Pharmaceutical Industries Ltd.Pharmaceutical Industries Ltd.Hila KollnesherHila Kollnesher

Ronald AdlerRonald Adler

Eugene KatchalovEugene Katchalov

Erin GoglickErin Goglick

Lisa VortsmanLisa Vortsman

What to expect from us:What to expect from us:

What makes this grass greenerWhat makes this grass greener Why its crucial to spot investment Why its crucial to spot investment

opportunities in Emerging Marketsopportunities in Emerging Markets Unexpected OutcomesUnexpected Outcomes

Investing in IsraelInvesting in Israel

"The land of the prophets is becoming the land of profits""The land of the prophets is becoming the land of profits"

Impressive growth of Israel's economy has been Impressive growth of Israel's economy has been attracting foreign capital to Israelattracting foreign capital to Israel

Investments in infrastructureInvestments in infrastructure Increases in industrial exportsIncreases in industrial exports Privatization of government companiesPrivatization of government companies Control of inflationControl of inflation Liberalization of capital markets Liberalization of capital markets Steady growth of Israel's GDPSteady growth of Israel's GDP

Israel: the land of milk and moneyIsrael: the land of milk and money(what makes our project unique – its major contributions)(what makes our project unique – its major contributions)

Sometimes it pays to search troubled regions for Sometimes it pays to search troubled regions for

investment ideasinvestment ideas – With Iraq out of the way, the Bush Administration will be more likely to prioritize With Iraq out of the way, the Bush Administration will be more likely to prioritize resolving the Israeli-Palestinian conflictresolving the Israeli-Palestinian conflict

Take advantage of Israel's Free Trade Agreements Take advantage of Israel's Free Trade Agreements with the EU and with the USwith the EU and with the US

The taxation climate is quite favorableThe taxation climate is quite favorable

Teva: Make Medicine, Not WarTeva: Make Medicine, Not War

World’s largest generic pharmaceutical amongst top 35 World’s largest generic pharmaceutical amongst top 35

One in every 15 prescriptions in the U.S. is a Teva productOne in every 15 prescriptions in the U.S. is a Teva product

It produces and sells more than 300 generic drugs in North It produces and sells more than 300 generic drugs in North America, Israel, and Europe; from antibiotics to painkillers and America, Israel, and Europe; from antibiotics to painkillers and heart medicines heart medicines

It plays the all-important patent game so well that it regularly wins It plays the all-important patent game so well that it regularly wins patent and marketing battles against drug companies 10x its sizepatent and marketing battles against drug companies 10x its size– built its dominance by beating rivals to lucrative opportunities and introducing scads built its dominance by beating rivals to lucrative opportunities and introducing scads

of new drugs at a rapid-fire paceof new drugs at a rapid-fire pace

For Teva having headquarters in Israel but operating for the most For Teva having headquarters in Israel but operating for the most part outside, the investment pros are suggesting that the biggest part outside, the investment pros are suggesting that the biggest danger is that they might “lose their mail”danger is that they might “lose their mail”

Teva PharmaceuticalsTeva Pharmaceuticals

World’s number 1 generic drug World’s number 1 generic drug companycompany

About 140 generic productsAbout 140 generic products

Specializes in the generic equivalents Specializes in the generic equivalents for brand name drugs for heart disease, for brand name drugs for heart disease, heartburn, antibioticsheartburn, antibiotics

Develops own proprietary drugs Develops own proprietary drugs focusing primarily on neurological focusing primarily on neurological disorders and autoimmune diseases. disorders and autoimmune diseases.

Teva PharmaceuticalsTeva Pharmaceuticals

Founded in 1901 in Jerusalem. Founded in 1901 in Jerusalem.

Dealt primarily with drug distributionDealt primarily with drug distribution

1951 – IPO on Tel Aviv Stock 1951 – IPO on Tel Aviv Stock ExchangeExchange

Since inception, many of company’s Since inception, many of company’s successes attributed to R&D successes attributed to R&D SpendingSpending

Major Player in this >$300 Billion Major Player in this >$300 Billion industryindustry

Teva PharmaceuticalsTeva Pharmaceuticals

Expansion into European Expansion into European MarketplaceMarketplace

Strong North American Strong North American presence:presence:– Teva Pharmaceuticals USTeva Pharmaceuticals US– Recent acquisition of Canadian Recent acquisition of Canadian

drug maker Novopharmdrug maker Novopharm

2002 Sales: $2.08 Billion2002 Sales: $2.08 Billion

2002 Net Income: $278.2 2002 Net Income: $278.2 MillionMillion

Teva PharmaceuticalsTeva Pharmaceuticals

Generic Pharmaceuticals IndustryGeneric Pharmaceuticals Industry

Teva Focuses primarily on:Teva Focuses primarily on:

– Human PharmaceuticalsHuman Pharmaceuticals (generic drugs in dosage forms such as (generic drugs in dosage forms such as tablets, creams, liquids, etc.)tablets, creams, liquids, etc.)

– Active Pharmaceutical Active Pharmaceutical IngredientsIngredients (used in the (used in the manufacturing process)manufacturing process)

Generic Drugmakers Drugmakers

Teva Pharmaceuticals Merck

Alpharma Inc. Johnson & Johnson

Mylan Labs Pfizer

Watson Pharmaceuticals GlaxoSmithKline

IVAX Novartis

(ranked by sales)

Life in IsraelLife in Israel

CreationCreation– Created by the UN after WWII for the Jewish people.Created by the UN after WWII for the Jewish people.– Land: Majority desert, not suitable for agricultural Land: Majority desert, not suitable for agricultural

growth.growth.– Almost no natural resources, dependant on human Almost no natural resources, dependant on human

capital for economic growth.capital for economic growth.

PopulationPopulation – 80.1% Jews, 14.6% Muslims, and 2.1% Christians80.1% Jews, 14.6% Muslims, and 2.1% Christians– Languages: Hebrew, Arabic and English Languages: Hebrew, Arabic and English – Immigration from the former Soviet UnionImmigration from the former Soviet Union– 1 Million migrants to IL , 17% of the electorate1 Million migrants to IL , 17% of the electorate

EducationEducationGlobally competitive in telecommunications, biotechnology and Globally competitive in telecommunications, biotechnology and high-tech industrieshigh-tech industries

1999: 13% of employed residents were educated professions, 1999: 13% of employed residents were educated professions, 14.5% were professionals/technicians and 15% of the labor force 14.5% were professionals/technicians and 15% of the labor force has 16 or more years of proper educationshas 16 or more years of proper educations

Minimum wage law, average wage per employee is about Minimum wage law, average wage per employee is about $1,680/yr$1,680/yr

Employment by Occupation 2000

Skilled Workers, 21%

Managers, 6%

Associate Professionals & Technicians ,

15%

Clerical Workers, 17%

Unskilled Workers, 8%

Academic Professionals,

13%

Skilled Agricultural Workers, 2%

Agents, Sales & Services, 18%

Israel’s Right to ExistIsrael’s Right to Exist

Israel’s existence has been plagued by Israel’s existence has been plagued by numerous wars and terrorist attacks.numerous wars and terrorist attacks.

Israel’s neighbors’ believe land was unfairly Israel’s neighbors’ believe land was unfairly taken taken

Improvement in relations with neighbors: Improvement in relations with neighbors: 1979 Israel-Egypt and 1994 Jordan-Israel 1979 Israel-Egypt and 1994 Jordan-Israel peace treaties.peace treaties.

Israeli/Palestinian violence increased after Israeli/Palestinian violence increased after Sept 2000. Sept 2000.   

Military, Patriotism and PeaceMilitary, Patriotism and Peace Military Draft: Israel needs to defend itself and protect its people who are Military Draft: Israel needs to defend itself and protect its people who are

threatened by terrorism.threatened by terrorism.– All citizens, men and women, serve in the military for a certain period of time after completing All citizens, men and women, serve in the military for a certain period of time after completing

school.school.

Israelis are known for their extreme patriotism. Israelis are known for their extreme patriotism. – Very proud and will sacrifice anything, Very proud and will sacrifice anything, – won’t be discouraged by terrorists and live their lives without fear.won’t be discouraged by terrorists and live their lives without fear.

The two halves of Israel: The two halves of Israel: Peace can’t be achieved until neighboring countries Peace can’t be achieved until neighboring countries begin to accept Israel as a country. The other half believe peace is achievable begin to accept Israel as a country. The other half believe peace is achievable regardless.regardless.– Assassination of Prime Minister…current prime minister different from previous oneAssassination of Prime Minister…current prime minister different from previous one

Israel’s Macroeconomic State and Israel’s Macroeconomic State and StructureStructure

1999 – 20001999 – 2000Transition from a consumption Transition from a consumption

growth pushed by Russian growth pushed by Russian

immigrants to a expert immigrants to a expert

influenced growth period.influenced growth period.

GDP in 2000: US$17,000 GDP in 2000: US$17,000

Higher than Portugal, Higher than Portugal,

Greece and New Zealand. Greece and New Zealand.

6.2 5.96.7

3.3

7 6.8

5

3.32.4 2.3

6

-1.1 -0.6

-2

0

2

4

6

8

Percent

GDP Growth Rate 1990 - 2002

Fiscal PolicyFiscal Policy

Goals to reduce the budget deficit as a percentage of Goals to reduce the budget deficit as a percentage of GDP and governments debt relative to GDP. GDP and governments debt relative to GDP.

Despite five changes in political leaders in the 1990’s Despite five changes in political leaders in the 1990’s Israel maintained economic stability.Israel maintained economic stability.

Deficit as % of GDPBefore 1996 Domestic Deficit after Total

Privatization and Foreign TradePrivatization and Foreign Trade

Over the past three decades Israel has induced Over the past three decades Israel has induced privatization in order to stimulate a market based economy privatization in order to stimulate a market based economy and help finance the budget. and help finance the budget.

Israel is a member of both the WTO and Government Israel is a member of both the WTO and Government Procurement Agreement and has free trade agreements Procurement Agreement and has free trade agreements with most of its major partners (US, EU, EFTA, Canada)with most of its major partners (US, EU, EFTA, Canada)

In 2000 the trade deficit between the US and Israel (to US) In 2000 the trade deficit between the US and Israel (to US) was balanced decreasing was balanced decreasing the total deficit from US$ the total deficit from US$ 2.9 Billion in 1999 to US$ .72.9 Billion in 1999 to US$ .7billion in 2000. Deficits to billion in 2000. Deficits to Asia and the EU, however,Asia and the EU, however,continued to increase.continued to increase.

Interest RateInterest Rate

The Bank of Israel sets The Bank of Israel sets the nominal interest rate the nominal interest rate every month to maintain every month to maintain the inflation target set the inflation target set by the government.by the government.

In comparison to more In comparison to more stable economies, the stable economies, the interest rate for residents interest rate for residents is relatively high despite is relatively high despite a decrease in the a decrease in the nominal rate as of 2001.nominal rate as of 2001.

Nominal Interest Rate

Inflation Rate

The Capital MarketThe Capital Market

The Tel-Aviv Stock exchange is the major The Tel-Aviv Stock exchange is the major exchange in Israel. exchange in Israel.

As of 1997 TASE runs on an automated system, As of 1997 TASE runs on an automated system, and allows its members to offer online services to and allows its members to offer online services to investors. investors.

The real value of stocks traded increased by The real value of stocks traded increased by 59% in 2000.59% in 2000.

665 companies currently listed on TASE665 companies currently listed on TASE– Over 2000 securities with a total market capitalization of Over 2000 securities with a total market capitalization of

approximately $80 billion approximately $80 billion

Current State 2001-2002Current State 2001-2002

2001-2002: Economy began to stagger due to a decline in 2001-2002: Economy began to stagger due to a decline in private consumption with a rise in public consumption. private consumption with a rise in public consumption.

Israel’s GDP declined 1.1% in 2001 and .6% in 2002. Israel’s GDP declined 1.1% in 2001 and .6% in 2002. Three factors that influenced Israel’s Recession:Three factors that influenced Israel’s Recession:

– Following the 9/11 attacks on WTC travel and tourism revenue declined as Following the 9/11 attacks on WTC travel and tourism revenue declined as the risk of traveling increased (in the ME). the risk of traveling increased (in the ME).

– After 2000 the global economic recovery began to slow. large slump in the After 2000 the global economic recovery began to slow. large slump in the global markets show signs that the market decline has not yet bottomed. global markets show signs that the market decline has not yet bottomed.

– Israel’s economy is increasingly affected by the rising security problems as Israel’s economy is increasingly affected by the rising security problems as well as a possible future US war with Iraq.well as a possible future US war with Iraq.

While Israel’s economic growth in GDP has slowed, While Israel’s economic growth in GDP has slowed, comparatively, Israel is one of the most developed comparatively, Israel is one of the most developed countries in Western Europe, with GDP per capita of US$ countries in Western Europe, with GDP per capita of US$ 20,000 in 2001. 20,000 in 2001.

Recession in past 2 years, value-added exports, a skilled Recession in past 2 years, value-added exports, a skilled workforce, and a committed government help post positive workforce, and a committed government help post positive GDP growth by the end of 2003. GDP growth by the end of 2003.

Israel’s Political SystemIsrael’s Political System

Three branches of government:Three branches of government:– legislative, executive and judicial. They also have a president legislative, executive and judicial. They also have a president

who serves a ritual function and has no real power.who serves a ritual function and has no real power.

Religion in the GovernmentReligion in the Government– no separation between state and religionno separation between state and religion

Prime ministerPrime minister – responsible for selecting a cabinet and forming a government responsible for selecting a cabinet and forming a government

from the coalition parties. from the coalition parties.

Political IssuesPolitical Issues

Political Issues affecting Business Political Issues affecting Business ClimateClimate

People afraid of investing because of constant violencePeople afraid of investing because of constant violence Past agreements act as hope for the possibility of peace in the Past agreements act as hope for the possibility of peace in the

futurefuture– Examples: 1979 Israel-Egypt peace treaty, the Regional Conference of Examples: 1979 Israel-Egypt peace treaty, the Regional Conference of

1991 in Madrid1991 in Madrid

Israel- PLO RecognitionIsrael- PLO Recognition Signing of the Declaration of PrinciplesSigning of the Declaration of Principles

– a timetable for achieving permanent and complete peace between Israel a timetable for achieving permanent and complete peace between Israel

and Palestineand Palestine

Attempting PeaceAttempting Peace

The Interim Agreement The Interim Agreement 19951995 – granted the Palestinians self-granted the Palestinians self-

government in the West Bankgovernment in the West Bank

Violence breaks - Violence breaks - peace agreements peace agreements collapsecollapse– Suicide bombing Suicide bombing – Israeli occupation Israeli occupation – Both lead to escalating hostilities Both lead to escalating hostilities

Pros for investing in IsraelPros for investing in Israel

LargeLarge numbers of professionalsnumbers of professionals– 135 engineers, scientists, and physicians per capita per 10,000 135 engineers, scientists, and physicians per capita per 10,000

people (largest per capita in the world)people (largest per capita in the world)

Hotbed for foreign investmentHotbed for foreign investment Low corruptionLow corruption

– According to the According to the Transparency International Corruption Perceptions Transparency International Corruption Perceptions IndexIndex for 2003, Israel ranked 18th in the world (for a benchmark, for 2003, Israel ranked 18th in the world (for a benchmark, the United States is currently ranked 16the United States is currently ranked 16th)th)

Government SupportGovernment Support– Numerous support for research intensive projects and small Numerous support for research intensive projects and small

businessesbusinesses

Israeli Shekel pegged to a basket of 5 currenciesIsraeli Shekel pegged to a basket of 5 currencies– The US dollar, German mark, British pound, French franc, and The US dollar, German mark, British pound, French franc, and

Japanese yenJapanese yen

Cons for investing in IsraelCons for investing in Israel

InstabilityInstability– Continuous conflict in the Middle East (Israel - Palestine/Much of Continuous conflict in the Middle East (Israel - Palestine/Much of

the Middle East, US - Iraq) the Middle East, US - Iraq)

Global Recession Global Recession – Current global economic situation is viewed by many as a “slump”Current global economic situation is viewed by many as a “slump”

Decline in tourism Decline in tourism – A vital revenue source for the country A vital revenue source for the country

Business and PoliticsBusiness and Politics

During the decade preceding 2000 moderate peace During the decade preceding 2000 moderate peace was maintained and communications between countries was maintained and communications between countries continued in hope of forming a new Middle East. Peace in the continued in hope of forming a new Middle East. Peace in the Middle East made high growth and margin companies like Middle East made high growth and margin companies like TEVA extremely attractive. From the years 1991 to 1998, TEVA extremely attractive. From the years 1991 to 1998, when the peace process appeared to be making strides, when the peace process appeared to be making strides, Teva’s stock price rose as it increased its drug pipeline, M&A Teva’s stock price rose as it increased its drug pipeline, M&A opportunities and released Copaxone internationally. Teva opportunities and released Copaxone internationally. Teva has managed to avoid any major interruption to its business, has managed to avoid any major interruption to its business, despite the terrorism and turmoil in and around Israel. despite the terrorism and turmoil in and around Israel. Nonetheless, escalating conflicts in the Middle East have Nonetheless, escalating conflicts in the Middle East have made more risk averse investors shy away from the stock as made more risk averse investors shy away from the stock as war is eminent and there appears to be no end to the on war is eminent and there appears to be no end to the on going violence. going violence.

In order to statistically determine if Teva is affected by political In order to statistically determine if Teva is affected by political events a regression analysis was done. events a regression analysis was done.

The Regression ModelThe Regression Model

Our final regression model is one that uses the political Our final regression model is one that uses the political rank as a dummy variable, P/E, P/S and Growth to predict rank as a dummy variable, P/E, P/S and Growth to predict the stock price. The model explains 53.9% of the variation the stock price. The model explains 53.9% of the variation in the stock price. in the stock price. The final regression equation is: The final regression equation is: Price ClosePrice Close = = 10.2 + 0.34 Neg5 + 1.63 Neg4 + 0.84 Neg3 10.2 + 0.34 Neg5 + 1.63 Neg4 + 0.84 Neg3 + 0.07 Neg2 + 1.69 Neg1 + 1.90 Pos1 - 0.03 Pos2 - 0.17 + 0.07 Neg2 + 1.69 Neg1 + 1.90 Pos1 - 0.03 Pos2 - 0.17 Pos3 + 0.26 Pos4 - 0.04 Pos5 + 0.181 PE + 2.07 Growth - Pos3 + 0.26 Pos4 - 0.04 Pos5 + 0.181 PE + 2.07 Growth - 0.76 P/S + 209 Net Margin - 43.2 Beta0.76 P/S + 209 Net Margin - 43.2 Beta

A best-subset test was utilized to prove this was the most A best-subset test was utilized to prove this was the most efficient model that could be used with the highest efficient model that could be used with the highest correlation.correlation.

VariablesVariables Event Date: Date upon which event in question occurredEvent Date: Date upon which event in question occurred Event Rank: Events are given a rank ranging from -5 to 5. Negative ranks represent negative political Event Rank: Events are given a rank ranging from -5 to 5. Negative ranks represent negative political

events, the greater than rank the more serious the political crisis. Positive ranks represent positive political events, the greater than rank the more serious the political crisis. Positive ranks represent positive political events. events.

-5: Political official or significant member of peace process is assassinated/wounded.-5: Political official or significant member of peace process is assassinated/wounded. -4: Troops invade, attack or occupy foreign territory or political figure resigns.-4: Troops invade, attack or occupy foreign territory or political figure resigns. -3: Terrorist Attack injures civilians or declared end of peace talks. -3: Terrorist Attack injures civilians or declared end of peace talks. -2: Riots break out in protest. Political Leaders reputation is smeared. -2: Riots break out in protest. Political Leaders reputation is smeared. -1: Rejection of an interim peace agreement/supplement or pause of peace talks -1: Rejection of an interim peace agreement/supplement or pause of peace talks 0: Normal Political day for Israeli Citizens: no significant events occur. 0: Normal Political day for Israeli Citizens: no significant events occur. 1: Elections occur or a meeting between officials is planned. 1: Elections occur or a meeting between officials is planned. 2: A Cease fire occurs or is planned.2: A Cease fire occurs or is planned. 3: A meet between officials occurs. 3: A meet between officials occurs. 4: Troops are removed from occupied areas or land turned over to Palestinians.4: Troops are removed from occupied areas or land turned over to Palestinians. 5: Interim peace agreements or supplements are signed or agreed upon.5: Interim peace agreements or supplements are signed or agreed upon. PE: PE ratio for the quarter in which the event occurredPE: PE ratio for the quarter in which the event occurred Growth: Growth rate for the quarter in which the event occurred. Growth: Growth rate for the quarter in which the event occurred. P/S: Price to sales ratio for the quarter in which the event occurred.P/S: Price to sales ratio for the quarter in which the event occurred. Net margin: Net Margin for the quarter in which the event occurred. Net margin: Net Margin for the quarter in which the event occurred. Predicted Price: Price predicted by the model given the about input multiples. Predicted Price: Price predicted by the model given the about input multiples. Price Close Prior Day: Stock closing price on the day prior to the event in question. Price Close Prior Day: Stock closing price on the day prior to the event in question. Price Close: Stock closing price on the day of the event in question.Price Close: Stock closing price on the day of the event in question. Percentage Change: Percentage change in price from the prior day to the day in questions closing price. Percentage Change: Percentage change in price from the prior day to the day in questions closing price. Description: Description of the event in question. Description: Description of the event in question.

Descriptive StatisticsDescriptive StatisticsPredictor Coef SE Coef T P

Constant 12.956 8.479 1.53 0.130Neg5 0.358 3.576 0.10 0.921Neg4 1.593 3.208 0.50 0.621Neg3 0.736 3.150 0.23 0.816Neg2 -0.221 3.345 -0.07 0.947Neg1 1.387 3.166 0.44 0.662Pos1 1.837 3.255 0.56 0.574Pos2 -0.406 3.277 -0.12 0.902Pos3 -0.491 3.314 -0.15 0.883Pos4 0.179 3.348 0.05 0.957Pos5 0.292 3.623 0.08 0.936

PE 0.11323 0.02015 5.62 0.000 Net Marg 168.56 29.63 5.69 0.000

Beta -40.047 9.430 -4.25 0.000S = 3.033 R-Sq = 53.9% R-Sq(adj) = 47.2%

Analysis of VarianceSource DF SS MS F P

Regression 13 958.125 73.702 8.01 0.000Residual Error 89 818.955 9.202

Total 102 1777.080

Political ConclusionPolitical Conclusion Israeli companies that react in correlation with political events should have negative beta-Israeli companies that react in correlation with political events should have negative beta-

hats for negatively viewed events and positive beta-hats for positively viewed events. Teva, hats for negatively viewed events and positive beta-hats for positively viewed events. Teva, however, has successfully created an organization that has been successful in beating both however, has successfully created an organization that has been successful in beating both the NASDAQ and S&P 500 over the past two years, as well as limiting its exposure to the NASDAQ and S&P 500 over the past two years, as well as limiting its exposure to political risk. political risk.

• The regression equation shows that Teva’s stock price is negatively correlated with political events. An event deemed a -2 on a -5 to 5 scale was the only negative event, on average to reduce the stocks price (-22.1 cents). In addition, positive events, which are likely to increase the stock price, on average were in some instances associated with a decrease in stock price ( +2 and +3 events). One can therefore conclude that though political events must have some effect on the company and the mindset of investors, the company has proven its ability to withstand even the worst of events. Investors should view Teva as an undervalued stock that is capable of high returns with limited political risk.

Teva, S%P 500 and NASDAQ 1998 - 2003

Relative ValuationRelative Valuation

Our SampleOur Sample– From this group only companies that were significantly From this group only companies that were significantly

comparable, given their focus, growth rate, cash flows and risk comparable, given their focus, growth rate, cash flows and risk were included as initial basis points. In order to control for large were included as initial basis points. In order to control for large difference within the sample, two outliers were removed: Bradley difference within the sample, two outliers were removed: Bradley Pharmaceuticals (BPRX) and First Horizon Pharmaceuti (FHRX), Pharmaceuticals (BPRX) and First Horizon Pharmaceuti (FHRX), leaving 32 basis points leaving 32 basis points

The MultiplesThe Multiples: : – Peg, P/S, Net MarginPeg, P/S, Net Margin

Assumptions:Assumptions:– Both the value and the standardizing variable represent the equity Both the value and the standardizing variable represent the equity

claimholders of the firm claimholders of the firm – The multiples used were uniformly estimated: accounting The multiples used were uniformly estimated: accounting

principles to measure earnings multiples are consistent across all principles to measure earnings multiples are consistent across all firms in the sample. firms in the sample.

– All simple relative valuations will utilize the median rather than the All simple relative valuations will utilize the median rather than the mean, as it is often a more reliable comparison point.mean, as it is often a more reliable comparison point.

Simple Valuation PEG RatioSimple Valuation PEG RatioCompanyCompany PEGPEG

Lannett CompanyLannett Company

King PharmaceuticalsKing Pharmaceuticals 0.520.52

American Pharmaceutical American Pharmaceutical PartnersPartners

0.580.58

ICN PharmaceuticalsICN Pharmaceuticals 0.630.63

Endo Pharmaceutical HldgsEndo Pharmaceutical Hldgs 0.650.65

NBTYNBTY 0.70.7

SerologicalsSerologicals 0.730.73

Biovail Corporation InternationalBiovail Corporation International 0.770.77

Draxis HealthDraxis Health 0.770.77

Noven PharmaceuticalsNoven Pharmaceuticals 0.820.82

Cima LabsCima Labs 0.830.83

Sanofi-Synthelabo ADRSanofi-Synthelabo ADR 0.830.83

Bentley PharmaceuticalsBentley Pharmaceuticals 0.850.85

Shire Pharmaceuticals Group Shire Pharmaceuticals Group PLC PLC ADRADR

0.880.88

IvaxIvax 0.890.89

0.460.46

Barr LaboratoriesBarr Laboratories 0.910.91

Hi-Tech PharmacalHi-Tech Pharmacal 0.970.97

Taro Pharmaceutical IndustriesTaro Pharmaceutical Industries 0.980.98

SicorSicor 11

Able LaboratoriesAble Laboratories 1.021.02

Flamel Technologies ADRFlamel Technologies ADR 1.031.03

ChattemChattem 1.061.06

DUSA PharmaceuticalsDUSA Pharmaceuticals 1.11.1

Pharmaceutical ResourcesPharmaceutical Resources 1.141.14

Teva Pharmaceutical Industries Teva Pharmaceutical Industries ADRADR

1.141.14

Forest LaboratoriesForest Laboratories 1.231.23

Mylan LaboratoriesMylan Laboratories 1.291.29

Medicis Pharmaceuticals AMedicis Pharmaceuticals A 1.371.37

Watson PharmaceuticalsWatson Pharmaceuticals 1.431.43

Novo Nordisk ADRNovo Nordisk ADR 1.561.56

AllerganAllergan 1.641.64

PerrigoPerrigo 1.881.88

MeanMean 0.9893750.989375

MedianMedian 0.890.89

PEG AnalysisPEG Analysis For an investor looking for a simple relative valuation PEG can be For an investor looking for a simple relative valuation PEG can be

used, however with some caveats:used, however with some caveats:

– High risk companies will often trade at much lower PEG ratios than low risk High risk companies will often trade at much lower PEG ratios than low risk firms with the same expected growth rate. This often leads to companies firms with the same expected growth rate. This often leads to companies appearing cheaper than the rest of the sample, however, they may be the appearing cheaper than the rest of the sample, however, they may be the riskiest firm in the group.riskiest firm in the group.

– Companies that attain growth by investing less in lower retention ratios will Companies that attain growth by investing less in lower retention ratios will

have higher PEG ratios than companies growing at the same rate. This have higher PEG ratios than companies growing at the same rate. This often leads to companies looking cheap on a Peg basis, however they may often leads to companies looking cheap on a Peg basis, however they may have high reinvestment rate and poor return on equity. have high reinvestment rate and poor return on equity.

– Companies with very low or very high growth rates will tend to have higher Companies with very low or very high growth rates will tend to have higher PEG ratios than firms with average growth rates. As an example, Teva is PEG ratios than firms with average growth rates. As an example, Teva is in the upper third of the sample with a high growth rate of 20%.in the upper third of the sample with a high growth rate of 20%.

– Though the data is easy to gather and analyze, dividing PE by expected Though the data is easy to gather and analyze, dividing PE by expected growth does not neutralize the effects of expected growth because the growth does not neutralize the effects of expected growth because the relationship between growth and value is not linear and fairly complex. relationship between growth and value is not linear and fairly complex.

Simple Price to SalesSimple Price to SalesCompanyCompany NetNet

Ordered By MarginOrdered By Margin SalesSales MarginMargin

IvaxIvax 00..77

5.30%5.30%

ChattemChattem 5.565.56 5.80%5.80%

ICN PharmaceuticalsICN Pharmaceuticals 4.414.41 6.40%6.40%

Pharmaceutical ResourcesPharmaceutical Resources 1.051.05 6.80%6.80%

Draxis HealthDraxis Health 1.281.28 7.10%7.10%

Noven PharmaceuticalsNoven Pharmaceuticals 3.093.09 7.70%7.70%

SerologicalsSerologicals 1.141.14 7.90%7.90%

Mylan LaboratoriesMylan Laboratories 1.591.59 9.60%9.60%

Flamel Technologies ADRFlamel Technologies ADR 1.271.27 10.20%10.20%

Barr LaboratoriesBarr Laboratories 1.791.79 11.30%11.30%

Shire Pharmaceuticals Group PLC Shire Pharmaceuticals Group PLC ADRADR

3.483.48 11.90%11.90%

Hi-Tech PharmacalHi-Tech Pharmacal 2.662.66 12.70%12.70%

Cima LabsCima Labs 0.840.84 12.90%12.90%

PerrigoPerrigo 2.562.56 14.40%14.40%

Sanofi-Synthelabo ADRSanofi-Synthelabo ADR 6.866.86 14.40%14.40%

Lannett CompanyLannett Company 4.754.75 15.40%15.40%

Price/Price/ DUSA PharmaceuticalsDUSA Pharmaceuticals 1.91.9 16.30%16.30%

AllerganAllergan 5.125.12 16.50%16.50%

NBTYNBTY 3.713.71 18.90%18.90%

American Pharmaceutical American Pharmaceutical PartnersPartners

4.084.08 20.40%20.40%

Teva Pharmaceutical Industries Teva Pharmaceutical Industries ADRADR

3.43.4 20.80%20.80%

Novo Nordisk ADRNovo Nordisk ADR 5.395.39 21.20%21.20%

King PharmaceuticalsKing Pharmaceuticals 5.025.02 22.00%22.00%

Able LaboratoriesAble Laboratories 4.434.43 22.20%22.20%

Medicis Pharmaceuticals AMedicis Pharmaceuticals A 3.073.07 23.20%23.20%

SicorSicor 7.287.28 23.60%23.60%

Forest LaboratoriesForest Laboratories 7.027.02 24.40%24.40%

Watson PharmaceuticalsWatson Pharmaceuticals 4.514.51 28.80%28.80%

Taro Pharmaceutical IndustriesTaro Pharmaceutical Industries 7.357.35 29.60%29.60%

Bentley PharmaceuticalsBentley Pharmaceuticals 10.4510.45 29.80%29.80%

Endo Pharmaceutical HldgsEndo Pharmaceutical Hldgs 9.599.59 35.90%35.90%

Biovail Corporation InternationalBiovail Corporation International 7.127.12 43.20%43.20%

        

MeanMean 4.144.14 17.39%17.39%

MedianMedian 3.713.71 15.40%15.40%

CompanyCompany NetNet

  Ordered By Price to SalesOrdered By Price to Sales SalesSales MarginMargin

IvaxIvax 0.770.77 5.30%5.30%

Cima LabsCima Labs 0.840.84 12.90%12.90%

Pharmaceutical ResourcesPharmaceutical Resources 1.051.05 6.80%6.80%

SerologicalsSerologicals 1.141.14 7.90%7.90%

Flamel Technologies ADRFlamel Technologies ADR 1.271.27 10.20%10.20%

Draxis HealthDraxis Health 1.281.28 7.10%7.10%

Mylan LaboratoriesMylan Laboratories 1.591.59 9.60%9.60%

Barr LaboratoriesBarr Laboratories 1.791.79 11.30%11.30%

DUSA PharmaceuticalsDUSA Pharmaceuticals 1.91.9 16.30%16.30%

PerrigoPerrigo 2.562.56 14.40%14.40%

Hi-Tech PharmacalHi-Tech Pharmacal 2.662.66 12.70%12.70%

Medicis Pharmaceuticals AMedicis Pharmaceuticals A 3.073.07 23.20%23.20%

Noven PharmaceuticalsNoven Pharmaceuticals 3.093.09 7.70%7.70%

Teva Pharmaceutical Industries ADRTeva Pharmaceutical Industries ADR 3.43.4 20.80%20.80%

Shire Pharmaceuticals Group PLC Shire Pharmaceuticals Group PLC ADRADR

3.483.48 11.90%11.90%

NBTYNBTY 3.713.71 18.90%18.90%

Price/Price/ NBTYNBTY 3.713.71 18.90%18.90%

American Pharmaceutical PartnersAmerican Pharmaceutical Partners 4.084.08 20.40%20.40%

ICN PharmaceuticalsICN Pharmaceuticals 4.414.41 6.40%6.40%

Able LaboratoriesAble Laboratories 4.434.43 22.20%22.20%

Watson PharmaceuticalsWatson Pharmaceuticals 4.514.51 28.80%28.80%

Lannett CompanyLannett Company 4.754.75 15.40%15.40%

King PharmaceuticalsKing Pharmaceuticals 5.025.02 22.00%22.00%

AllerganAllergan 5.125.12 16.50%16.50%

Novo Nordisk ADRNovo Nordisk ADR 5.395.39 21.20%21.20%

ChattemChattem 5.565.56 5.80%5.80%

Sanofi-Synthelabo ADRSanofi-Synthelabo ADR 6.866.86 14.40%14.40%

Forest LaboratoriesForest Laboratories 7.027.02 24.40%24.40%

Biovail Corporation InternationalBiovail Corporation International 7.127.12 43.20%43.20%

SicorSicor 7.287.28 23.60%23.60%

Taro Pharmaceutical IndustriesTaro Pharmaceutical Industries 7.357.35 29.60%29.60%

Endo Pharmaceutical HldgsEndo Pharmaceutical Hldgs 9.599.59 35.90%35.90%

Bentley PharmaceuticalsBentley Pharmaceuticals 10.4510.45 29.80%29.80%

        

MeanMean 4.144.14 17.39%17.39%

MedianMedian 3.713.71 15.40%15.40%

Simple Relative P/S Valuation Conclusions: Fundamentally investors should look for stocks that have low Price to sales multiples with high net margins. By analyzing the simple valuation result we see that Teva has a price to sales multiple slightly higher than the median and a net margin slightly below the median. We can therefore conclude that Teva is neither an extremely attractive or unattractive investment.

Price to Sales and Net Margin RegressionPrice to Sales and Net Margin Regression

Regression Without Outliers

y = 20.009x + 0.6615

R2 = 0.5325

02468

1012

0.00% 10.00% 20.00% 30.00% 40.00% 50.00%

Net Margin

Pric

e t

o S

ale

s

Regression Predicted Price:Regression Predicted Price:Given a regression equation of: y = 20.009x + 0.6615Given a regression equation of: y = 20.009x + 0.6615And Price to Sales Multiple of : 3.4 And Price to Sales Multiple of : 3.4 Predicted Price = 20.009*3.4+.6615 = $68.69Predicted Price = 20.009*3.4+.6615 = $68.69

By analyzing Teva’s current price fluctuations we can conclude that By analyzing Teva’s current price fluctuations we can conclude that Teva is under-valued. Our recommendation, considering Teva’s ability Teva is under-valued. Our recommendation, considering Teva’s ability to maintain economic stability and consistently beat the market is a to maintain economic stability and consistently beat the market is a strong buy. strong buy.

Economic Value AddedEconomic Value Added

300

310

320

330

340

350

360

7% 9% 10%

$ Mill

Developed by Stern, Developed by Stern, Stewart & Co.Stewart & Co.

Maximizes Maximizes Shareholder ValueShareholder Value

Calculates Company’s Calculates Company’s True Profit using True Profit using WACCWACC

EVA EVA (Calculated)(Calculated)

Using Calculated WACC Using WACC at 10% Using WACC at 9%

Total Debt $1,161,400,000 $1,161,400,000 $1,161,400,000

BV of Equity $33,900,000 $33,900,000 $33,900,000

Total Cap $1,195,300,000 $1,195,300,000 $1,195,300,000

WACC 6.99% 10.00% 9.00%

Net Op. Profit $524,000,000 $524,000,000 $524,000,000

Income Tax $84,800,000 $84,800,000 $84,800,000

NOPAT $439,200,000 $439,200,000 $439,200,000

EVA $355,648,530 $319,670,000 $331,623,000

Free Cash FlowsFree Cash Flows(In Millions) Time(Year) 0 1 2 3 4 5 6 7 8

Revenues $2,518.60 $3,022.32 $3,626.78 $4,352.14 $5,222.57 $6,267.08 $7,207.15 $8,288.22 $9,531.45

Less: Cost of Goods Sold $1,707.84 $2,049.41 $2,459.29 $2,951.15 $3,541.38 $4,072.58 $4,683.47 $5,385.99

Gross Profit $1,314.48 $1,577.38 $1,892.85 $2,271.42 $2,725.71 $3,134.56 $3,604.75 $4,145.46

Less: Selling, general, and admin (SGA) $487.68 $585.22 $702.26 $842.71 $1,011.25 $1,162.94 $1,337.38 $1,537.99

EBITDA $826.80 $992.16 $1,190.59 $1,428.71 $1,714.45 $1,971.62 $2,267.36 $2,607.47

Less: Depreciation and Amortization $96.80 $106.48 $117.13 $128.84 $141.72 $155.90 $171.49 $188.64 $207.50

EBIT (Unadjusted) 720.32 875.03 1,061.75 1,286.99 1,558.56 1,800.13 2,078.73 2,399.97

*(1 - Marginal Tax Rate) 83.00% 83.00% 83.00% 83.00% 83.00% 83.00% 83.00% 83.00%

EBIT*(1-t) 597.87 726.28 881.25 1068.20 1293.60 1494.11 1725.34 1991.97

Noncash Working Capital (NWC) 1377.2 1,511.16 1,813.39 2,176.07 2,611.28 3,133.54 3,603.57 4,144.11 4,765.72

Change in Noncash Working Capital (DNWC) 133.96 302.23 362.68 435.21 522.26 470.03 540.54 621.62

EBIT*(1-t) 597.87 726.28 881.25 1,068.20 1,293.60 1,494.11 1,725.34 1,991.97

+ Depreciation 96.8 106.48 117.13 128.84 141.72 155.90 171.49 188.64 207.50

- Capital Expenditures (CapEx) 544.3 332.46 398.95 478.74 574.48 689.38 792.79 911.70 1048.46

- Change in Noncash Working Capital (DNWC) 133.96 302.23 362.68 435.21 522.26 470.03 540.54 621.62

Free Cash Flow to the Firm (FCFF) 237.93 142.23 168.68 200.23 237.86 402.78 461.74 529.40

Interest Expense 31.00 33.48 36.16 39.05 42.18 45.55 49.19 53.13

Free Cash Flow to Equity (FCFE) 206.93 108.75 132.52 161.18 195.69 357.23 412.55 476.27

Average Growth in FCFF and FCFE

Grow ths in FCFF (Used to calculate FCFF in Year 11) 8% -67% 16% 16% 16% 41% 13% 13%

Grow ths in FCFE 18% -47% 22% 22% 21% 83% 15% 15%

FCFF in Year 11 751.90

Terminal Value = FCFFn+1/ (WACC - Gn)

Terminal Value 24,815.06

Free Cash Flow to the Firm (FCFF) 237.93 142.23 168.68 200.23 237.86 402.78 461.74 529.40

+ Terminal Value @ EOY10

Total Cash Flow s to Firm 237.93 142.23 168.68 200.23 237.86 402.78 461.74 529.40

Interest Expense 31.00 33.48 36.16 39.05 42.18 45.55 49.19 53.13

Free Cash Flow to Equity 206.93 108.75 132.52 161.18 195.69 357.23 412.55 476.27

Terminal ValueTerminal Value

Calculated by using Calculated by using Stable Growth FormulaStable Growth Formula

FCFFFCFF(n+1)(n+1)/ (WACC-g/ (WACC-gnn)) Growth Rate taken Growth Rate taken

from U.S. Ten Year from U.S. Ten Year Treasury BondTreasury Bond

FCFF in Year 11 751.9 Mill.

Terminal Value = FCFFn+1/ (WACC - Gn)

Terminal Value = 751.9M/(6.99%-3.96%)Terminal Value = 24815.1815

Target Price CalculationTarget Price Calculation

Used Terminal value Used Terminal value and Free Cash Flows and Free Cash Flows to Calculate Value Of to Calculate Value Of AssetsAssets

Target Price: $52.79Target Price: $52.79 Current Price $44.16Current Price $44.16

Value of Op Assets (Discounted WACC) (in 000s) 14982.67728

+ Cash and Equivalents 809.9

Value of Firm 15792.57728

- Firm's Debt 1,899.00

PV of Equity 13,893.58

Divided by: Shares Outstanding 263.2 Million Shares

Target Price per Share $52.79

Current Price $44.16

Altman EM Z-Score ModelAltman EM Z-Score Model

Used to calculate risk of debt in Emerging Used to calculate risk of debt in Emerging Market CountriesMarket Countries

Z-Score = 3.25 + (6.56)*X1 + (3.26)*X2 + Z-Score = 3.25 + (6.56)*X1 + (3.26)*X2 + (6.72)*X3 + (1.05)X4(6.72)*X3 + (1.05)X4

X1 = Working Cap./ Total AssetsX1 = Working Cap./ Total Assets X2 = Retained Earnings/ Total AssetsX2 = Retained Earnings/ Total Assets X3 = EBIT/ Total AssetsX3 = EBIT/ Total Assets X4 = BV of Equity/ Total LiabilitiesX4 = BV of Equity/ Total Liabilities

Altman Z-Score ModelAltman Z-Score Model

Z Score = 3.25 + X1(6.56)+ X2 (3.26) + X3(6.72) + X4(1.05)

Year 2002 3.25 + 1.952631 + 0.948168 + 0.725332 + 0.012747 = 6.8888774Year 2001 3.25 + 2.729636 + 0.914255 + 0.660891 + 0.015669 = 7.5704518

6.888877446 Is an A+ Rating for 20027.570451761 Is an AA Rating for 2001

Profitability & Growth RatiosProfitability & Growth Ratios

Profitability Ratios 1997 1998 1999 2000 2001 2002ROA 8.70% 4.80% 6.70% 5.20% 8.00% 8.87%ROE 17.30% 10.70% 15.60% 12.90% 20.20% 22.43%Net Profit Margin 9.58% 6.36% 9.13% 8.46% 13.38% 16.29%Gross Profit Margin 15.31% 11.02% 15.05% 14.51% 17.81% 19.83%

1997 1998 1999 2000 2001 2002Sales % Growth 17.09% -0.09% 14.87% 36.51% 18.69% 21.26%Op Income % Growth 44.34% -23.53% 54.70% 35.36% 49.51% 43.05%Net Income % Growth 46.58% -33.64% 64.79% 26.50% 87.84% 47.59%

Heal the worldHeal the world make it a healthier place make it a healthier place

Baby-boomers will soon be taking more medicine to stave Baby-boomers will soon be taking more medicine to stave off illnesses connected with old ageoff illnesses connected with old age

By 2030 the ranks of the elderly are expected to double to By 2030 the ranks of the elderly are expected to double to more than 70 million people, or 20% of the U.S. population more than 70 million people, or 20% of the U.S. population

In the next 4 years patents will expire on brand-name In the next 4 years patents will expire on brand-name drugs worth some $36 billion in annual sales, broadening drugs worth some $36 billion in annual sales, broadening the field for generics makersthe field for generics makers