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Case studies in finance 7th Case studies in finance 7th edition by bruner and schill Case studies in finance 7th edition by bruner and schill Case studies in finance 7th edition by bruner and schill Case studies in finance 7th edition by bruner and schill Case studies in finance 7th edition by bruner and schill Case studies in finance 7th edition by bruner and schill
Bruner Eades Schill Visit the Online Learning Center at www.mhhe.com/bruner7e to see a complete list of changes to the Seventh Edition and to access study and teaching tools seventh edition Eades S chill Case Studies in Finance managing for corporate value creation seventh edition MD DALIM #1218056 12/10/12 CYAN MAG YELO BLK managing for corporate value creation investors At the core of almost all of the cases is a valuation task that requires students to look to financial markets for guidance in resolving the case problem These cases also invite students to apply modern information technology to the analysis of managerial decisions In the Seventh Edition, 25% of the cases are new with many dating from 2011–2012, ensuring that your students are learning from the most relevant and current sources Case Studies in Finance Case Studies in Finance links managerial decisions to capital markets and the expectations of Bruner bru6171X_fm_i-l.qxd 12/11/12 3:01 PM Page i Case Studies in Finance Managing for Corporate Value Creation bru6171X_fm_i-l.qxd ii ii 12/11/12 Part One Part Title 3:01 PM Page ii bru6171X_fm_i-l.qxd 12/11/12 3:01 PM Page iii Case Studies in Finance Managing for Corporate Value Creation Seventh Edition Robert F Bruner Kenneth M Eades Michael J Schill bru6171X_fm_i-l.qxd 12/11/12 3:01 PM Page iv CASE STUDIES IN FINANCE: MANAGING FOR CORPORATE VALUE CREATION, SEVENTH EDITION Published by McGraw-Hill, a business unit of The McGraw-Hill Companies, Inc., 1221 Avenue of the Americas, New York, NY, 10020 Copyright © 2014 by The McGraw-Hill Companies, Inc All rights reserved Printed in the United States of America Previous editions © 2002, 1989, and 1975 No part of this publication may be reproduced or distributed in any form or by any means, or stored in a database or retrieval system, without the prior written consent of The McGraw-Hill Companies, Inc., including, but not limited to, in any network or other electronic storage or transmission, or broadcast for distance learning Some ancillaries, including electronic and print components, may not be available to customers outside the United States This book is printed on acid-free paper DOC/DOC ISBN 978-0-07-786171-1 MHID 0-07-786171-X Senior Vice President, Products & Markets: Kurt L Strand Vice President, Content Production & Technology Services: Kimberly Meriwether David Managing Director: Douglas Reiner Executive Brand Manager: Charles Synovec Developmental Editor II: Jennifer Lohn Executive Marketing Manager: Melissa Caughlin Editorial Coordinator: Casey Rasch Director, Content Production: Terri Schiesl Senior Project Manager: Lisa A Bruflodt Buyer: Nichole Birkenholz Media Project Manager: Prashanthi Nadipalli Cover Design: Studio Montage, St Louis, MO Cover Image: Alija/Getty Images Typeface: 10/12 Times Compositor: Cenveo Publisher Services Printer: R R Donnelley Library of Congress Cataloging-in-Publication Data Bruner, Robert F., 1949Case studies in finance : managing for corporate value creation / Robert F Bruner, Kenneth M Eades, Michael J Scholl.––Seventh Edition pages cm Includes index ISBN-13: 978-0-07-786171-1 (alk paper) ISBN-10: 0-07-786171-X (alk paper) Corporations––Finance––Case studies International business enterprises––Finance––Case studies I Eades, Ken M II Schill, Michael J III Title HG4015.5.B78 2013 658.15––dc23 2012046392 The Internet addresses listed in the text were accurate at the time of publication The inclusion of a website does not indicate an endorsement by the authors or McGraw-Hill, and McGraw-Hill does not guarantee the accuracy of the information presented at these sites www.mhhe.com bru6171X_fm_i-l.qxd 12/18/12 5:52 PM Page v The McGraw-Hill/Irwin Series in Finance, Insurance and Real Estate Stephen A Ross Franco Modigliani Professor of Finance and Economics Sloan School of Management Massachusetts Institute of Technology Consulting Editor FINANCIAL MANAGEMENT Block, Hirt, and Danielsen Foundations of Financial Management Fourteenth Edition Grinblatt and Titman Financial Markets and Corporate Strategy Second Edition Brealey, Myers, and Allen Principles of Corporate Finance Eleventh Edition Higgins Analysis for Financial Management Tenth Edition Brealey, Myers, and Allen Principles of Corporate Finance, Concise Second Edition Kellison Theory of Interest Third Edition Brealey, Myers, and Marcus Fundamentals of Corporate Finance Seventh Edition Ross, Westerfield, and Jaffe Corporate Finance Tenth Edition Brooks FinGame Online 5.0 Ross, Westerfield, Jaffe, and Jordan Corporate Finance: Core Principles and Applications Third Edition Bruner, Eades, and Schill Case Studies in Finance: Managing for Corporate Value Creation Seventh Edition Cornett, Adair, and Nofsinger Finance: Applications and Theory Second Edition Cornett, Adair, and Nofsinger M: Finance Second Edition DeMello Cases in Finance Second Edition Grinblatt (editor) Stephen A Ross, Mentor: Influence through Generations Ross, Westerfield, and Jordan Essentials of Corporate Finance Eighth Edition Ross, Westerfield, and Jordan Fundamentals of Corporate Finance Tenth Edition Shefrin Behavioral Corporate Finance: Decisions that Create Value First Edition White Financial Analysis with an Electronic Calculator Sixth Edition bru6171X_fm_i-l.qxd 12/18/12 5:52 PM Page vi INVESTMENTS Bodie, Kane, and Marcus Essentials of Investments Ninth Edition Bodie, Kane, and Marcus Investments Ninth Edition Hirt and Block Fundamentals of Investment Management Tenth Edition Jordan, Miller, and Dolvin Fundamentals of Investments: Valuation and Management Sixth Edition Stewart, Piros, and Heisler Running Money: Professional Portfolio Management First Edition Sundaram and Das Derivatives: Principles and Practice First Edition FINANCIAL INSTITUTIONS AND MARKETS Rose and Hudgins Bank Management and Financial Services Ninth Edition Saunders and Cornett Financial Institutions Management: A Risk Management Approach Seventh Edition Rose and Marquis Financial Institutions and Markets Eleventh Edition Saunders and Cornett Financial Markets and Institutions Fifth Edition INTERNATIONAL FINANCE Eun and Resnick International Financial Management Sixth Edition REAL ESTATE Brueggeman and Fisher Real Estate Finance and Investments Fourteenth Edition Ling and Archer Real Estate Principles: A Value Approach Fourth Edition FINANCIAL PLANNING AND INSURANCE Allen, Melone, Rosenbloom, and Mahoney Retirement Plans: 401(k)s, IRAs, and Other Deferred Compensation Approaches Tenth Edition Altfest Personal Financial Planning First Edition Harrington and Niehaus Risk Management and Insurance Second Edition Kapoor, Dlabay, and Hughes Focus on Personal Finance: An Active Approach to Help You Develop Successful Financial Skills Fourth Edition Kapoor, Dlabay, and Hughes Personal Finance Tenth Edition Walker and Walker Personal Finance: Building Your Future First Edition bru6171X_fm_i-l.qxd 12/11/12 3:01 PM Page vii Dedication In dedication to our wives Barbara M Bruner Kathy N Eades Mary Ann H Schill and to our children vii bru6171X_fm_i-l.qxd 12/11/12 3:01 PM Page viii About the Authors Robert F Bruner is Dean of the Darden Graduate School of Business Administration, Distinguished Professor of Business Administration and Charles C Abbott Professor of Business Administration at the University of Virginia He has taught and written in various areas, including corporate finance, mergers and acquisitions, investing in emerging markets, innovation, and technology transfer In addition to Case Studies in Finance, his books include Finance Interactive, multimedia tutorial software in Finance (Irwin/ McGraw-Hill 1997), The Portable MBA (Wiley 2003), Applied Mergers and Acquisitions, (Wiley, 2004), Deals from Hell: M&A Lessons that Rise Above the Ashes (Wiley, 2005) and The Panic of 1907 (Wiley, 2007) He has been recognized in the United States and Europe for his teaching and case writing BusinessWeek magazine cited him as one of the “masters of the MBA classroom.” He is the author or co-author of over 400 case studies and notes His research has been published in journals such as Financial Management, Journal of Accounting and Economics, Journal of Applied Corporate Finance, Journal of Financial Economics, Journal of Financial and Quantitative Analysis, and Journal of Money, Credit, and Banking Industrial corporations, financial institutions, and government agencies have retained him for counsel and training He has been on the faculty of the Darden School since 1982, and has been a visiting professor at various schools including Columbia, INSEAD, and IESE Formerly he was a loan officer and investment analyst for First Chicago Corporation He holds the B.A degree from Yale University and the M.B.A and D.B.A degrees from Harvard University Copies of his papers and essays may be obtained from his website, http://www.darden.virginia.edu/ web/Faculty-Research/Directory/Full-time/Robert-F-Bruner/ He may be reached via email at brunerr@virginia.edu Kenneth M Eades is Professor of Business Administration and Area Coordinator of the Finance Department of the Darden Graduate School of Business Administration at the University of Virginia He has taught a variety of corporate finance topics including: capital structure, dividend policy, risk management, capital investments and firm valuation His research interests are in the area of corporate finance where he has published articles in The Journal of Finance, Journal of Financial Economics, Journal of Financial and Quantitative Analysis, and Financial Management In addition to Case Studies in Finance, his books include The Portable MBA (Wiley 2010) Finance Interactive, a multimedia tutorial software in Finance (Irwin/McGraw-Hill 1997) and Case Studies in Financial Decision Making (Dryden Press, 1994) He has written numerous case studies as well as a web-based, interactive tutorial on the pricing of financial derivatives He has received the Wachovia Award for Excellence in Teaching Materials and the Wachovia Award for Excellence in Research Mr Eades is active in executive education programs at the Darden School and has served as a consultant to a number of corporations and institutions; including many commercial banks and investment banks; Fortune 500 companies and the Internal Revenue Service Prior to joining Darden in 1988, Professor Eades was a member of the faculties at The University viii bru6171X_fm_i-l.qxd 12/11/12 3:01 PM Page ix About the Authors ix of Michigan and the Kellogg School of Management at Northwestern University He has a B.S from the University of Kentucky and Ph.D from Purdue University His website is http://www.darden.virginia.edu/web/Faculty-Research/Directory/Full-time/Kenneth-MEades/ and he may be reached via email at eades@virginia.edu Michael J Schill is Associate Professor of Business Administration of the Darden Graduate School of Business Administration at the University of Virginia where he teaches corporate finance and investments His research spans empirical questions in corporate finance, investments, and international finance He is the author of numerous articles that have been published in leading finance journals such as Journal of Business, Journal of Finance, Journal of Financial Economics, and Review of Financial Studies, and cited by major media outlets such as The Wall Street Journal Some of his recent research projects investigate the market pricing of firm growth and the corporate gains to foreign stock exchange listing or foreign currency borrowing He has been on the faculty of the Darden School since 2001 and was previously with the University of California, Riverside, as well as a visiting professor at Cambridge and Melbourne Prior to his doctoral work, he was a management consultant with Marakon Associates in Stamford and London He continues to be active in consulting and executive education for major corporations He received a B.S degree from Brigham Young University, an M.B.A from INSEAD, and a Ph.D from University of Washington More details are available from his website, http://www.darden.virginia.edu/web/Faculty-Research/Directory/Full-time/ Michael-J-Schill/ He may be reached via email at schill@virginia.edu ix bru6171X_case52_745-754.qxd 12/8/12 1:47 PM Page 753 Case 52 Purinex, Inc 753 EXHIBIT | Recent Biotechnology/Pharmaceutical Partnering Deals Companies Date Details of the Deals Curagen/TopoTarget Jun–04 Histone deacetylase inhibitor: $5 million (m) in equity, $5m in license fees, plus $41m in milestones and royalties; deal includes rights to follow-up compounds at $1m license fee and $30m in milestones per product Serono/4SC May–04 Licenses worldwide rights to small-molecule dihydroorotate dehydrogenase inhibitors for autoimmune disorders—up-front, R&D funding and milestones, plus undisclosed royalties Arqule/Roche Apr–04 E2F pathway: $15m up-front, $276m in milestones, plus undisclosed royalties Lundbeck/Merck Feb–04 Gaboxadol, sleep deprivation: $70m up-front plus $200m in milestones plus royalties plus copromotion rights to undisclosed Merck product Biostratum/NovoNordisk Jan–04 Cancer project focused on Anti-laminin antibodies: $80m milestones per antibody plus royalties and undisclosed royalties Array Biopharma/AZ Dec–03 Oncology: $10m up-front, $85m milestones, R&D funding plus milestones Neurogean/Merck Dec–03 Neurology/pain: $42m up-front, $118m in milestones, plus R&D funding plus milestones MorphoSys/Pfizer Dec–03 Five-year license, $50m in potential milestones plus royalties Actelion/Merck Dec–03 Renin inhibitor: $10m up-front, $262m in milestones Neurosearch/GSK Dec–03 Central nervous system area: $82m in guaranteed payments plus $200m in “bioworld payments” Source of data: Credit Suisse First Boston bru6171X_case52_745-754.qxd 754 12/8/12 1:47 PM Page 754 Part Eight Valuing the Enterprise: Acquisitions and Buyouts EXHIBIT | Mean and Median Terms of Partnership-Deal Licensing (in millions of dollars) Preclinical Stage Phase I Phase II Phase III $82.7 $57.0 $268.0 $200.4 $212.3 $179.5 $227.0 $247.5 $30.2 $19.0 $32.6 $11.7 $44.6 $25.0 $42.7 $32.0 $72.9 $62.0 $213.0 $184.6 $196.6 $120.0 $241.7 $200.0 Total Value Mean Median Up-front Mean Median Milestones Mean Median Source of data: Credit Suisse First Boston, citing Biocentury (2003–February 2004) EXHIBIT | Financings in the North American Biotechnology Industry, 2003 IPO 2% Follow-On 14% Partnering 36% VC 11% Other 1% Source of data: Burrill & Company Note: PIPEs were private investments in public entities PIPEs 8% Debt 28% bru6171X_case53_755-766.qxd 12/8/12 5:49 PM Page 755 CASE 53 Medfield Pharmaceuticals Susan Johnson, founder and CEO of Medfield Pharmaceuticals, had planned to spend the first few weeks of 2011 sorting out conflicting recommendations for extending the patent life of the company’s flagship product, Fleximat, which was scheduled to go off patent in two years With only three other products in Medfield’s lineup of medications, one of which had only just received U.S Food and Drug Administration (FDA) approval, strategic management of the company’s product pipeline was of paramount importance But a recent $750 million offer to purchase the company had entirely shifted her focus The offer was not a complete surprise The pharmaceutical industry landscape had changed considerably since Johnson, formerly a research scientist, had founded Medfield 20 years earlier.1 Development costs were rising, patents were running out, and new breakthroughs seemed ever more difficult to obtain The industry was now focused on mergers and acquisitions, restructuring, and other strategies for cost-cutting and survival Smaller firms like Medfield were being gobbled up by the major players all the time Companies with approved products or products in the later stages of development, such as Medfield, were especially likely targets While she no longer owned a controlling interest in the firm and could not force a particular decision, Johnson recognized that as CEO, founder, and largest single investor, she would be expected to offer an opinion and that her opinion would be extremely influential It was also clear that determining the value of the company, and therefore whether the offer was reasonable, would necessitate a careful review of the company’s existing and potential future products, and no one understood these as well as Johnson Of course, for Johnson, this was more than simply a financial decision She believed strongly, as did other employees, particularly among the research staff, that Medfield was engaged in work that was important, and she took great pride in the firm’s accomplishments Medfield’s corporate culture was explicitly oriented toward the end goal of improving patients’ health, as evidenced by its slogan: “We Bring Wellness.” This was Except where otherwise noted, general statistics and information about the pharmaceutical industry come from Plunkett Research, http://www.plunkettresearch.com This case was prepared by Marc L Lipson, Associate Professor of Business Administration, Jared D Harris, Assistant Professor of Business Administration, and Jenny Mead, Senior Researcher It was written as a basis for class discussion rather than to illustrate effective or ineffective handling of an administrative situation Copyright © 2011 by the University of Virginia Darden School Foundation, Charlottesville, VA All rights reserved To order copies, send an e-mail to sales@dardenbusinesspublishing.com No part of this publication may be reproduced, stored in a retrieval system, used in a spreadsheet, or transmitted in any form or by any means––electronic, mechanical, photocopying, recording, or otherwise––without the permission of the Darden School Foundation 755 bru6171X_case53_755-766.qxd 756 12/8/12 1:48 PM Page 756 Part Eight Valuing the Enterprise: Acquisitions and Buyouts an important value that Johnson had consciously and specifically built into the firm’s culture Both Johnson’s parents were doctors and ran a small family-oriented practice that they had taken over from Johnson’s maternal grandfather in the town where Johnson was raised The idea of bettering lives through medicine was one Johnson had grown up with Current Product Lines The company had experienced excellent growth over the years and in 2009 had 290 employees, total sales of $329 million (primarily in the United States), and a net income of $58 million See Exhibits and for financial information The company manufactured and sold three primary drugs; all but one had substantial patent life remaining Two were for pain management and the third was for auto-immune diseases A fourth drug, also for pain management, had been approved and was ready for distribution Due to its strong marketing and sales force, Medfield enjoyed an excellent reputation with both physicians and hospitals The company’s leading seller—responsible for 64% of its revenues—was Fleximat Fleximat was a monoclonal antibody used to treat pain and swelling in patients with ulcerative colitis, rheumatoid arthritis, and Crohn’s disease, an ongoing disorder that caused painful inflammation of the digestive tract Fleximat had proved to be much more effective than competing sulfa-based drugs (such as sulfasalazine) in treating those patients—particularly juveniles—who had an inadequate response to conventional therapies for Crohn’s disease Fleximat, however, was due to go off patent in two years The other three products were as follows: • • • Lodamadal was an extended-release tablet for once-daily treatment of moderate to severe pain in patients requiring continuous, around-the-clock opioid therapy for an extended period of time It was in the class of medications called opiate agonists, which worked by changing the way the body sensed pain This drug accounted for 12% of Medfield’s revenues Orsamorph was a morphine sulfate sustained-release tablet designed to treat more intense pain This was a popular drug in hospitals and accounted for 24% of revenues; it had eight years of patent life left Reximet treated acute migraines Reximet, which would begin selling in 2012, was a single tablet containing sumatriptan succinate, a 5-HT 1B/1D agonist, and naproxen sodium, a non-steroidal anti-inflammatory drug Reximet had proved effective in treating arthritis and joint pain The Pharmaceutical Industry Globally, the pharmaceutical industry was a powerhouse, generating billions in revenues The U.S pharmaceutical manufacturing industry, at the core of the global business, had historically enjoyed high profits Yearly, from 1995 through 2002, it was the most profitable industry in the United States, and drug manufacturers had experienced three times more profitability than the median of all Fortune 500 companies in 2004.2 Haiden A Huskamp, “Prices, Profits, and Innovation: Examining Criticisms of New Psychotropic Drugs’ Value,” Health Affairs 25, no (2006) bru6171X_case53_755-766.qxd 12/8/12 1:48 PM Page 757 Case 53 Medfield Pharmaceuticals 757 Drug companies made money by bringing “blockbuster” drugs to market, relying on the period during which they were protected by patent to make significant revenues and focusing on mass-market drugs that treated a wide variety of ailments Traditional pharmaceutical companies, several of which had existed since the 19th century, discovered and created new drugs using organic chemistry and natural compounds, but biotechnology companies—which used gene-splicing to produce their drugs had been on the rise since the mid-1970s These companies often created “orphan drugs” that focused on rare diseases affecting a small percentage of the population.3 In 2009, the pharmaceutical industry had approximately 1,500 companies with combined annual revenues of $200 billion At the top of the drug-company pile were Abbott, Bristol-Myers Squibb, Eli Lilly and Company, Johnson & Johnson, Pfizer, and Merck More than 80% of pharmaceutical revenue was brought in by the 50 largest companies But the pharmaceutical industry had found itself at a crossroads as the first decade of the 21st century wound down With the economic downturn, impending healthcare-reform legislation, and many drugs losing their patents, drug companies had to determine how best to boost their bottom line Most alarming to many of the major pharmaceutical companies was the imminent expiration of patents; estimates were that from 2009 to 2016, losses from these expirations would benefit generics to the tune of $140 billion.4 As a result, the large pharmaceuticals were turning to various options to stay viable, including restructuring, cutting internal R&D, adding biologics,5 building generic units, entering emerging markets, and looking at M&A Many large companies were bulking up their products by buying or licensing drugs from other companies or acquiring smaller outfits New drug approvals had also taken a dive In 2009, there were only 25 new drugs6 that received approval from the Center for Drug Evaluation and Research at the FDA In contrast, during the mid-1990s, more than twice that number had been approved The cost of bringing a drug to market was high: The latest figure (2005) was $1.3 billion, as compared with $802 million in 2001, $300 million in 1991, and $100 million in 1979 In general, only in 10 approved medicines recouped R&D costs The pharmaceutical industry—particularly in the 1990s and in the first decade of the 21st century—had come under criticism both from the public and the government, not only for the high price of branded drugs, but also for some of its tactics and strategies Various manufacturers were accused of, among other things, withholding data from the FDA; manipulating certain data to achieve specific results (as Merck was accused of doing with Vioxx); hiring physician opinion leaders at great cost to promote its products; lavishing gifts, meals, and other luxuries on physicians in an An example of an orphan drug was Rituxan, which had been developed by Genentech and Biogen to treat people suffering from non-Hodgkin’s lymphoma—a relatively small market Ian Mawhinney, “2020: A New Drug Delivery Landscape,” Drug Discovery and Development 12, no 10 (December 2009): 32 Biologics were created using biological processes, such as T-cell activation or stimulation of blood components, rather than chemical synthesis This number refers to traditional pharmaceuticals, which were discovered via organic chemistry; there were nine approvals of biologics in 2009 bru6171X_case53_755-766.qxd 758 12/8/12 1:48 PM Page 758 Part Eight Valuing the Enterprise: Acquisitions and Buyouts attempt to get them to prescribe a particular drug; and promoting drugs for off-label use Drug companies had become the whipping posts for practically everyone, from presidents to consumer activists to the general public The Generic Equation U.S patent policy gave drug manufacturers a 20-year protection from the date of the original patent (usually filed early in the research process), plus 14 years from the date of FDA approval Once the patent expired, the medication was fair game and other companies could make generic forms of it In the United States, the modern system of generics came into being in 1984, after passage of the Drug Price Competition and Patent Term Restoration Act (or the Hatch-Waxman Act), which significantly changed the pharmaceutical patent landscape The legislation’s purpose was to ensure that generics were more widely available and to ensure adequate incentives for investing in the development of new drugs The act expedited the process of generics reaching the market by letting manufacturers file an abbreviated new drug application with the FDA The act also granted concessions to the brand manufacturers, allowing them to increase the patent time Generics were, on average, 50% to 75% cheaper than the branded drug, and in many cases, the price difference was much bigger This disparity benefited consumers tremendously but had the opposite effect on name-brand pharmaceutical firms Sales of blockbuster drugs could plunge 80% or more the first year after a generic competitor entered the market In 2009, the generics’ share of the market was 74%, compared with 49% in 2000 In 2008, generics manufacturers Teva Pharmaceuticals and Mylan Laboratories topped the list of producers of dispensed prescriptions in the United States at 494.2 million and 307.7 million, respectively, beating out Pfizer and Merck.7 Of that top ten, six were generics manufacturers Generics received a big boost in 2006, when Wal-Mart pharmacies, primarily to fight mail-order pharmacies, began offering deeply discounted generic brands for a flat $4 per month Other large chains with pharmacies (e.g., Kroger, Target, and Walgreens) jumped on the $4 generic bandwagon The popularity of these programs led to still-deeper discounts and even some free medication over the following years Wal-Mart offered 90-day supplies of some generic drugs for $10, and grocery chain Publix offered free generic antibiotics for up to 14 days Competition was fierce among manufacturers of generic drugs, resulting in heavy discounting Given this change in the competitive landscape, toward the end of the first decade of the 21st century, many major pharmaceutical companies were branching out by producing generics, not only of their own brands but also those of other companies This represented an attempt to introduce a subtle form of differentiation into the mostly costleader-focused generics market; brand-name companies that produced generics could charge slightly more for the promise of quality, as opposed to no-name generic producers, whose selling point was rock-bottom prices Among others, Pfizer (with its Business Monitor International, “Competitive Landscape,” United States Pharmaceuticals & Healthcare Report Q1 2010, 62 bru6171X_case53_755-766.qxd 12/8/12 1:48 PM Page 759 Case 53 Medfield Pharmaceuticals 759 generics division Greenstone), Schering-Plough (which created a generic subsidiary, Warrick Pharmaceuticals), Novartis, Sanofi-Aventis, and GlaxoSmithKline were manufacturing copycat drugs from other companies; the latter two targeted non-U.S markets Obviously, independent generic manufacturers were not pleased with this practice Fleximat Strategies As Johnson considered the state of the industry and Medfield’s specific situation, her attention increasingly focused on Fleximat—the firm’s core product but biggest source of uncertainty Aside from simply letting Fleximat’s patent lapse and losing sales to the inevitable generic substitutes, Johnson knew the company had several possible alternative actions Of these, Johnson believed four approaches stood out: Launch a renewed marketing effort This would include becoming more aggressive in Medfield’s current tactics Johnson was well aware of how successful AstraZeneca’s commercials for Nexium had been, which featured apparently suicidal people standing on cliffs, desperate for heartburn relief, and diners at fancy restaurants mishearing a waiter describe the gastric distress that would follow after they ate their meals Engage in evergreening tactics This essentially would allow the firm to maintain the benefits of patents through aggressive litigation For example, a manufacturer could “stockpile” patent protections by taking out many separate patents (each good for 20 years), legitimate or not, on various components or attributes of one of its products Components covered could include the color of the medication, a particular chemical reaction when the drug is taken and metabolized, or dose amounts The firm would then defend these with legal actions that would impede the development and sale of generics Manufacture the generic form of Fleximat in-house Medfield could also partner with a large generic manufacturer This would be the easiest approach and would lead to the widest use of Fleximat by patients, but it would generate little in the way of financial benefits to the firm Reformulate Fleximat This was the practice of “reinventing” a drug to “improve” it and thus stave off the generics It meant reconfiguring the medication so it was different enough for FDA approval and a new patent, although this often could be done without substantially changing the medication itself Methods to extend the patent life of the compound could include slightly changing the formulation, dosage, or labeling See Exhibit for examples of drug reformulation Of these four alternatives, reformulation struck Johnson as likely the most beneficial to Medfield; however, there were notable risks The most famous reformulation controversy had been the case of AstraZeneca’s Nexium (a.k.a “the purple pill”) AstraZeneca (AZ) released the patented heartburn drug Prilosec in 1981 It was one of the company’s biggest blockbuster drugs As patent expiration loomed, AZ got FDA approval in February 2001 for the reformulation of Prilosec into a newly patented drug called Nexium, also a heartburn prescription and very similar to Prilosec AZ bru6171X_case53_755-766.qxd 760 12/8/12 1:48 PM Page 760 Part Eight Valuing the Enterprise: Acquisitions and Buyouts then ceased promoting Prilosec and began aggressively pushing Nexium Two years later, the FDA approved an over-the-counter (OTC) version of Prilosec, which had exclusivity in the OTC market until 2006 As a result of this reformulation, Walgreen Company sued AstraZeneca for antitrust violations, claiming the pharmaceutical company had deliberately switched “the market from its heartburn prescription drug Prilosec just as that patent was about to expire to its newly approved drug Nexium, which had a fresh patent.”8 Walgreen’s lawsuit alleged that AZ manipulated the market, taking the emphasis off Prilosec, which had generic competition, and placing it on Nexium, which had a patent until 2014 and no generic competition, and that in doing so, the company eliminated choices for patients Furthermore, Walgreen argued that there was little difference between Prilosec and Nexium and that AZ’s switching of them was exclusionary and violated the Sherman Antitrust Act Walgreen also claimed that AZ was guilty of further exclusionary action when it introduced the OTC version of Prilosec and received a three-year exclusivity grant from the FDA In addition, Walgreen contended that AstraZeneca engaged in prohibited exclusionary conduct when it introduced Prilosec OTC and obtained an FDA grant of exclusivity for three years Ultimately, all five complaints in the lawsuit were dismissed for “failure to state a claim,” and the federal district court judge asserted, among other things, that instead of having taken away drug choices, as Walgreen claimed, AZ had created additional choices (Prilosec OTC and Nexium) The court also made the point that antitrust laws not evaluate the quality of a particular drug—whether superior or inferior; new products could only affect the market share if customers preferred them Finally, the court did not find that AZ had interfered with Walgreen’s freedom to compete; in other words, the court found that AZ was not guilty of illegal antitrust activity While there was only one study that demonstrated superiority of Nexium, it had been sponsored by AstraZeneca.9 Nevertheless, while not considered racketeering in the courts, the process of reformulation came under increasing public scrutiny According to author Malcolm Gladwell, Nexium had become a “symbol of everything that is wrong with the pharmaceutical industry”: The big drug companies justify the high prices they charge—and the extraordinary profits they enjoy—by arguing that the search for innovative, life-saving medicines is risky and expensive But Nexium is little more than a repackaged version of an old medicine And the hundred and twenty dollars a month that AstraZeneca charges isn’t to recoup the costs of risky research and development; the costs were for a series of clinical trials that told us nothing we needed to know, and a half-billion-dollar marketing campaign selling the solution to a problem we’d already solved.10 “Prilosec/Nexium Antitrust Claims Dismissed: No Antitrust Violation for Introducing New Drugs to the Market,” Judicial View, https://www.judicialview.com/Court-Cases/Antitrust/Prilosec-Nexium-AntitrustClaims-Dismissed/No-Antitrust-Violation-for-Introducing-New-Drugs-to-the-Market/5/2666 (accessed September 1, 2011) Esomeprazole (Nexium) provided improved acid control versus omeprazole (Prilosec) in patients with symptoms of gastroesophageal reflux disease 10 Malcolm Gladwell, “High Prices: How to Think About Prescription Drugs,” New Yorker, October 25, 2004, 86 bru6171X_case53_755-766.qxd 12/8/12 1:48 PM Page 761 Case 53 Medfield Pharmaceuticals 761 Furthermore, in a front-page article that first revealed AZ’s initiative to reformulate its expiring medication, the Wall Street Journal concluded that “the Prilosec pattern, repeated across the pharmaceutical industry, goes a long way to explain why the nation’s prescription drug bill is rising an estimated 17% a year even as general inflation is quiescent.11 The Value of Medfield As Johnson sat down to contemplate the acquisition offer, she began to look at the company’s portfolio of drugs in a new light Rather than therapies for ailments, they were sources of cash flow Fortunately, whereas the R&D process was notoriously unpredictable, once a product was approved, the future was relatively clear This future could be summarized as follows: • • • • • • For 20 years, the product would be patent-protected, and from the initial sales level, sales would grow at about 2% a year When the patent expired, sales would decline 50% in each of the following three years and then would have effectively negligible sales in the fourth year The direct cost of sales would be 23% Direct marketing costs were 27% of revenue and Medfield typically spent 19% of revenue on future R&D The company estimated other general and administrative expenses would be about 4% of sales A large portion of this expense category was tied directly or indirectly to sales and little of the cost was reasonably classified as fixed Capital expenditures were typically close to depreciation levels so that net changes in plant and equipment associated with a given product could be ignored Similarly, net working capital tended to be very small and could be ignored The marginal tax rate for the firm was 32% and Johnson estimated that 8.5% was a reasonable discount rate (cost of capital) for this industry Johnson had recently requested a forecast of the firm’s financials based on approved products This forecast (Exhibit 4) included a forecast for Reximet starting with initial sales of $80 million This forecast was generated largely as a tool for examining the prospects associated with products already in existence and to allow her to gauge the possible impact of Fleximat going off patent Clearly, the forecast did not include the operating effects of adding new products to the lineup While generated for an alternate purpose, the forecast was built from the assumptions listed above, and Johnson wondered if this forecast could also form a reasonable basis for valuing the company As Johnson contemplated her analysis, she immediately recognized that she needed to reach some decision regarding extending the patent life of Fleximat The simplest and most obvious approach was to reformulate the drug Her research team 11 Gardiner Harris, “Prilosec’s Maker Switches Users To Nexium, Thwarting Generics,” Wall Street Journal, June 6, 2002, bru6171X_case53_755-766.qxd 762 12/8/12 1:48 PM Page 762 Part Eight Valuing the Enterprise: Acquisitions and Buyouts was reasonably certain that if it focused its efforts on changing the shape of the pill and applying an easier-to-swallow coating, a reformulation push in 2011 and 2012 at a cost of $35 million a year would likely generate a suitable reformulation This reformulation would very likely leave the pharmacology of the medication unchanged Of course, getting users to opt for the reformulation would require a strong marketing campaign above what was typical She estimated the firm would have to spend $25 million annually for five years starting in 2011 (the first year getting the market ready for the reformulation) to ensure the success of the reformulation A reformulation would not, of course, prevent some erosion in sales Johnson estimated that when the patent expired in 2013, the drug would still see a 50% decline in sales, but after that, sales would grow at 2% a year for eight years After that eight-year period, she reasonably expected that sales would dissipate in a manner similar to drugs going off patent (three years of 50% declines before dissipating entirely) Big Decisions Johnson had started the company with a simple mission: to find and develop medicines that would make lives better Fleximat, she knew, had brought untold relief to children suffering from Crohn’s disease, and this was particularly important to her because her nephew had Crohn’s disease and Johnson had witnessed the incurable, chronic disease firsthand For this reason, she wondered how the potential sale of the company might transform Medfield The focus on making lives better, she hoped, would remain unchanged since the effectiveness of Medfield’s drugs was the core source of its demand She also expected the research staff and structures would be only slightly altered given that the team she had put together was quite effective; whereas a typical firm might have to spend $50 million for five years to develop a new product such as Reximet, her team could probably it for $35 million a year.12 It was clear to Johnson that this offer was a great opportunity for her to exit the business on a high note Given that Medfield was about to roll out Reximet and that it had two other products with substantial patent lives remaining, the company was a good catch for a potential buyer Johnson also realized that the state of early-stage product development at Medfield was quite weak at the time None of its new products was in late-stage trials The fact was that the offer would leave her extremely wealthy and it would afford her a graceful exit from her venture Of course, in deference to the many other owners, she had to put aside her own cares and evaluate the offer in the spirit of a financial transaction This was a big decision—likely the largest of her life 12 Research costs at Medfield were lower, and development times were shorter than they were for the typical large pharmaceutical company given that Medfield targeted small markets; Medfield was not seeking the next blockbuster drug bru6171X_case53_755-766.qxd 12/8/12 1:48 PM Page 763 Case 53 Medfield Pharmaceuticals 763 EXHIBIT | Medfield Pharmaceuticals Annual Income Statement1 (in thousands of dollars) Revenue Cost of Goods Sold Gross Profit SG&A Expenses Research and Development Earnings Before Interest and Taxes Interest Income Taxes Net Income 2007 2008 2009 2010 223,721 55,788 167,933 71,586 42,175 113,761 54,172 984 53,188 16,457 36,731 261,253 65,724 195,529 82,446 54,078 136,524 59,005 1,385 57,620 18,982 38,638 300,556 75,241 225,315 97,542 57,535 155,077 70,238 1,403 68,835 22,495 46,340 329,203 76,472 252,731 105,166 62,457 167,623 85,108 1,457 83,651 25,875 57,776 Note: The company has negligible depreciation and amortization All exhibits were created by the case writer EXHIBIT | Medfield Pharmaceuticals Balance Sheet (in thousands of dollars) Cash Receivables Inventory Property and Equipment Other Assets Accounts Payable Accrued Expenses Current LTD LTD Equity 2007 2008 2009 2010 21,465 28,815 24,704 74,984 102,977 28,227 39,568 24,316 92,111 118,553 29,542 39,117 27,859 96,518 127,498 32,251 41,927 30,559 104,737 129,171 45,937 223,898 25,187 39,236 2,882 67,305 17,069 139,524 223,898 49,312 259,976 26,460 52,634 3,373 82,467 23,609 153,900 259,976 61,569 285,585 27,070 55,256 3,801 86,127 25,278 174,180 285,585 67,718 301,626 30,142 59,850 4,501 94,493 26,850 180,283 301,626 bru6171X_case53_755-766.qxd 764 12/8/12 1:48 PM Page 764 Part Eight Valuing the Enterprise: Acquisitions and Buyouts EXHIBIT | Drug Reformulation Methods AstraZeneca GlaxoSmithKline Eli Lilly and Company Schering-Plough Pfizer Elan To create Nexium, AstraZeneca cut Prilosec in half and changed its color (modest change, basically repackaging) and thus maintained a patented brand As GlaxoSmithKline lost its patent on Paxil, an antidepressant, the company developed a new version (Paxil CR) that patients took just once a day, rather than twice (Even though a Paxil generic weakened sales of Paxil CR, the company stuck with the extended-release version because it was a better fit for people with depression, who tended not to take their medication.) As Eli Lilly’s patent expired on the antidepressant Prozac, the company introduced Prozac Weekly (again, easier and more efficient for patients with depression) Nonetheless, the $182 million sales of Prozac Weekly paled in comparison to the $2 billion sales that the daily Prozac, when patented, had brought in Schering-Plough launched Clarinex, a tweaked version of Claritin, its blockbuster antihistamine, the same year that Claritin lost patent protection Schering-Plough also beat the generic companies at their own game by launching Claritin as an OTC drug within days of losing its patent (Nonetheless, though Claritin was making $3 billion in sales when it lost patent exclusivity, the combined OTC Claritin and Clarinex sales were $1 billion—only a third of peak [and patented] prescription Claritin sales.) Pfizer created an under-the-tongue version of Xanax (formerly just a pill), which provided faster delivery into the system, thus changing the method of delivery Drugmaker Elan used Nanocrystal technology for a 600% improvement in the bioavailability of compounds that dissolved poorly in water Patients would still take the medication orally, but it allowed for a lower required dosage, smaller and more convenient dosage forms, and faster rates of absorption For example, Elan reformulated Bristol-Myers Squibb’s liquid Megace so it was not so thick and so that HIV/AIDS patients could drink less of it and more easily Novartis created a patch delivery system with the Alzheimer’s drug Exelon 335.79 77.23 63.80 90.66 13.43 90.66 329.20 76.47 62.46 91.22 13.94 85.11 29.01 61.65 80.55 18.53 78.97 18.46 27.15 57.96 40.47 9.31 39.67 10.55 27.39 58.21 81.60 18.77 317.04 72.92 60.24 85.60 12.68 85.60 80.00 18.40 422.50 97.18 80.28 114.08 16.90 114.08 36.50 77.57 83.80 19.27 42.10 9.68 109.53 25.19 82.16 18.90 41.28 9.49 219.07 50.39 2013 23.02 48.91 83.23 19.14 266.42 61.28 50.62 71.93 10.66 71.93 85.48 19.66 42.94 9.88 54.77 12.60 4.0% 2014 27.0% 21.02 44.66 84.90 19.53 243.27 55.95 46.22 65.68 9.73 65.68 87.19 20.05 43.80 10.07 27.38 6.30 2015 17.06 36.25 86.59 19.92 197.43 45.41 37.51 53.31 7.90 53.31 88.93 20.45 21.90 5.04 Taxes Discount Rate 2016 16.41 34.88 88.33 20.32 189.99 43.70 36.10 51.30 7.60 51.30 90.71 20.86 10.95 2.52 2017 16.25 34.53 90.09 20.72 188.09 43.26 35.74 50.78 7.52 50.78 92.52 21.28 5.48 1.26 8.5% 2018 32.0% 16.09 34.20 91.89 21.14 186.27 42.84 35.39 50.29 7.45 50.29 94.37 21.71 2019 1:48 PM Taxes NOPAT 214.77 49.40 2011 210.56 47.46 23.0% 19.0% 2010 12/8/12 Fleximat Sales Cost of Sales Lodamadal Sales Cost of Sales Orsamorph Sales Cost of Sales Reximet Sales Cost of Sales Total Sales Cost of Sales Research Direct Marketing General and Administrative Costs of Sales Research Direct Marketing General and Admin 2012 EXHIBIT | Financial Forecast Based on Existing Products (in millions of dollars, unless otherwise noted) bru6171X_case53_755-766.qxd Page 765 765 bru6171X_case53_755-766.qxd 12/8/12 1:48 PM Page 766 Bruner Eades Schill Visit the Online Learning Center at www.mhhe.com/bruner7e to see a complete list of changes to the Seventh Edition and to access study and teaching tools seventh edition uploaded by [stormrg] Eades S chill Case Studies in Finance managing for corporate value creation seventh edition MD DALIM #1218056 12/10/12 CYAN MAG YELO BLK managing for corporate value creation investors At the core of almost all of the cases is a valuation task that requires students to look to financial markets for guidance in resolving the case problem These cases also invite students to apply modern information technology to the analysis of managerial decisions In the Seventh Edition, 25% of the cases are new with many dating from 2011–2012, ensuring that your students are learning from the most relevant and current sources Case Studies in Finance Case Studies in Finance links managerial decisions to capital markets and the expectations of Bruner ... areas, including corporate finance, mergers and acquisitions, investing in emerging markets, innovation, and technology transfer In addition to Case Studies in Finance, his books include Finance Interactive,... 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