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VALUE CREATION IN THE PHARMACEUTICAL INDUSTRY

UNLOCKING THE MAGIC OF NUMBERS 2 = 3-1+ 4 2 -22+3 2 -3 DR. GEORGE WEBSTER EXECUTIVE EDUCATION PHARMACEUTICAL MARKETING ST. JOSEPH’S UNIVERSITY. VALUE CREATION IN THE PHARMACEUTICAL INDUSTRY. What is value creation? What are the drivers of value creation ?

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VALUE CREATION IN THE PHARMACEUTICAL INDUSTRY

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  1. UNLOCKINGTHEMAGIC OF NUMBERS2 = 3-1+ 42-22+32-3DR.GEORGE WEBSTER EXECUTIVE EDUCATION PHARMACEUTICAL MARKETING ST. JOSEPH’S UNIVERSITY

  2. VALUE CREATION INTHE PHARMACEUTICALINDUSTRY • What is value creation? • What are the drivers of value creation ? • How do we measure value creation?

  3. WHAT IS VALUE CREATION? • Process • Involves decision making • Financing • Investing • Operating • Includes all stakeholders

  4. THE F-I-O MODEL • FINANCING - the process of obtaining capital for the business • INVESTING - the process of asset acquisition to operate the business • OPERATING - using resources to maximize shareholder wealth

  5. “THE SCORECARDS” • BALANCE SHEET- a statement of position at a point in time • Shows what we own and what we owe • Of particular interest to the CFO • INCOME STATEMENT - a statement of value creation over time • Measures how well we operated • Of particular interest to the CEO • CASH FLOW STATEMENT- puts operations on a cash basis • Gives sources and uses of cash • Of particular interest to the COO

  6. BALANCE SHEET- FACSIMILE COMPANY DECEMBER 31, 19XX ASSETSLIABILITIES & O.E. CURRENT ASSETSCURRENT LIABILITIES Cash 3000 Accts. Payable 2000 Accts. Rec. 2000 Wages Payable 1000 Inventory 8000 13000 Rent 1000 4000 LONG TERMLONG TERM P & E 25000 Long Term Debt 7000 Other 4000OWNER’S EQUITY TOTAL 29000 Common Stock 5000 Ret. Earnings 26000 TOTAL31000 TOTAL ASSETS42000TOTAL LIAB. & OE42000

  7. INCOME STATEMENT- FASCIMILE CO.FOR THE YEAR ENDED 12/31/XX NET SALES 55000 LESS: COST OF GOODS35000 GROSS MARGIN 20000 LESS: OPERATING EXPENSES Salaries 5000 Rent Expense 1000 S.,G., & A. 4000 10000 OPERATING PROFIT 10000 LESS: INCOME TAX (.40)4000 NET INCOME AFTER TAX 6000

  8. STATEMENT OF CASH FLOWS-FASCIMILE CO.FOR THE YEAR ENDED 12/31/XX CASH FROM OPERATIONS Net Income 2000 Depreciation 500 2500 CASH FROM INVESTING ACTIVITIES Capital Expenditures 5000 Acquisitions 15000 20000 CASH FROM FINANCING ACTIVITIES Issuance of Long Term Debt 700 Sale of Common Stock 11500 Cash Dividends 40011800 NET CHANGE IN CASH-5700

  9. WHAT ARE THE DRIVERS OF VALUE? • EFFECTIVENESS - How much revenue do we generate from the assets we have? • EFFICIENCY - How well do we use the assets we own? • LEVERAGE - How much debt do we have in the capital structure?

  10. Total Sales Total Assets EFFECTIVENESS = $18,284,000,000 $16,272,000,000 BMS -1998 = EFFECTIVENESS BMS - 1998 Effectiveness is 1.12 BMS - 1996 Effectiveness is 1.03

  11. Net Income Total Sales EFFICIENCY = $3,052,000,000 $18,284,000,000 BMS -1998 = EFFICIENCY BMS - 1998 Efficiency is .167 BMS - 1996 Efficiency is .187

  12. Total Assets Owner’s Equity LEVERAGE = $16,272,000,000 $7,576,000,000 BMS -1998 = LEVERAGE BMS - 1998 Leverage is 2.15 BMS - 1996 Leverage is 2.24

  13. HOW WE MEASURE VALUE CREATION • ROI - Return on investment • ROE - Return on equity • EPS - Earnings per share • EVA - Economic value added

  14. Net Income Total Assets RETURN ON INVESTMENT = Net Income Sales ROI = X Total Assets Sales RETURN ON INVESTMENT ROI = Net Margin X Asset Turnover BMS 1998 ROI = .167 X 1.12 = .187 BMS 1996 ROI = .187 X 1.03 = .193

  15. Net Income Owner’s Equity RETURN ON EQUITY = Total Assets Sales Net Income X X Sales Total Assets Owner’s Equity RETURN ON EQUITY (Effectiveness) X (Efficiency) X (Leverage) BMS 1998 ROE = $3,052,000,000 / $7,576,000,000 = .40 = 1.12 X .167 X 2.15 = .40

  16. THE F-I-O MODEL • FINANCING- the process of obtaining capital for the business • INVESTING- the process of asset acquisition to operate the business • OPERATING- using resources to maximize shareholder wealth

  17. (Asset Turnover) X (Net Margin) X (Degree Financial Leverage) Total Assets Sales Net Income X X Sales Total Assets Owner’s Equity Operating Financing Investing HOW WE MEASURE VALUE CREATION (Effectiveness) X (Efficiency) X (Leverage) FIO MODEL

  18. Earnings EARNINGS PER SHARE = Shares of Common Stock Outstanding EARNINGS PER SHARE BMS 1998 EPS = $1.54 BMS 1996 EPS = $2.81 • Market Measure • External to the Firm • Unambiguous • Represents per Share Value Creation

  19. ACTIVITY/PERFORMANCE/LEVERAGE MEASURES BMS SCHERING P&G ACTIVITY Total Asset Turnover 1.12 1.03 1.20 PERFORMANCE Net Margin (%) 16.7 21.7 10 Return on Equity (%) 40 44 31 LEVERAGE Total Assets/ Equity 2.15 1.96 2.53

  20. ECONOMIC VALUE ADDED • Measures real profitably- on a cash basis • Measures the cost of equity- not shown on balance sheets • Cost of equity is its opportunity cost- what the investors could do in their next best alternative • Capital includes long term debt, preferred stock, and common stock • Cost of capital is its weighted average

  21. ECONOMIC VALUE ADDED ECONOMIC VALUE ADDED = [Net Operating Profit After Tax - After Tax Dollar Cost of Capital] Operating Profit - Income Tax Net Operating Profit After Tax = After Tax Dollar Cost of Capital= Cost of Capital (%) X Capital Cost of Capital = Weighted After Tax Cost of Capital Capital = Total Capital Employed = Common and Preferred Stock + Long Term Debt

  22. WACC Debt 1846 @.06 Equity 7576@.17 WACC = .148 $ CC = 9422(.148) = 1394 Economic Value Added ExampleBMS, 1998 NOPAT Operating Profit 14026 Less: Income Tax -1127 Equals: NOPAT =12889 EVA EVA = NOPAT - $ CC = 12889-1394 =11495

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