Wednesday, April 22, 2009

Amgen Valuation – DCF and Market Multiples

Table of Contents

1. Executive Summary    3

1.1 Company    3

1.2 Major Developments    3

1.3 Valuation    3

1.4 Recommendation    3

2. Business Summary    4

2.1 Company description    4

2.2 Industrial analysis    4

2.3 Competitive Analysis    4

2.4 Company Strategies    5

2.5 Historical Performance    5

3. Risks    5

4. Valuation    6

4.1 Discounted Cash Flow model (DCF)    6

4.1.1 Estimation of WACC    6

4.1.2 Cash Flow Forecast    6

4.1.3 Terminal Value Forecast    6

4.1.4 Adjustments to Obtain Equity Value    7

4.2 Market Multiples Model    7

4.2.1 Comparable Companies    7

4.2.2 Selection, Calculation and Analysis of Market Multiples    7

4.2.3 Equity Value    7

1. Executive Summary

1.1 Company

Amgen is the world's biggest biotechnology company that manufactures and markets human therapeutic products in the areas of supportive cancer care, nephrology, inflammation and oncology.

1.2 Major

In July 2007, the Center for Medicare Services (CMS) limited reimbursement of Aranesp, Amgen's best selling anemia drug. In September 2007, the FDA opted to not limit Epogen dosing at an advisory panel meeting. In March 2008, an FDA advisory panel recommended that Aranesp not be used for breast and head/neck cancer, and other uses, resulting in further label restrictions.

In late 2007, a court ruled that Roche's Mircera violated AMGN's patents, and blocked Micera's launch. In October 2008, a U.S. District Court upheld AMGN's patents and issued a permanent injunction blocking a U.S. launch. In December 2008, Merck announced it would work on developing generic biotech drugs and that its first target, intended for a 2012 launch, would be AMGN's Aranesp.

New drugs in the pipeline: AMGN has announced positive Phase III trial results for Denosumab its osteoporosis drug which is slated to be the next blockbuster drug in its stable. It is forecasted to get approval by the end of 2009. Denosumab is also in late-stage study for cancer-induced bone loss and for rheumatoid arthritis. In August 2008, Nplate was approved by the FDA for treating a rare bleeding disorder.

1.3 Valuation

We used the DCF and Market Multiples models to arrive at a valuation for Amgen's stock. With the DCF model we get a stock price of $84.4 and with the market multiples model we get a stock price of $88.34.

1.4 Recommendation

We recommend a buy on Amgen's stock as its share price as of 04/04/09 of $46.57 is trading well below our DCF and Market Multiples estimates of $84.4 and $88.34 respectively. We believe our estimate is a fair evaluation of Amgen's share price and reflects the current competitive and regulatory environment and the expected sales growth due to launch of Denosumab in the coming years.


2. Business Summary

2.1 Company description

Amgen Inc. was founded in Thousand Oaks California in 1980 and went public on Sept 1984. It is a global biotechnology company that develops, manufactures and markets human therapeutics. Amgen provides human therapeutic products in the areas of supportive cancer care, nephrology, inflammation and oncology to healthcare sectors such as physicians, clinics, dialysis centers, hospitals and pharmacies. The company's principal products include Aranesp, Enbrel, and Neulasta.

2.2 Industrial analysis

Amgen is a leading company in the Biological Product (except diagnostic) Manufacturing Industry (NAICS: 325414), which applies molecular and cellular processes to solve problems, conduct research, and create goods and services. The industry is capital intensive. Sufficient long-term capital is extremely important for this industry since new products may take 10 to 15 years to come to market.

Biological drugs are much less vulnerable to the threats from generic products due to the complexity of the product processes. Regulators would thus increase the number of conditions for any generic product approval. Besides, as most biological products are dispensed by doctors and cannot be sold through pharmacies, the very high marketing cost would also protect biological drugs from generics.

The industry is maturing speedily and a number of major players are well-established and acquisitive of smaller companies in complimentary sectors and with a full product pipeline.

2.3 Competitive Analysis

Amgen has the biggest market share in the industry. Its 2008 sales volume is bigger than the total of its top 4 competitors as Genentech, Inc., Biogen Idec Inc., Gilead Sciences Inc., and Genzyme Corp. Scale matters in the industry in term of capital investment, talents resources, continuous products development on pipeline, manufacturing costs, marketing power and etc.

Barriers to entry in this industry are high. Access to start-up capital is an impediment to industry entry; the cost of research is also high and ongoing due to the specialist buildings and equipments. There is a long lead-time between research and commercialization and high fail rate of R&D projects. Acquiring highly skilled researchers is often difficult. Contracts are awarded largely on the good reputation of an organization and key scientists. The Competition for capital investment, talents and products will eventually lead to greater industry merger and acquisition activity.

2.4 Company Strategies

As an entrepreneurial, science-driven enterprise, Amgen invests heavily on product R&D and production improvement. Amgen also actively sponsor and support philanthropy events to improve brand image and awareness.


With its strengthen in finance and operation, Amgen builds strategic cooperation with over 100 partners and offer partners the resources to support a new medicine as it advances from lab to clinic to marketplace.


Besides, Amgen grows fast by actively pursuing acquisition opportunities. It acquired 5 companies in the past 5 years to achieve the necessary scale for the optimization of development and production cost. These acquisitions also help Amgen to fill its pipeline and leverage its marketing power and brand equities.

2.5 Historical Performance

Amgen was a fast growing company before 2000 and its stock prices during the same time increased 630 times in 15 years. It grew steadily since 2000 and acquired 7 companies since then to keep growing. Its stock price changed slightly during the past 8 years. Its average year on year net income growth rate for the past 2 years was 7.3% for 2007 and 32.4% for 2008. Its shareholder's equities increased by 14.1% in 2008, a huge improvement comparing to the 5.8% loss in 2007. The 4 acquisitions in 2006 and 2007 were often quoted as the reason behind the big improvement in its financial reporting.


3. Risks


Our risk assessment reflects that the company's products are sold in highly competitive markets and are subject to government regulation. Changes to government reimbursement policies could significantly affect AMGN's revenues and profitability. Though adoption has been mild thus far, we believe that generic versions of several of AMGN's drugs pose a long-term threat in Europe.

The industry is vulnerable to changes in investor sentiment - some areas of biotechnology research, such as embryonic stem cells continue to encounter substantial public opposition, which tends to limit the availability of both government and private funding. With increased globalization, the industry is at risk of sourcing tainted raw materials from other countries which have adverse effects on patients (e.g. in 2008, one of Baxter's drugs Herapin had to be recalled). Most biotech drug companies depend on 2-3 blockbuster drugs that account for 90% of their revenues; a recall by the FDA on any one of these drugs can have a very large negative impact on revenues (e.g. Restriction placed on Amgen's biggest selling anemia drug Aranesp in 2007 hurt sales considerably).

Though the risks mentioned above can have a large impact on sales they are not very common and it is relatively easy to forecast cash flows as biotech companies have virtual monopolies in particular markets due to patent protection over 10-15 years.


4. Valuation


We have used two valuation models to come up with a valuation of Amgen's stock:

4.1 Discounted Cash Flow model (DCF)

4.1.1 Estimation of WACC

We calculate a WACC of 6.68% as shown below:

Cost of Equity: Using the CAPM, we concluded that the cost of equity is 7.11%. We multiplied a Beta of 0.6 by the equity risk premium of 7%, and then added the risk free rate of 2.91% (10yr T bond rate).


Cost of Debt: Amgen's outstanding long-term debt is rated "A" with a stable outlook as reported by Standard & Poor's. Thus we use YTM of 5.83% multiplied by (1-tax rate), which led us to a 4.66% cost of debt (tax rate 20%).


Total Equity: Total shares outstanding multiplied by the current share price gave us an equity value of $47.9B (i.e. 1.030 billion shares outstanding * price of $46.57).


Total Debt: The book value of total debt is $10.2B including current portion of long-term debt ($1B), convertible notes ($5.1B) and long-term debt ($4.1B).

4.1.2 Cash Flow Forecast

Amgen is an established company with good performance and we assume that it will grow consistently over the long run. We chose 10 years (2009-2018) as the projected period for our forecast.


We expect that the tax rate will be stable at 20% and EBIT/sales rate at 33% (average value of past 5 years). We calculated NOA as the sum of equity and net debt (all long term debt and convertible notes less cash and marketable securities). NOA in 2008 is $21B. We used 2008 data of the assumed ratio of NOA/Sales rate of 140% for further forecast.


We see AMGN continuing to manage challenges to its anemia franchise. We expect continued pressure in 2009, as the drug's label is further restricted by the FDA over safety concerns. We also see signs of slowing demand for Enbrel from increased competition, with additional competitors set to enter the market, and from biosimilars in Europe. Due to this we forecast sales as remaining flat in 2009 with growth rates recovering from 2010 onwards up to 5% in 2011 due to the commercialization of their osteoporosis drug Denosumab.

4.1.3 Terminal Value Forecast

We use the last estimated year (2018) FCFF as baseline, use WACC as discount rate and the GDP growth rate of 3% as the long term growth rate.

4.1.4 Adjustments to Obtain Equity Value

Using WACC we discount the forecasted cash flow and terminal value to get an enterprise value of $95.3B. Once we had the enterprise value, we subtracted the net debt and minority interest to get to the equity value, which we obtained as $86.9B. Dividing by the number of shares outstanding we get our valuation of Amgen's stock as $84.4.

4.2 Market Multiples Model

4.2.1 Comparable Companies

We started by taking the entire list of top competitors for Amgen from The list included – Biogen, Genzyme, Giliead, JNJ, Novartis, Life Technologies and Teva. We then calculated the following ratios from their Income Statements as given in yahoo finance - EBIT/Sales, EBITDA/Sales, NI/Sales,ROIC, ROE, Debt/Capital, Debt/Equity, Debt/EBITDA. We also looked at the previous 5yr growth rate in EPS and 5yr projected growth rate in sales and EPS as given in ValueLine. We were not able to narrow our comparable companies based on the ratios and we decided to go with Biogen, Genzym and Giliead as their business models were closest to that of Amgen's. JNJ and Novartis are large diversified pharmaceutical companies of which biotech drugs was just one of the lines of business.

4.2.2 Selection, Calculation and Analysis of Market Multiples

We chose the following Market Multiples for our analysis – Price/Book Value, Price/Earnings, EV/Sales, EV/EBIT and EV/EBITDA. We end up choosing the EV/EBITDA multiple for two reasons – the dispersion range of ratios was the least, and the fact that the Biotech drug industry is a capital intensive industry with very high fixed costs involved in developing a drug. The EV/EBITDA multiple we calculated ranges from 9.43 – 14.97. We feel that Amgen should be at the higher end of this range as 14.97 because it is a better run company as compared to its competitors (by looking at the EBIT/Sales, ROIC, ROE and other comparable ratios). Using EV/EBIT ratio of 14.97 we get the Enterprise Value for Amgen as $99,387M.

4.2.3 Equity Value

Once we had the enterprise value, we subtracted the net debt and minority interest to get to the equity value, which we obtained as $90,985M. Dividing by the number of shares outstanding we get our valuation of Amgen's stock as $88.34.

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