825
1,127,246
4,208,504
768,771
3,461,274
433,320 260,326
2,592,819 1,768,074
R&D expenses
SG&A expenses
Purchased in-process R&D
Operating income
1,280,658
1,309,971
0
5,061,664
1,166,355
1,193,052
0
4,609,894
1,092,093 939,918
1,117,089 946,686
0
0
4,316,380 3,529,221
721,768
797,344
10,851
2,678,541
591,026
705,741
0
2,164,507
383,861 277,724
573,660 379,248
2,394,051
0
-758,753 1,111,102
Net interest income
Pre-tax income
106,881
4,954,782
97,342
4,512,552
91,144 -17,102
4,225,236 3,512,119
55,864
2,734,405
105,831
2,270,338
120,546
50,690
-638,207 1,161,792
Provision for income taxes
Net income
1,189,148
3,765,635
1,083,013
3,429,540
1,014,057 876,364
3,211,179 2,635,755
723,251
2,011,154
655,040
551,750
1,615,298 -1,189,957
904,604
934,109
904,604
934,109
904,604
934,109
904,604
934,109
920,693
958,825
929,133
964,356
918,212
918,212
908,678
948,568
4.16
4.03
4.13
3.79
3.67
4.05
3.55
3.44
3.66
2.91
2.82
2.18
2.10
1.74
1.68
-1.30
-1.30
0.90
0.86
1,891,097
1,455,381
108,086
1,107,371
-209,494
1,722,310
1,325,484
98,439
1,008,535
-136,108
1,612,650 1,389,534
1,241,090 1,051,771
92,171
78,111
944,321 810,544
-292,718 -286,992
1,023,397
927,868
71,815
601,200
-260,583
795,127
599,966
56,537
290,333
-304,750
609,320
564,145
50,111
367,029
-256,219
396,125
216,903
48,383
61,083
294,660
318,340
268,361
289,927
102,467
115,005
51,279
78,648
47,284
105,208
35,777
47,951
Weighted average shares outstanding - basic
Weighted average shares outstanding - diluted
EPS - basic
EPS - diluted
EPS consensus - diluted
Accounts receivables, net
Inventories
Prepaid expenses
Accounts payable
Change in working capital
Depreciation and Amortization
Capital Expenditures
251,274
271,467
212,944
230,057
347,878
813,914
Gilead Sciences
Analyst: Justin Mahida
Page 13
Appendix B: Discounted Cash Flow Valuation
Gilead Sciences (GILD)
Justin Mahida
5/27/2010
(000s)
Year
Terminal Discount Rate =
Terminal FCF Growth =
2010E
Revenue
8,273,432
% Grow th
18.0%
Operating Income
4,316,380
Operating Margin
52.2%
Interest Income
91,144
Interest % of Sales
1.1%
Taxes
1,014,057
Tax Rate
24.0%
Net Income
3,211,179
% Grow th
251,274
% of Sales
Plus/(minus) Changes WC
% of Sales
Subtract Cap Ex
6.8%
4,609,894
52.2%
97,342
1.1%
1,083,013
24.0%
3,429,540
52.2%
106,881
1.1%
1,189,148
24.0%
3,765,635
9.8%
294,660
8.7%
5,502,028
52.2%
116,180
1.1%
1,292,604
24.0%
4,093,245
8.7%
320,295
11,400,254
8.1%
5,947,693
52.2%
221,652
1.9%
1,398,790
24.4%
4,327,251
5.7%
348,227
11,662,460
2.3%
6,084,490
52.2%
325,020
2.8%
1,431,640
24.9%
4,327,830
0.0%
358,269
2016E
11,954,021
2.5%
6,236,602
52.2%
433,873
3.6%
1,467,262
25.3%
4,335,468
0.2%
369,310
2017E
12,252,872
2.5%
6,392,517
52.2%
547,965
4.5%
1,502,885
25.7%
4,341,667
0.1%
380,679
2018E
9,557,240
-22.0%
4,986,163
52.2%
507,944
5.3%
1,170,734
26.1%
3,307,485
-23.8%
298,596
2019E
9,174,950
-4.0%
4,786,717
52.2%
564,936
6.2%
1,121,787
26.6%
3,099,993
-6.3%
288,251
2020E
9,587,823
4.5%
5,002,119
52.2%
671,148
7.0%
1,169,362
27.0%
3,161,609
2.0%
302,894
3.0%
3.0%
3.0%
3.1%
3.1%
3.1%
3.1%
3.1%
3.1%
3.2%
(209,494)
(227,720)
(246,166)
(251,828)
(258,123)
(264,576)
(206,370)
(198,115)
(207,030)
-1.5%
-2.2%
-2.2%
-2.2%
-2.2%
-2.2%
-2.2%
-2.2%
-2.2%
-2.2%
289,927
3.3%
3,271,865
12.9%
22,736,104
24,917,285
47,653,390
8.64%
10.4
14.8
7.3
10.4
Shares Outstanding
5,061,664
10,546,026
2015E
(136,108)
% Grow th
Current P/E
Projected P/E
Current EV/EBITDA
Projected EV/EBITDA
9.8%
2014E
3.0%
2,898,268
NPV of Cash Flows
NPV of terminal value
Projected Equity Value
Free Cash Flow Yield
9,701,956
2013E
-3.5%
3.3%
Free Cash Flow
268,361
2012E
(292,718)
271,467
Capex % of sales
Debt
Cash
Cash/share
8,836,025
6.8%
Add Depreciation/Amort
Current Price
Implied equity value/share
Upside/(Downside) to DCF
2011E
9.5%
4.5%
318,340
3.3%
3,532,460
8.0%
48%
52%
100%
346,035
3.3%
3,839,784
8.7%
372,077
3.3%
4,057,235
7.7%
378,601
3.2%
4,055,670
6.8%
385,982
3.2%
4,060,672
5.8%
393,496
3.2%
4,064,274
4.8%
305,260
3.2%
3,094,450
3.9%
291,451
3.2%
2,898,679
2.9%
Terminal Value
Free Cash Yield
9.8
13.9
6.9
9.7
8.9
12.7
6.2
8.9
302,894
3.2%
2,954,579
1.9%
61,750,705
4.78%
Terminal P/E
19.5
Terminal EV/EBITDA
11.6
934,109
$
$
35.92
51.01
42.0%
1,155,440
1,272,960
1.36
Gilead Sciences
Analyst: Justin Mahida
Page 14
Appendix C: Endnotes
i
Gilead Sciences 2009 10-K
Data extracted from an audit of Gilead Sciences investor relations website using a search for “acquisition”.
Sources for Exhibit 3 include <www.gilead.com/pr_933138351>, <www.gilead.com/pr_1038971547>, and <
http://www.gilead.com/pr_869116>.
iii
http://www.reuters.com/finance/stocks/companyOfficers?symbol=GILD.O
iv
http://www.aidsbeacon.com/news/2010/05/07/application-for-new-hiv-single-tablet-therapy-to-be-filed-withfda/
v
http://www.gilead.com/pr_1414682
vi
http://www.gilead.com/pr_1054845
vii
Claxton, Ami J., Joyce Cramer, and Courtney Pierce. “A systematic review of the associations between dose
regimens and medication compliance”. Clinical Therapeutics, 23(8), pp., 1296-1310.
viii
Gilead Sciences 2009 10-K.
ix
Gilead Sciences 2009 10-K.
x
Gilead Sciences 2009 10-K.
xi
Anderson G. Chronic care and the private sector: partnerships for solutions. Paper presented at: 2001 Health
Sector Assembly; October 30, 2001; Baltimore, MD.
xii
Source information for this section is from the personal background of the analyst. The analyst serves on the
Board of Trustees of the American Medical Association (AMA) and has appropriate insider exposure to health care
reform.
xiii
http://www.gilead.com/pr_1415271
xiv
Gilead Sciences 2009 10-K.
xv
http://mba.tuck.dartmouth.edu/pages/faculty/ken.french/data_library.html
ii
Gilead Sciences
Analyst: Justin Mahida
Page 15