Pfizer Equity Analysis and Valuation
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Pfizer Equity Analysis and Valuation Pfizer Equity Analysis and Valuation Document Transcript

  • Pfizer Equity Analysis and Valuation Valuation Date: April 1, 2005 Rusty Klein – rusty.d.klein@ttu.edu Justin Kime – justin.kime@us.army.mil Rene Jimenez – lucio.r.jimenez@ttu.edu Todd Johnson – todd.m.johnson@ttu.edu 0
  • Pfizer Equity Analysis & Valuation Table of Contents Executive Summary……………………….….….2 Business and Industry Analysis…….…………..7 Industry Overview………………………...7 Five Forces Model………………….……..8 Key Success Factors……………………..10 Firm & Industry Conclusions……………11 Accounting Analysis……………………………13 Key Accounting Policies………………...13 Degree of Flexibility...........................…...16 Actual Accounting Strategy……………...17 Quality of Disclosure…………………….19 Ratio Analysis & Forecast Financials…………25 Financial Ratio Analysis…………………25 Financial Statement Forecasts……………37 Valuation Analysis……………………………...39 Cost of Capital…………………………...39 Intrinsic Valuation Methods……………..41 Method of Comparables…………………46 Appendix………………………………………..49 References………………………………………71 1
  • Mo Money Rusty Klein Justin Kime Rene Jimenez Todd Johnson Pfizer, Inc. Investment Recommendation Under-Valued Date of Valuation 4/1/2005 PFE - NYSE (4/13/2005) $27.28 EPS Forecast 52 week price range $21.99 - 37.90 FYE 12/31 2004(A) 2005(E) 2006(E) 2007(E) Revenue(2004 $52.5B EPS $1.87 $1.70 $1.93 $2.09 Market Capitalization $203.53B Industry Shares Outstanding 7.46B Valuation Ratio Comparison Pfizer Average Trailing P/E 31.30 20.90 Dividend Yield 2.80% Forward P/E 16.40 20.23 3-Month Avg. Daily Trading Volume 28.65M Forward PEG 1.08 1.82 Percent Institutional Ownership 65% M/B 2.66 3.85 D/E 4.00 0.57 Book Value Per Share (mrq) $9.37 Valuation Estimates ROE(2004) 17% Actual Current Price (4/1/2005) $ 26.15 ROA(2004) 9% Est. 5 year EPS growth rate 12% Ratio Based Valuations Trailing P/E $ 39.08 Cost of Capital Estimations R Squared Beta Ke Forward P/E $ 37.84 Forward PEG $ 21.84 5-Year Regression 0.132 0.458 4.58% D/E $ 44.98 3-Year Regression 0.234 0.595 4.99% M/B $ 35.58 2-Year Regression 0.061 0.436 4.52% Ford Epic Valuation $ 62.16 Published 0.393 Intrinsic Valuations Kd 3.45% Discounted Dividends $ 35.58 WACC(bt) 4.07% Free Cash Flows $ 58.27 Residual Income $ 55.52 Abnormal Earnings Growth $ 55.52 Long-Run Residual Income Perpetuity $ 99.42 2
  • Executive Summary Recommendation – Undervalued Security A fter thorough forecasting and evaluations, we have recommended to investors to buy market shares of Pfizer due to their continual growth of price share with no signs of decreasing. With the recent acquisition of Pharmacia, Pfizer has continued to maintain their dominant position in the pharmaceutical industry. Even though many companies are in the pharmaceutical industry, competition is limited to the handful of major drug manufacturers. Pfizer has now grown to be the top pharmaceutical company in the United States and one of the top 10 in the world with $52.5 billion in revenues in 2004. Industry Demand Drivers With new drug innovations serving as the driving force in the industry, companies are forced to allocate larger amounts of capital each year to research and development. In 2004 Pfizer invested $7.7 billion on research and development which was almost twice the amount of its nearest competitor, Novartis. Realizing this necessity of discovering the next “big drug,” Pfizer plans to further increase R&D spending to over $8 billion in 2005. One of the largest threats to any drug company, including Pfizer, is the competition imposed by generic drug companies after patents have expired on highly profitable prescription drugs, such as Viagra. 3
  • Pfizer’s Industry Standing Pfizer’s main competitors are Abbot Laboratories, Bristol-Meyers Squibb, Novartis, and Merck. Pfizer expects to sustain long-term growth driven by innovative products, strong research and development pipeline and operating efficiencies. Pfizer has grown to be the industry leader, but doesn’t settle for simply being the best. They are constantly seeking to improve, and making the necessary changes to become more effective, in order to further separate themselves from the competition. For example, Pfizer is targeting $4 billion in total annualized cost savings by 2008, representing the other 12% of their total current cost base. Pfizer continually strives to be the leader in the innovation of new pharmaceutical products, such as the completion of 13 new drug applications resulting in 20 filings with the FDA in the next five years. Margin Expansion In the pharmaceutical industry, mergers and acquisitions are increasing in popularity as a means to capture a greater percentage of the market share. Evidence of this trend is Pfizer’s acquisition of Warner-Lambert in 2001 and Pharmacia in 2003. Another margin expansion method used by our company is competing in more than one market such as: pharmaceuticals, consumer health, and animal health. The use of modern technology, the internet, is yet another way to capture market share. Financials 4
  • The financials for Pfizer the last few years have fluctuated dramatically, due to the acquisition of Pharmacia, in 2003. This proves to be true in the results of operating income dropping from $9.1 billion in 2002 to $1.6 billion in 2003. Pfizer had shown a relatively constant growth since initially going public until the Pharmacia acquisition, the post acquisition years and the forecasts show continual growth in years to come. The forecasted earning per share also confirms our expectations of Pfizer’s future growth. Valuations Based upon our valuations, Pfizer’s stock price is currently undervalued. Using the three intrinsic valuation methods that we feel most confident in; free cash flows, residual income, and abnormal earnings growth we arrived at the conclusion that the stocks should be valued at a price in the vicinity of $50. Also, all five intrinsic valuations used showed that the current stock price of $26.15 is lower than it should be, which only increases our confidence that Pfizer’s stock price is undervalued. Risks The first mover advantage is huge in the pharmaceutical industry. The company to first discover and patent a breakthrough drug will be the only company selling a drug of that type for the next 8-10 years. While that company is raking in the cash, the other companies in the industry can only sit idly by and wait for the patent to expire. The risk in this situation comes from not being the first mover on one of these breakthrough drugs. Legal risk also plays a very large role for companies such as Pfizer. If a drug is sent to 5
  • market and side effects become apparent, legal fees and settlement costs can cost a company millions of dollars. 6
  • Business & Industry Analysis P fizer Inc. is a research-based, global pharmaceutical company that discovers, develops, manufactures, and markets prescription medicines for humans and animals, as well as consumer healthcare products. Pfizer, whose corporate headquarters are located in New York, NY, got its start in 1862 by producing antacids. Pfizer has now grown to be the top pharmaceutical in the United States and one of the top 10 in the world. In 2004 Pfizer had revenues of 52.5 billion and spent 7.7 billion on Research and Development. Industry Overview The pharmaceutical industry covers a broad base of segments that allows companies to specialize and create a competitive advantage. The US has the largest market share with five of the top ten Drug Companies in the world. Europe has the second largest market share and the other five top ten companies. Internet pharmacies, along with Canadian drug suppliers continue to increase competition in an already highly competitive market. Generic Drug Manufacturers also diversify the industry by providing lower cost drugs than the big name pharmaceutical companies. Patents which do not last forever can create a temporary monopoly for a company that develops a new drug. Regulation by the FDA and lawsuits also increase costs and draw out the process of bringing a drug to market. Trends 7
  • As research and development costs continue to sky rocket pharmaceutical companies tend to focus on products for chronic rather than acute diseases with large patient populations such as cancer, arthritis, and cardiovascular conditions. The potential benefit of pooling research and development has lead to large mergers such as Pfizer with Pharmacia along with Glaxo Wellcome with SmithKline Beecham. Drug manufactures are continuing to make their drugs available online which helps them further penetrate the market and keep up with technology. Advertising decreases the drug companies reliance on physicians and further educates the general population on new and innovative drugs. Five Forces Current Competitors Even though many companies are in the pharmaceutical industry competition is limited to the handful of major drug manufacturers. Leaders in market capitalization include companies such as Pfizer Inc, Johnson & Johnson, Glaxo SmithKline, and Merck Co. Generic drugs are one of the most prevalent sources of competition for the major drug companies. Companies providing consumers with low cost generic drugs take away profitability from the major players in the industry. First mover advantage is huge in the industry because of the protection offered by a patent. New Entrants The threat of new competitors in the pharmaceutical industry is relatively low because of the amount of capital needed along with the high cost of research and 8
  • development. Smaller firms attempting to enter the industry are often bought out by the huge drug companies trying to protect themselves from competition. FDA regulations and the threat of lawsuits discourage potential firms from entering the market. Substitute Products There is a high volume of substitute products between the leaders in the industry. Competitive pricing and product marketing are essential factors that determine who leads in a particular sector. Generic companies pose the largest threat to the major companies because of low cost which sways consumers from name brand drugs. The increasing popularity of herbal remedies continues to threaten the profitability of the large companies. Customer Bargaining Power The bargaining power of buyers is low since products are differentiated and made to meet specific consumer needs. Generic drugs are often unavailable to consumers for a period of time because of patent restrictions. These patent restrictions allow the developing company to dictate prices until the patent expires. Supplier Bargaining Power Suppliers are limited in their bargaining leverage due to the pharmaceutical companies ability to dictate what products are to be made. Another way that companies keep supplier bargaining power low is by easily being able to find an alternate supplier. 9
  • Classification of Industry Pfizer operates in the three particular segments of the pharmaceutical industry. They separate themselves from competition by producing pharmaceutical, consumer health care, and animal health products. Key Success Factors Global research and development have helped Pfizer maintain a competitive advantage in the major drug industry. Also contributing to Pfizer’s advantage is operating worldwide with a multi-domestic strategy. Pfizer further set itself apart from competition by merging with Pharmacia in 2003. Because of these advantages Pfizer was able to generate 52.5 billion dollars in revenue for 2004. Drug companies focus on the baby boomer generation because people over the age of 65 consume three times as many drugs as younger populations. Pfizer continues to cater to its customers by offering its drugs online and accepting discount cards. In addition to providing drugs online Pfizer distributes its drugs with various vendors and wholesalers. Pfizer is lead by CEO Henry McKinnell and a board of directors with 16 members. Also managing Pfizer is CFO, Alan Levin. Management focus is concentrated on maintaining performance while creating an inclusive environment. 10
  • Pfizer operates research and development facilities in a several US states as well as England, Japan, and France. Its consumer health care branch is based out of New Jersey. With facilities strategically located around the globe Pfizer is able to stay competitive in the market. Pfizer is prone to several risks. One of the principal concerns is lawsuits stemming from side affects caused by medication. Merck, one of Pfizer’s largest rivals, is constantly being investigated on its popular painkiller, Vioxx. This will cost Merck millions of dollars and take focus away from innovating and developing new drugs. Another risk Pfizer has to be aware of is time. With companies in a race to develop the cure for certain diseases such as cancer and diabetes anybody who isn’t on pace with the industry could be left out and lose a huge portion of their market share. Patents also correspond to the time risk involved in pharmaceuticals. A patent lasts for 20 years but with the numerous FDA regulations and testing involved, a drug could be eight to ten years into the patent by the time it is ready to distribute. This cuts back on the length of time the company is able to exclusively produce the drug. Firm & Industry Conclusions Pfizer is able to maintain its position as a market leader in the pharmaceutical industry by exploiting its competitive advantage, key success factors, and by being diversified within the industry. Pfizer’s size plays to its advantage by creating the ability to invest huge quantities of money in research and development. 11
  • With the threat of substitute products extremely high coupled with the huge cost of research and development the industry is highly competitive. Companies must keep up with competition and produce and vital innovative drugs to be successful. Low bargaining power of suppliers and customers and low power of shareholders plays in favor of the drug companies. As the world population becomes increasingly dependant on pharmaceutical products the industry will continue to grow and stay competitive as companies seek to generate the next wonder drug. 12
  • Accounting Analysis T o properly evaluate the performance of Pfizer it is necessary to evaluate certain qualitative and quantitative measures. After evaluating Pfizer’s financial statements it is apparent that Pfizer is transparent and discloses all relevant information that is pertinent to investors and regulators. Key Accounting Policies Pfizer competes on a strategy that is designed to differentiate itself from competitors, but also competes on cost leadership once a patent expires and they no longer exclusively control production rights for that drug. It is necessary to identify key accounting policies that are used in operation and in material disclosure in financial statements. The more significant accounting policies are outlined below. Consolidation and Basis of Presentation The consolidated financial statements include Pfizer’s parents company along with all subsidiaries operated in the US and internationally. Financial information included for companies operated internationally is included as of November 30th of each year. Also, all remitted earnings of international subsidiaries are free of legal and contractual restrictions. On April 16, 2003 Pfizer purchases Pharmacia Corporation in a stock for stock transaction which was accounted for using the purchase method of accounting. Assets 13
  • acquired and liabilities assumed as a result of the transaction are included in the consolidated financials. Also included in the consolidated financial statements ending December 31, 2003 are the results of seven months of international operations along with the results of eight months of US operations of the former company, Pharmacia. Business Acquisitions Pfizer uses the purchase method of accounting when acquiring other businesses. This requires the assets acquired and liabilities assumed to be stated at fair value by the date of acquisition. The transaction costs and other related costs when acquiring another company are allocated to the underlying assets of that company in proportion to the related values. If purchase price is above the fair value of net assets, any difference is recorded as goodwill. Revenues Pfizer revenue recognition policy records revenue when the products are shipped and legal title is transferred to the customer. This type of policy prevents the accumulation of unearned revenues. Estimates and assumption are used in the process of preparing the financial statements. These estimates include values used to account for sales discounts and allowances, and incentives. The estimates used have the potential to affect the reported numbers and quality of disclosure. Pfizer helps co-promote other pharmaceutical companies products in exchange for additional revenue. Pfizer earns revenue when the co-promotion partners ship the good 14
  • and the title is passed to their customer. The revenue received from the alliance is included in revenues and is based upon a percentage of the partner’s net sales. Expenses related to the alliance are recorded in selling, informational, and administrative expenses. Research and Development Expenses Costs associates with Research and Development are expenses as they are incurred. Pfizer’s own R&D costs as well as those of associated third parties are included. Milestone payments received from third parties are expensed when the specific milestone is achieved. Pfizer has no R&D arrangement that results in recognition of revenue (Pfizer 10-K, 2003). Inventories Inventories are valued at the lower of the two either cost of fair value. Costs for work in process and finished goods are determined by average actual cost. Cost for supplies and raw materials are calculated at average or latest actual cost. Long Lived Assets Included under long lived assets are property, plant, and equipment, which are recorded at original cost and then adjusted for any improvements made. Also recorded under long lived assets are goodwill and other intangible assets such as deferred taxes and deferred charges. Stock Based Compensation 15
  • Compensation of employees with the issuance of stock options is accounted for using Accounting Principle Board(APB) Opinion No. 251, Accounting for Stock Issued to Employees. This is in accordance with SFAS No. 123, Accounting for Stock Based Compensation. The market price on the day the stock option is issued is the exercise price of the option. The grants of stock options incur no related expenses. (Pfizer 2004 10-K) Degree of Potential Accounting Flexibility Pfizer has a moderate degree of flexibility when disclosing financial reports. One of the key accounting policies Pfizer has relates to inventory. Pfizer determines the value of work in process and finished goods inventory by average actual cost. This conservatively states the value of inventory, as the market value of this inventory is noticeably bigger than the stated value. Costs for supplies and raw materials is calculated by average costs or latest actual costs which helps keep costs stable and helps prevent large fluctuations in the cost level. Estimates are used when calculating values that account for sales discounts and allowances, as well as customer incentives. The values Pfizer uses to calculate these values have the ability to distort the actual underlying reality of the company. Pfizer is required by GAAP to record Research and Development expenditures as an expense and not allowed to classify this as an asset. This limits the degree of flexibility that the company has. Because Pfizer spends large quantities of money on R&D which is a large part of the pharmaceutical industry this has a significant impact on their bottom line. 16
  • Actual Accounting Strategy Pfizer’s accounting strategy and policies are conservative in nature and reflect the underlying economic reality of the company. Pfizer’s policy is in accordance with generally accepted accounting procedures as set forth by the Financial Accounting Standards Board. GAAP is subject to choices and multiple methods of valuation. Pfizer has chosen a policy that accurately reflects the situation of the company and does not capitalize on the accounting flexibility offered by GAAP to manipulate its financial statements to look more appealing to investors. Overall, Pfizer is conservative in nature with its financials and discloses all pertinent information. The pharmaceutical industry is dominated by large companies in the US and Europe. Merck & Co. along with Bristol-Meyers Squibb are two of Pfizer’s competitors in the US. Pfizer and Merck do a good job in disclosing financial information while Bristol-Meyers is slightly more hesitant isn’t as transparent as the other two companies. The three companies’ accounting policies are similar in regard to the key accounting policies such as revenue recognition, inventory, principles of consolidation, etc. with no major differences. Bristol-Meyers is more aggressive in its accounting policies and because of this has to restate its consolidated balance sheet at December 31, 2002. Also restated were consolidated earnings, cash flows, comprehensive income, and retained earnings for 2002, 2001, and its financial statements for the first three quarters of 2003. Revenue Recognition 17
  • Pfizer has adopted a revenue recognition policy that is simple and is in accordance with GAAP. It records revenues when the products are shipped and title passes to the customer. This method is the norm for the industry since there are no alternative ways to record revenue under GAAP. Research and Development Research and Development is one of the key investments in the pharmaceutical industry. In 2004 Pfizer spent 7.7 billion on R&D and brought in 52.5 billion in revenues. Pfizer records Research and Development costs as expenses when they are incurred. These costs also include related of costs of third parties. When milestone agreements are made and Pfizer receives payments, these are expensed when the specific milestone is achieved. Pfizer is conservative in regard to R&D in that they have no R&D arrangements that result in recognition of revenue. Business Acquisition Pfizer uses the purchase method of accounting which states that the assets acquired and liabilities assumed be recorded at their respective fair values on the date of acquisition. For valuing the value of significant items Pfizer gets assistance from independent valuation specialists. When determining the fair value of assets and liabilities obtained through an acquisition Pfizer uses the income method. This method forecasts the expected future net cash flows and then adjusts this to present value with an appropriate discount rate, which reflects the risks associated with these cash flows. 18
  • Quality of Disclosure While other firms in the industry aren’t as transparent and don’t fully disclose the actual situation Pfizer goes beyond GAAP requirements and makes the effort to disclose all information relevant to investors and regulators. In a portion of the 2003 10-K Pfizer discloses the adjusted net income. This is the state the company would have been in prior to the Pharmacia acquisition. Pfizer is committed to showing the true economic situation of the company by choosing an accounting strategy that accurately depicts the circumstances at the time of disclosure. The footnotes provided in the 10-K discloses the revenue recognition, and inventory calculation methods. They also provide information on other key policies and give further insight to the company’s management activities. Also in the management discussion and analysis Pfizer gives clear insight to the formal structure of the financial reports. Given the extensive level of disclosure of internal controls and recollection of independent Certified Public Accountants that audited the reports, Pfizer took the recommendations made by auditing firm KPMG LLP and their own internal auditors. Management claims,” We believe that our system of internal control is effective and adequate to accomplish the objectives discussed.” (Pfizer 10-K 2003) Sales Manipulation Diagnostics 2003 2002 2001 2000 1999 Net Sales / Cash From Sales 1.00 1.10 1.02 0.99 1.00 19
  • Net Sales /Accounts Receivable 5.15 5.60 5.44 5.39 5.10 Net Sale / Inventory 7.74 12.09 10.59 10.95 10.58 Appendix A: Sales Manipulation Diagnostics These ratios remained steady throughout the five year observation period with the exception of net sales to inventory. Net sales to inventory showed a noticeable increase in 2002 which can be explained by an increase in sales. The next year net sales to inventory decreases by a substantial amount. This is explained by an increase in inventory due to the acquisition of Pharmacia. The net sales to unearned revenues ratio is not applicable to Pfizer because of Pfizer’s revenue recognition policy. Pfizer’s revenue recognition policy is set up to record revenue after products have been shipped to consumers, which results in zero unearned revenues. Net sales to warranty liabilities are also not applicable to Pfizer because Pfizer does not produce products which are subject to warranties. The FDA may force Pfizer to recall a certain drug to do health concerns but this will result in an extraordinary loss, and not a warranty liability. Expense Manipulation Diagnostics 2003 2002 2001 2000 1999 20
  • Asset Turnover 0.39 0.70 0.74 0.88 0.87 CFFO/OI 7.15 1.07 1.18 1.67 1.10 CFFO/NOA 0.26 0.64 0.59 0.45 0.72 Total Accruals / Change in Sales 1.28 0.43 -2.79 0.70 0.23 Pension Expense / SG&A 0.01 0.01 0.01 0.01 0.01 Appendix B: Expense Manipulation Diagnostics The ratios were relatively constant for the five years of observation with a few exceptions. In 2000 Pfizer acquired Warner-Lambert and thus affecting certain ratios such as cash flow from operations to operating income as well as total accruals to change in sales. Also, the acquisition of Pharmacia affected nearly all ratios for 2003. From 2002 to 2003 the CFFO/OI income ratio jumped from 1.07 to 7.15. This large of an increase should be investigated to determine any manipulation by Pfizer’s management. The Pharmacia merger had drastic affects on Pfizer’s financial statements. The Cash Flow From Operations increases from $9.9 billion to $11.7 billion. Operating Income decreased from $9.2 billion to $1.6 billion. This is the reason that the change in CFFO/OI was so drastic. After evaluating a company’s sales and expense manipulation ratios, it is also necessary to compare the company to its competitors as an additional check. Because of the increasing number of mergers and acquisitions it is hard to directly compare these manipulation ratios to do the volatility and fluctuations. 21
  • The net sales to cash from sales ratios for all companies stayed very closely to 1. There were no large fluctuations in Pfizer or any other company which would suggest foul play. The net sales to accounts receivable ratio was prone to large fluctuations. Pfizer was the most stable of all companies in regard to this ratio which suggests sound management and no creation of false sales. Net sales to inventory was another ratio which large variances from year to year. Pfizer had noticeable increase and decreases like all companies due to the acquisitions of Warner Lambert and Pharmacia. This was consistent for all companies in the industry and did not raise any red flags. The expense manipulation diagnostics had the same patterns as the sales manipulation ratios with large fluctuations. Pfizer’s asset turnover ratio was constant until 2003 when it had a noticeable drop. This was due to the large and sudden increase in assets due to the acquisition of Pharmacia. CFFO/OI had the same degree of fluctuation as most ratios with Pfizer again having a large rise in 2003 due primarily to the decrease in operating income. This also did not raise any red flags because the material increase was due again to the acquisition of Pharmacia. Total accruals to change in sales were relatively constant for Pfizer when compared to other companies in the industry. Merck for example, increased from -.35 to 42.72 in one year. Pfizer’s largest fluctuation was .7 to -2.79 which suggests that Pfizer’s management is doing a good job of preventing large swings in this ratio when compared to other companies in the industry. Pension expense to SG&A is a ratio which should be carefully looked into because of the rising cost of health care. Pfizer’s ratio was consistently around 1% while other companies had fluctuations as large as around 80%. Pension expense is hard to not explicitly listen on most income statements, with Pfizer being no exception. To 22
  • accurately compute this ratio, the footnotes of the income statement must carefully be examined to determine actual expenses as well as discount rates used. Percentage Change in Ratios 2000 2001 2002 2003 Net Sales / Cash From Sales -0.95% 2.09% 8.48% -9.24% Net Sales /Accounts Receivable 5.65% 0.94% 2.90% -7.98% Net Sale / Inventory 3.47% -3.26% 14.16% -35.96% Asset Turnover 1.14% -16.00% -5.79% -44.59% CFFO/OI 50.82% -29.44% -8.61% 565.84% CFFO/NOA -37.36% 31.76% 7.59% -58.65% Total Accruals / Change in Sales 198.42% -499.64% -115.49% 195.86% Pension Expense / SG&A 45.86% 0.36% 21.84% 8.83% Potential Red Flags As explained earlier Pfizer maintains transparent records in its financial disclosure. Although there have been some potential discrepancies in the raw data, the causes of these have been well explained by mergers, acquisitions, and supplemental data in the footnotes. For example, the acquisitions of Warner-Lambert and Pharmacia caused fluctuations in inventory levels, sales, and accruals, which affected many of the 23
  • diagnostic ratios. Although these changes might raise concerns of revenue and expense manipulation, Pfizer’s quality of disclosure and reporting justified all causes of variation. Because Pfizer is the world’s leading pharmaceutical company with 14 drugs that are the high sellers in their respective categories, this lowers the level of concern because the company continues to improve and dominate the industry. Accounting Distortions After reviewing five years of financial statements for Pfizer, there appears to be no symptoms of accounting distortions. The financial statements were in accord with the supplemental data disclosed in the footnotes. While Pfizer had a moderate degree of accounting flexibility within GAAP regulations, it did not use this to manipulate its financial position. All methods of accounting used were well explained in the footnotes. As there were no distortions in the financial statements, there is no need to correct for accounting misrepresentation. 24
  • Ratio Analysis & Forecast Financials T he financial ratio analysis and forecasting methods are essential to understanding potential performance based on a company’s past and present operations. The financial ratio analysis utilizes a variety of methods, using past financial data to evaluate past performances. Methods used, such as liquidity, profitability, capital structure, and others are used to help show the history of overall success. Not only does the financial ratio analysis take the financial data of the company at focus, but as well of that of the competitors and industry. Financial statement forecasting methods are used to give insight on possible future performances. Forecasting methods used for Pfizer will take into account of the recent acquisition of Pharmacia. The forecast will span a ten year period because, a longer forecast period shows possible trends over time. The purpose of the financial ratio analysis and forecasting methods is to provide the company as well as investors a picture of what the future may hold. Financial Ratio Analysis The Financial ratio analysis section covers the past five years of financial data; with this data such ratios used will help determine liquidity, profitability, and capital structure. Other ratios will be used to help show past performances of Pfizer that is crucial to this particular company and it success. The sustainable growth rate (SGR) will 25
  • be used, which says that the increase in sales must be below the SGR in order to grow. All the information presented in the financial ratio analysis will be vital to accurately forecast future performance of Pfizer. Pfizer Financial Ratios 1999 2000 2001 2002 2003 2004 Liquidity Analysis Current Ratio 1.37 1.43 1.40 1.34 1.26 1.50 Quick Asset Ratio 0.99 1.03 0.98 0.99 0.88 1.11 Inventory Turnover(Days) 172.88 200.98 237.25 241.65 216.69 322.36 Accounts Receivable Turnover(Days) 71.57 67.74 60.34 65.22 70.88 65.10 Profitability Analysis Gross Profit Margin 0.80 0.83 0.87 0.88 0.78 0.86 Operating Profit Margin 0.25 0.20 0.34 0.36 0.07 0.27 Net Profit Margin 0.18 0.13 0.27 0.28 0.09 0.22 Asset Turnover 0.87 0.88 0.74 0.70 0.39 0.42 Return on Assets 0.16 0.11 0.20 0.20 0.03 0.09 Return on Equity 0.35 0.23 0.43 0.46 0.06 0.17 Capital Structure Analysis Total Liabilities/Total Equity 1.25 1.08 1.14 1.32 0.79 0.81 Times Interest Earned 18.32 12.57 34.31 46.08 9.32 28.24 Debt Service Margin 2.91 3.60 6.28 6.09 4.51 6.12 Sustainable growth rate 22.45% 9.51% 27.73% 29.86% -0.68% 9.20% Pfizer’s sustainable growth rate is very volatile. This is due in large parts to sizeable acquisitions. Pfizer’s return on equity ratio fluctuates largely from year to year because of these mergers which causes a large part of the volatility in the sustainable growth rate. Pfizer’s sustainable growth rate is probably around 9%, which is drawn 26
  • from the 2 years of observation where conditions were favorable enough to let the SGR smooth out to realistic levels. This implies that Pfizer will be able to grow at roughly nine percent per year without becoming constrained. . Liquidity Analysis Pfizer’s liquidity has improved over the past 5 years. The current ratio and quick asset ratio showed constant improvement from 1999 through 2004. The inventory turnover decreased slightly over the same five year period, making Pfizer slightly less efficient. Some of this is attributable to large acquisitions in 2000 and 2003. Pfizer’s inventory turnover while fluctuating between years has increased marginally over the five year period. This also shows Pfizer becoming less efficient. Even though the liquidity ratios yield mixed results, Pfizer continues to expand and remain liquid in respect to competitors. Profitability Analysis Pfizer’s gross profit margin has fluctuated slightly for the analysis period but ends up six percent higher at 86%. While this rate of gross profit is likely to fall slightly in the future because of regulation and public attitude toward pharmaceutical companies Pfizer is in position to maintain its market power. Operating profit had varied it is up slightly higher, showing a slight increase in operating efficiency. Net profit has had a range of almost 20 percent but ends up 4 percent higher in 2004 than 1999. The dramatic variation is due to acquisitions of large firms such as Pharmacia. Asset turnover has been cut roughly in half because the acquisition of Pharmacia caused Pfizer’s asset base to double. As Pfizer sells off some of Pharmacia’s assets this ratio will improve but will 27
  • probably not reach the level it was at prior to the acquisition. Return on assets and equity has also dropped noticeably during the period of observation. It stayed relatively constant but was also affected by the acquisition. Pfizer has experienced surges and drops in its profitability over the past six years due in large part to its level of assets. It remains a leader in almost every profitability ratio except for asset turnover proving that it is able to continue its domination of other firms. Capital Structure Pfizer has constantly improved its capital structure over the past five years. It is now twenty percent lower than its nearest competitor, Abbot, in the debt to equity ratio. While Pfizer’s times interest earned ratio is low compared to competitors it has a favorable debt service margin. It is the leader in the industry in debt service margin. Pfizer is able to generate six dollars of operating income for every dollar of current notes payable. Cross Sectional (Benchmark) Analysis The following ratios were calculated for Pfizer, Pfizer’s main competitors, and the industry average. The industry average was calculated from Pfizer’s three main competitors. Merck Company’s 10-K was not released at the time of analysis, therefore its numbers for 2004 are labeled N/A. Financial Ratios Appendix C: Financial Ratio Analysis 28
  • Current Ratio 1.80 1.70 1.60 1.50 1.40 1.30 1.20 1.10 1.00 2000 2001 2002 2003 2004 Pfizer Abbot Bristol Meyers Merck Industry Average Quick Asset Ratio 1.40 1.20 1.00 0.80 0.60 0.40 0.20 0.00 2000 2001 2002 2003 2004 Pf izer A bbot Bristol Meyers Merck Industry A verage 29
  • Accounts Re cie vable Turnove r 9.00 8.00 7.00 6.00 5.00 4.00 3.00 2.00 1.00 0.00 2000 2001 2002 2003 2004 Pf izer A bbot Bristol Meyers Merck Industry A verage Days Supply of Re cie vable s 300.00 250.00 200.00 150.00 100.00 50.00 0.00 2000 2001 2002 2003 2004 Pf izer A bbot Bristol Meyers Merck Industry A verage 30
  • Inventory Turnover 8.00 7.00 6.00 5.00 4.00 3.00 2.00 1.00 0.00 2000 2001 2002 2003 2004 Pf izer A bbot Bristol Meyers Merck Industry A verage Days Supply of Inve ntory 1000.00 900.00 800.00 700.00 600.00 500.00 400.00 300.00 200.00 100.00 0.00 2000 2001 2002 2003 2004 Pf izer A bbot Bristol Meyers Merck Industry Average 31
  • Gross Profit Margin 100% 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% 2000 2001 2002 2003 2004 Pfizer Abbot Bristol Meyers Merck Industry Average Operating Profit Margin 60% 50% 40% 30% 20% 10% 0% 2000 2001 2002 2003 2004 Pf izer Abbot Bristol Meyers Merck Industry Average 32
  • Net Profit Margin 40% 35% 30% 25% 20% 15% 10% 5% 0% 2000 2001 2002 2003 2004 Pfizer Abbot Bristol Meyers Merck Industry Average Asset Turnover 1.20 1.00 0.80 0.60 0.40 0.20 0.00 2000 2001 2002 2003 2004 Pfizer Abbot Bristol Meyers Merck Industry Average 33
  • Return on Assets 30% 25% 20% 15% 10% 5% 0% 2000 2001 2002 2003 2004 Pfizer Abbot Bristol Meyers Merck Industry Average Return on Equity 60% 50% 40% 30% 20% 10% 0% 2000 2001 2002 2003 2004 Pfizer Abbot Bristol Meyers Merck Industry Average 34
  • Debt to Equity 2.50 2.00 1.50 1.00 0.50 0.00 2000 2001 2002 2003 2004 Pfizer Abbot Bristol Meyers Merck Industry Average Times Interest Earned 95.00 85.00 75.00 65.00 55.00 45.00 35.00 25.00 15.00 5.00 -5.00 2000 2001 2002 2003 2004 Pfizer Abbot Bristol Meyers Merck Industry Average 35
  • Debt Service Margin 14.00 12.00 10.00 8.00 6.00 4.00 2.00 0.00 2000 2001 2002 2003 2004 Pfizer Abbot Bristol Meyers Merck Industry Average Operating Cash Flow as a Percentage of Operating Income 400% 350% 300% 250% 200% 150% 100% 50% 0% 2000 2001 2002 2003 2004 Pfizer Abbot Bristol Meyers Merck Industry Average 36
  • Financial Statement Forecasting To accurately forecast financial statements needed to perform intrinsic valuations, considerable effort, time, and care is needed. All the financial ratios must be calculated and analyzed for a period of five years. Pro-forma financial statements are also a tool used to forecast the financial statements. These are created by stating everything in percentages of the biggest number on the financial statement or section of the financial statements. Once this is completed future values can be computed by looking at historical patterns and impacts of current market conditions. When forecasting the income statement, balance sheet, and statement of cash flows the acquisition of Pharmacia played a key role. This acquisition caused drastic fluctuations in Pfizer’s ratios in 2003 as compared to 2002. When taking this into account, historical patterns of past acquisitions were used to provide a basis for future predictions. The acquisition of Warner Lambert in 2001 showed increases in sales, inventory, and assets. This acquisition also showed decreases in operating cash flows and net income. After a year these numbers and financial ratios were at levels slightly higher than before the acquisition. These cyclical impacts were used in forecasting Pfizer’s financial reports for the future ten years which are used in the intrinsic valuation models. Although many percentage based growth rates are used, some drive many key aspects of forecasts. In 2005, a 5% growth rate in sales is used. This number is increased to 6.5% in 2006 and then to 8% in 2007. For the remaining years, Pfizer’s growth rate in sales is estimated to be 10%. Another key number used in calculations is the gross profit 37
  • margin. Pfizer’s growth profit margin at the end of 2004 was 86%. With the hostile attitude towards drug manufacturers for charging high prices, Pfizer’s gross profit margin in our models is 83% in 2005 and 80% for the remaining years. With many growth rates and assumptions used in the models, these are two of the most important numbers which carry through to all the financial statements. Appendix D: Forecasted Financial Statements 38
  • Valuation Analysis A fter financial statements and ratios have been forecast, in this case for ten years, valuation methods can be performed. Different valuation methods have different underlying theoretical support which will provide different suggested share prices. One method alone cannot provide a sound basis for a firm valuation. Many intrinsic methods along with comparable ratios from firms in the same industry are necessary to get a complete feel for the firm. Also, sensitivity analysis must be performed to ensure that misestimating costs of capital and growth rates will not provide unreliable results. Accurate and believable costs of capital along with the forecasted financial statements are necessary before any valuations can be performed. The following sections provide detailed methods of cost of capital estimation and the implementation of those numbers in the various intrinsic valuation methods. Methods of comparables are also included to value firms against industry averages. Cost of Capital Estimation To properly value Pfizer using intrinsic valuation models, the cost of debt, equity, and weighted average cost of capital must first be estimated. This in itself requires considerable work and attention to detail. The cost of debt is the easiest to estimate and also the most reliable. In the notes of its 10-K Pfizer explained its short and long term borrowings in detail to allow easy estimation of its cost of debt. The cost of debt for short term borrowings was given in the 10-K at 2.5%. The cost of long term borrowings had to be calculated from a list of borrowings including bonds, debentures, and mortgages. The cost of long term debt was 39
  • estimated at 4.38%. These percentages were then used to compute a weighted average cost of debt from the liabilities section from the 2004 Balance Sheet. The Balance Sheet debt was calculated to be 3.45%. This calculation was performed by excluding deferred taxes on income because the number has been staying at a constant level, without material increases or decreases. This implies that it will continue to stay at a constant level and is not needed in determining Pfizer’s weighted average cost of debt. The beta (β) for Pfizer was calculated using three different time periods. Used in the calculations were the firm’s monthly returns, and the Standard and Poor’s index fund monthly returns from 2000 to 2005. Also used in calculating the risk free rate was the monthly yield on the five year US treasury bonds. The risk free rate was estimated to be 3.21% and was used in the calculations of Pfizer’s cost of equity. The long run average market risk premium since 2002 and used in the calculations was 3%. The beta which showed the highest degree of explanation by the R-Squared measure was for the time period 2002-2005. The R-squared variable for this time period was .234 and computed the beta to be .59. This was used to compute a cost of equity at 4.99%. The implied cost of equity which supports Pfizer’s current share price was 4.56%. Appendix E: Cost of Debt Calculations Time Estimated Period Beta Estimate R-Squared Ke 2002-2005 0.594927185 0.233958482 4.99% 2003-2005 0.435905178 0.060637378 4.52% 2000-2005 0.458094958 0.131888494 4.58% Implied 4.56% 40
  • The estimated costs of debt and equity are consistent with a company of Pfizer’s size and organization. A large corporation such as Pfizer that has operations internationally is able to borrow money from many different sources and keep their costs of capital down to reasonable levels. Time Estimated Estimated Estimated Period Ke WACCbt WACCat 2002-2005 4.99% 4.07% 3.78% 2003-2005 4.52% 4.04% 3.74% 2000-2005 4.58% 4.30% 4.01% Implied 4.56% 4.06% 3.77% The weighted average cost of capital (WACC) before tax consideration was calculated to be 4.07%. A 4.99 % cost of equity was used in this calculation. The after tax WACC was estimated to be 3.78%. Appendix F: Regression Analysis The values used in the intrinsic valuations are as follows: Beta(β) 0.595 Cost of Equity(Ke) 4.99% Cost of Debt(Kd) 3.45% WACCbt 4.07% WACCat 3.78% Intrinsic Valuation Methods Various intrinsic valuation methods are needed to accurately value a company’s stock price. The different methods used take into account different variables and 41
  • different discount rates. Once each model has been worked out an accurate investment recommendation can be made. Appendix G: Intrinsic Valuation Methods Discounted Dividends The discounted dividend model uses forecasted dividends per share, cost of equity, and an estimated growth rate to discount the nominal amounts back to the current year. ⎛d ⎞ ~ ⎜ t +1 ⎟ E⎝ ∞ ⎠ PPS t = ∑ t =1 (1 + k ) e t This model relies on assumptions and the accuracy of the discount rate. Pfizer has an estimated cost of equity of 4.99% and a growth rate of 2%. This model gives Pfizer an estimated price per share of $36.02. When assuming a growth rate of zero for the terminal year perpetuity the model yields an intrinsic valuation of $23.76 a share. The model is limited by the accuracy of the forecasted dividends and the growth rate in the terminal year. This model shows Pfizer to be undervalued. Sensitivity Analysis g 0 0.015 0.03 0.045 Ke 0.03 $35.48 $64.88 N/A N/A 0.04 $28.13 $41.36 $94.29 N/A 0.05 $23.72 $31.28 $50.18 $182.50 0.06 $20.78 $25.68 $35.48 $64.88 0.07 $18.68 $22.12 $28.13 $41.36 42
  • Discounted Free Cash Flows The discounted free cash flow model uses the free cash flows to the firm to estimate a price per share. The free cash flows to the firm include cash flows from operations and investing. It does not include cash flows from financing activities. The free cash flows to the firm are then discounted to the current year using the firms before tax WACC. ~ ∞ Et ( FCF t +1 ) VE, t = ∑ t=0 (1 + k ) e t +1 In Pfizer’s case this before tax WACC is estimated to be 4.07%. Assuming a 2% growth rate this model yields an intrinsic valuation of 58.98. Using a growth rate of 0% yields a value of $29.50 which is closer to the firms actual share price. This model takes more data into consideration than the discounted dividend model does. This model is also prone to the limitations of forecast accuracy and growth rate estimation. Sensitivity Analysis g 0 0.015 0.03 0.045 WACC 0.03 $44.50 $88.83 N/A N/A 0.04 $30.23 $48.52 $121.68 N/A 0.05 $21.75 $31.34 $55.31 $223.10 0.06 $16.14 $21.85 $33.26 $67.50 0.07 $12.18 $15.86 $22.29 $36.45 Discounted Residual Income 43
  • This model uses beginning equity per share, forecasted earnings per share, and dividends per share to determine normal and residual income. Normal income is the beginning book value of equity multiplied by the firms cost of equity. Residual income is equal to earnings per share minus normal income. The residual income values are then discounted back to the current year to give an intrinsic valuation. ⎛ E ( NI ) − k ( BVE )⎞ ⎜ t ~ ⎟ ∞ ⎝ t +1 t ⎠ ∑ e VE, t = BVEt + t=0 (1 + k ) e t +1 In Pfizer’s case, using a cost of equity of 4.99% and a growth rate of 0% this model yields an intrinsic valuation of $56.20 per share. For this model a zero percent growth rate was used because residual income is more likely to fluctuate and a aggressive growth rate is likely to over-value the firm. Sensitivity Analysis g 0 0.015 0.03 0.045 Ke 0.03 $103.17 $180.52 N/A N/A 0.04 $73.13 $102.67 $220.84 N/A 0.05 $55.37 $69.62 $105.24 $354.58 0.06 $43.75 $51.49 $66.97 $113.42 0.07 $35.60 $40.12 $48.01 $65.39 Abnormal Earnings Growth The abnormal earnings growth model is a more complicated model that uses earnings per share and dividends per share along with the firm’s cost of equity. It assumes that dividends are reinvested at the cost of equity. The abnormal earnings growth is the difference between the cumulative dividend earnings and normal earnings. 44
  • Cumulative dividend earnings are equal to the beginning price per share plus the percentage earned off of the reinvested dividends. Earn1 1 ⎡ AEG2 AEG3 AEG4 ⎤ V0E = + + + + L⎥ ρE −1 ρE −1 ⎢ ρE ⎣ ρE 2 ρE 3 ⎦ 1 ⎡ AEG2 AEG3 AEG4 ⎤ = Earn1 + + + + L⎥ ρE −1 ⎢ ⎣ ρE ρE 2 ρE 3 ⎦ This model yields a price per share of $56.20 for Pfizer. This model assumes no terminal year perpetuity because of the volatility on earnings per share. Because of this the growth rate is not a factor in the intrinsic valuation. Sensitivity Analysis g 0 0.015 0.03 0.045 Ke 0.03 $62.03 $62.03 $62.03 $62.03 0.04 $59.20 $59.20 $59.20 $59.20 0.05 $55.49 $55.49 $55.49 $55.49 0.06 $52.60 $52.60 $52.60 $52.60 0.07 $50.80 $50.80 $50.80 $50.80 Long Run Average Residual Income Perpetuity The long run average residual income perpetuity is based on the price to book ratio. This valuation method is performed by multiplying the book value of equity times (the long run ROE minus the cost of equity) divided by (the cost of equity minus the expected growth rate). This value is then added back to the book value of equity. Assuming a 2% growth rate, this method of valuation yield an expected price per share of $99.42, which is greatly higher than that current share price. If a 0% growth rate is 45
  • substituted into the formula the model then yields a price per share of $63.33 which is closer to the other valuation models. Sensitivity Analysis g 0 0.015 0.03 0.045 Ke 0.03 $105.34 $201.30 N/A N/A 0.04 $79.00 $120.78 $287.90 N/A 0.05 $63.20 $86.27 $143.95 $547.69 0.06 $52.66 $67.10 $95.97 $182.56 0.07 $45.14 $54.90 $71.98 $109.54 Method of Comparables This method utilizes ratios from the firm’s competitors to find an industry average and an expected share price for the company. Pfizer’s main competitors which were used in this valuation are Abbot Laboratories, Bristol-Meyers Squibb, Glaxo-Smith Kline, and Merck. These companies provide a solid basis for performing the ratio based valuations. average ⎛ P⎞ PPSassessed, t = E ( EPSt +1 ) * ⎜ ⎟ ⎝ E ⎠ comparable firms The actual firm being valued is not included when calculating the industry average to prevent bias. It may also be necessary to eliminate firms with an outlying ratio from the average to provide a stronger basis of valuation. Appendix H: Method of Comparables 46
  • The average P/E trailing ratio for Pfizer’s competitors was 20.9. There were no outliers for this ratio. When multiplied by Pfizer’s earnings per share of $1.87, this gives a valuation of $39.08. This is higher than Pfizer’s actual share price of $26.15 The forward looking P/E average ratio was 18.125. When eliminating Merck’s outlying value of 11.8 a more reliable average of 23.23 is attained. When this is multiplied by Pfizer’s earnings per share this gives a valuation of $37.84 which is always over the actual price per share. It was necessary to take out Abbot Lab’s P/B ratio of 5.27 from the industry average to get a more accurate and reliable average of 3.85 as compared to 4.20. When the 3.85 is multiplied by Pfizer’s book value of equity this yields a valuation of $35.58. When evaluating the dividend yield ratio it was necessary to eliminate both Abbot Labs and Novartis from the average. The remaining two firms had an average dividend yield percentage of 4.8. When this was multiplied by Pfizer’s book value of equity it gives a suggested price per share of $44.40. This number indicated that Pfizer is an undervalued security. The price to sales ratio industry average after excluding Bristol-Meyers Squibb outlying value was 3.53. When multiplied by Pfizer’s sales per share of 7.21 gives a suggested price per share of $25.43. This is only $.72 lower than Pfizer’s actual share price which suggests Pfizer is just slightly undervalued. After excluding Bristol-Meyers Squibb outlying value of 2.82 the industry average was 1.82. When this average is multiplied by Pfizer’s projected growth rate of 12% gives a share price of $21.84 which suggests that Pfizer is undervalued by $4.31. 47
  • Conclusions After analyzing the results of the intrinsic valuations and comparables suggested valuations, Pfizer appears to be overvalued. Every intrinsic valuation method provides a suggested share price above the actual price of $26.15. Four out of the six comparable ratios also suggest a share price higher than Pfizer’s actual price. The other two comparable ratios are just slightly under Pfizer’s actual price per share. Even after looking at the sensitivity analysis performed for every intrinsic valuation model, Pfizer’s cost of capital would have to be over-estimated by a large amount for Pfizer’s stock price to be undervalued. 48
  • References United States. Securities and Exchange Commission. Edgar Database. Retrieved February 1, 2005 from the World Wide Web: http://sec.gov/edgar/searchedgar/webusers.htm Pricewaterhouse Coopers. Edgarscan. Retrieved February 1, 2005 from the World Wide Web: http://edgarscan.pwcglobal.com/servlets/edgarscan Yahoo Finance. Retrieved February 1, 2005 from the World Wide Web: http://finance.yahoo.com/ Wilde Mathews, A. & Hensly S. (2005, April 8). FDA Stiffens Painkiller Warnings, Pushed Pfizer to Suspend Bextra. TheWall Street Journal, p. A1 Hensly, S. (2005 February 11). Pfizer Plans $2 Billion In Cost Cuts. The Wall Street Journal, p. A3 Pfizer, Inc. Retrieved February 1, 2005 from the World Wide Web: http://pfizer.com/main.html 49
  • Moore, M. Chapter 7 – Prospective Analysis: Valuation Theory Basics. Retrieved February 1, 2005 from the World Wide Web: http://mmoore.ba.ttu.edu/Fin3321- Spring-05/Lecture_Notes/Chapter-7.doc Moore, M. Chapter 8 – Prospective Analysis: Valuation. Retrieved February 1, 2005 From the World Wide Web: http://mmoore.ba.ttu.edu/Fin3321-Spring- 05/Lecture_Notes/Chapter-8.doc 50
  • Appendix Appendix A: Sales Manipulation Diagnostics Net Sales/Cash From Sales 2003 2002 2001 2000 Pfizer 1.00 1.10 1.02 0.99 Abbot Labs 1.00 1.03 1.03 1.22 Bristol Meyers Squibb 1.00 1.04 0.95 1.02 Merck 1.00 0.94 1.01 1.00 Industry Average 1.00 1.00 1.00 1.08 Net Sales/Accounts Recievable 2003 2002 2001 2000 Pfizer 5.15 5.60 5.44 5.39 Abbot Labs 5.22 5.22 1.35 1.62 Bristol Meyers Squibb 5.10 5.46 4.51 4.76 Merck 5.59 3.95 4.06 7.67 Industry Average 5.30 4.88 3.31 4.69 Net Sales/Inventory 2003 2002 2001 2000 Pfizer 7.74 12.09 10.59 10.95 Abbot Labs 6.31 6.26 1.71 2.03 Bristol Meyers Squibb 11.65 10.30 10.59 9.09 Merck 8.80 7.23 5.92 13.36 Industry Average 8.92 7.93 6.07 8.16 Appendix B: Expense Manipulation Diagnostics Asset Turnover 2003 2002 2001 2000 Pfizer 0.39 0.70 0.74 0.88 Abbot Labs 0.66 0.65 0.16 0.23 Bristol Meyers Squibb 0.68 0.65 0.65 0.99 Merck 0.55 0.45 0.48 1.01 Industry Average 0.63 0.58 0.43 0.74 CFFO/OI 2003 2002 2001 2000 Pfizer 7.15 1.07 1.18 1.67 Abbot Labs 1.35 1.43 3.09 2.34 Bristol Meyers Squibb 1.13 0.46 2.64 1.21 Merck 1.28 1.28 1.18 0.81 Industry Average 1.25 1.06 2.31 1.46 CFFO/NOA 2003 2002 2001 2000 Pfizer 0.26 0.64 0.59 0.45 Abbot Labs 0.19 0.23 0.25 0.29 Bristol Meyers Squibb 0.33 0.09 0.54 0.79 Merck 0.38 0.35 0.32 0.32 Industry Average 0.30 0.22 0.37 0.46 51
  • Total Accruals/Change in Sales 2003 2002 2001 2000 Pfizer 1.28 0.43 -2.79 0.70 Abbot Labs 1.40 0.24 11.45 0.55 Bristol Meyers Squibb 1.64 -1.67 7.07 N/A Merck 9.81 42.72 -0.35 N/A Industry Average 4.28 13.76 6.06 0.55 Pension Expense/SG&A 2003 2002 2001 2000 Pfizer 0.01 0.01 0.01 0.01 Abbot Labs 0.53 0.62 1.35 1.22 Bristol Meyers Squibb N/A N/A N/A N/A Merck N/A N/A N/A N/A Industry Average 0.53 0.62 1.35 1.22 Appendix C: Financial Ratio Analysis Current Ratio 2000 2001 2002 2003 2004 Pfizer 1.43 1.40 1.34 1.26 1.50 Abbot 1.72 1.06 1.33 1.38 1.57 Bristol Meyers 1.44 1.19 1.21 1.61 1.50 Merck 1.37 1.12 1.16 1.20 N/A Industry Average 1.51 1.13 1.24 1.40 1.54 Quick Asset Ratio 2000 2001 2002 2003 2004 Pfizer 1.03 0.98 0.99 0.88 1.11 Abbot 0.78 0.44 0.61 0.66 0.84 Bristol Meyers 1.00 0.87 0.85 1.24 1.20 Merck 0.96 0.74 0.84 0.86 N/A Industry Average 0.91 0.68 0.77 0.92 1.02 Accounts Receivable Turnover 2000 2001 2002 2003 2004 Pfizer 5.39 6.05 5.60 5.15 5.61 Abbot 1.62 1.35 5.22 5.22 5.32 Bristol Meyers 4.76 4.51 5.46 5.10 4.43 Merck 7.67 4.06 3.95 5.59 N/A Industry Average 4.69 3.31 4.88 5.30 4.88 52
  • Days Supply of Receivables 2000 2001 2002 2003 2004 Pfizer 67.74 60.34 65.22 70.88 65.10 Abbot 224.79 271.08 69.93 69.99 68.55 Bristol Meyers 76.63 81.01 66.84 71.62 82.36 Merck 47.59 89.80 92.30 65.31 N/A Industry Average 77.90 110.42 74.82 68.87 74.82 Inventory Turnover 2000 2001 2002 2003 2004 Pfizer 1.82 1.54 1.51 1.68 1.13 Abbot 0.51 0.42 2.79 2.84 3.39 Bristol Meyers 2.45 3.21 2.98 3.18 3.81 Merck 7.43 1.01 1.32 1.69 N/A Industry Average 3.46 1.55 2.36 2.57 3.60 Days Supply of Inventory 2000 2001 2002 2003 2004 Pfizer 200.98 237.25 241.65 216.69 322.36 Abbot 721.06 860.22 130.65 128.57 107.66 Bristol Meyers 148.93 113.72 122.39 114.71 95.87 Merck 49.14 360.42 276.92 216.08 N/A Industry Average 105.44 235.66 154.35 142.02 101.42 Gross Profit Margin 2000 2001 2002 2003 2004 Pfizer 83% 87% 88% 78% 86% Abbot 75% 75% 55% 55% 55% Bristol Meyers 73% 70% 71% 71% 69% Merck 44% 83% 82% 81% N/A Industry Average 64% 76% 69% 69% 62% Operating Profit Margin 2000 2001 2002 2003 2004 53
  • Pfizer 20% 34% 36% 7% 27% Abbot 30% 51% 22% 20% 21% Bristol Meyers 30% 12% 17% 25% 23% Merck 24% 47% 45% 40% N/A Industry Average 28% 37% 28% 28% 22% Net Profit Margin 2000 2001 2002 2003 2004 Pfizer 13% 27% 28% 9% 22% Abbot 26% 18% 18% 16% 16% Bristol Meyers 25% 27% 13% 17% 12% Merck 17% 34% 33% 30% N/A Industry Average 23% 26% 22% 21% 14% Asset Turnover 2000 2001 2002 2003 2004 Pfizer 0.88 0.74 0.70 0.39 0.42 Abbot 0.23 0.16 0.65 0.66 0.68 Bristol Meyers 0.99 0.65 0.65 0.68 0.64 Merck 1.01 0.48 0.45 0.55 N/A Industry Average 0.74 0.43 0.58 0.63 0.66 Return on Assets 2000 2001 2002 2003 2004 Pfizer 11% 20% 20% 3% 9% Abbot 6% 3% 12% 11% 11% Bristol Meyers 25% 17% 9% 11% 8% Merck 17% 17% 15% 17% N/A Industry Average 16% 12% 12% 13% 10% Return on Equity 2000 2001 2002 2003 2004 Pfizer 23% 43% 46% 6% 17% Abbot 11% 7% 26% 21% 23% Bristol Meyers 57% 53% 24% 32% 23% 54
  • Merck 46% 45% 39% 44% N/A Industry Average 38% 35% 30% 32% 23% Debt to Equity Ratio 2000 2001 2002 2003 2004 Pfizer 1.08 1.14 1.32 0.79 0.81 Abbot 0.78 1.57 1.21 0.99 1.01 Bristol Meyers 1.25 2.06 1.77 1.80 1.98 Merck 1.71 1.74 1.61 1.61 N/A Industry Average 1.25 1.79 1.53 1.47 1.50 Times Interest Earned 2000 2001 2002 2003 2004 Pfizer 12.57 34.31 46.08 9.32 28.24 Abbot N/A N/A 16.16 23.14 27.67 Bristol Meyers 48.58 12.19 6.46 26.15 84.96 Merck 0.32 0.88 0.82 0.67 N/A Industry Average 24.45 6.54 7.81 16.65 56.32 Debt Service Margin 2000 2001 2002 2003 2004 Pfizer 3.60 6.28 6.09 4.51 6.12 Abbot 2.29 2.34 3.67 3.14 4.08 Bristol Meyers 2.79 3.65 0.61 1.86 1.49 Merck 1.67 1.63 3.61 11.46 N/A Industry Average 2.25 2.54 2.63 5.49 2.79 55
  • Appendix D: Forecasted Financial Statements Income Statement Actuals(Millions) Forecasts(Millions) 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 Revenues $27,376 $29,574 $29,024 $32,373 $45,188 $52,516 $55,142 $58,726 $63,424 $69,767 $76,743 $84,417 $92,859 $102,145 $112,360 $123,596 Cost of sales $5,464 $4,907 $3,823 $4,045 $9,832 $7,541 $11,028 $11,745 $12,685 $13,953 $15,349 $16,883 $18,572 $20,429 $22,472 $24,719 Gross Profit $21,912 $24,667 $25,201 $28,328 $35,356 $44,975 $44,113 $46,981 $50,739 $55,813 $61,395 $67,534 $74,287 $81,716 $89,888 $98,877 Operating Expenses: Selling, informational and administrative expenses $10,810 $11,442 $9,717 $10,846 $15,242 $16,903 $17,645 $17,094 $16,543 $16,543 $16,543 $16,543 $16,543 $16,543 $16,543 $16,543 Research and development expenses $4,036 $4,435 $4,776 $5,176 $7,131 $7,684 $8,271 $8,271 $8,271 $8,271 $8,271 $8,271 $8,271 $8,271 $8,271 $8,271 Merger-related costs $33 $3,257 $819 $630 $1,058 $1,193 $0 $0 $0 $0 $0 $0 $0 $0 $0 $0 Merger-related in-process research and development charge Other (income)/deductions-net $88 ($248) ($95) ($120) $3,610 $753 $0 $0 $0 $0 $0 $0 $0 $0 $0 $0 Income from continuing operations before provision for taxes on income and minority interests $6,945 $5,781 $9,984 $11,796 $3,263 $14,007 $15,440 $17,618 $19,661 $21,628 $23,790 $26,169 $28,786 $31,665 $34,831 $38,315 Provision for taxes on income $1,968 $2,049 $2,433 $2,609 $1,621 $2,665 $0 $0 $0 $0 $0 $0 $0 $0 $0 $0 Minority interests $5 $14 $14 $6 $3 $10 $0 $0 $0 $0 $0 $0 $0 $0 $0 $0 Income from continuing operations $4,972 $3,718 $7,537 $9,181 $1,639 $11,332 $13,234 $15,562 $16,807 $18,488 $20,337 $22,371 $24,608 $27,068 $29,775 $32,753 Discontinued operations: $0 $0 $251 $278 $16 ($22) $0 $0 $0 $0 $0 $0 $0 $0 $0 $0 $0 $0 $0 $77 $2,285 $51 $0 $0 $0 $0 $0 $0 $0 $0 $0 $0 Discontinued operations-net of tax ($20) $8 $251 $355 $2,301 $29 $0 $0 $0 $0 $0 $0 $0 $0 $0 $0 $0 $0 $7,788 $9,536 $3,940 $0 $0 $0 $0 $0 $0 $0 $0 $0 $0 $0 $0 $0 $0 ($410) ($30) $0 $0 $0 $0 $0 $0 $0 $0 $0 $0 $0 Net income $4,952 $3,726 $7,788 $9,126 $3,910 $11,361 $12,407 $14,094 $15,222 $16,744 $18,418 $20,260 $22,286 $24,515 $26,966 $29,663 56
  • Pro-forma Income Statement Actuals Forecasts 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 Revenues 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100% 100% 100% 100% 100% 100% 100% 100% 100% 100% Cost of sales 19.96% 16.59% 13.17% 12.49% 21.76% 14.36% 20.00% 20.00% 20.00% 20.00% 20.00% 20.00% 20.00% 20.00% 20.00% 20.00% Gross Profit 80.04% 83.41% 86.83% 87.51% 78.24% 85.64% 80.00% 80.00% 80.00% 80.00% 80.00% 80.00% 80.00% 80.00% 80.00% 80.00% Operating Expenses: 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% Selling, informational and administrative expenses 39.49% 38.69% 33.48% 33.50% 33.73% 32.19% 32.00% 31.00% 30.00% 30.00% 30.00% 30.00% 30.00% 30.00% 30.00% 30.00% Research and development expenses 14.74% 15.00% 16.46% 15.99% 15.78% 14.63% 15.00% 15.00% 15.00% 15.00% 15.00% 15.00% 15.00% 15.00% 15.00% 15.00% Merger-related costs 0.12% 11.01% 2.82% 1.95% 2.34% 2.27% Merger-related in-process research and development charge 0.00% 0.00% 0.00% 0.00% 11.18% 2.04% Other (income)/deductions-net 0.32% -0.84% -0.33% -0.37% 7.99% 1.43% Income from continuing operations before provision for taxes on income and minority interests 25.37% 19.55% 34.40% 36.44% 7.22% 26.67% 28.00% 30.00% 31.00% 31.00% 31.00% 31.00% 31.00% 31.00% 31.00% 31.00% Provision for taxes on income 7.19% 6.93% 8.38% 8.06% 3.59% 5.07% Minority interests 0.02% 0.05% 0.05% 0.02% 0.01% 0.02% Income from continuing operations 18.16% 12.57% 25.97% 28.36% 3.63% 21.58% 24.00% 26.50% 26.50% 26.50% 26.50% 26.50% 26.50% 26.50% 26.50% 26.50% Discontinued operations: 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.86% 0.86% 0.04% -0.04% 0.00% 0.00% 0.00% 0.24% 5.06% 0.10% Discontinued operations-net of tax -0.07% 0.03% 0.86% 1.10% 5.09% 0.06% 0.00% 0.00% 26.83% 29.46% 8.72% 0.00% 0.00% 0.00% 0.00% -1.27% -0.07% 0.00% Net income 18.09% 12.60% 26.83% 28.19% 8.65% 21.63% 22.50% 24.00% 24.00% 24.00% 24.00% 24.00% 24.00% 24.00% 24.00% 24.00% 57
  • Balance Sheet Actuals(Millions) Forecasts(Millions) FORECASTS 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 Assets Current Assets Cash and cash equivalents $2,358 $1,099 $1,036 $1,878 $1,520 $1,808 $0 $0 $0 $0 $0 $0 $0 $0 $0 $0 Short-term investments $4,028 $5,764 $7,579 $10,673 $10,432 $18,085 $0 $0 $0 $0 $0 $0 $0 $0 $0 $0 Accounts receivable, less allowance for doubtful accounts: $5,368 $5,489 $4,798 $5,785 $8,775 $9,367 $9,803 $11,623 $12,685 $13,953 $15,349 $15,477 $17,024 $18,727 $20,599 $22,659 Short-term loans $273 $140 $269 $399 $391 $653 $0 $0 $0 $0 $0 $0 $0 $0 $0 $0 Inventories $0 $0 $1,011 $1,133 $0 $0 $0 $0 $0 $0 $0 $0 $0 $0 $0 $0 Finished goods $1,147 $1,195 $0 $0 $2,308 $0 $0 $0 $0 $0 $0 $0 $0 $0 $0 $0 Work in process $977 $1,074 $1,062 $1,142 $2,219 $0 $0 $0 $0 $0 $0 $0 $0 $0 $0 $0 Raw materials and supplies $464 $433 $412 $403 $1,310 $0 $0 $0 $0 $0 $0 $0 $0 $0 $0 $0 Total inventories $2,588 $2,702 $2,485 $2,678 $5,837 $6,660 $6,740 $6,729 $6,977 $6,977 $7,674 $7,738 $8,512 $9,363 $10,300 $11,330 Prepaid expenses and taxes $1,696 $1,993 $1,418 $1,797 $2,786 $2,939 $0 $0 $0 $0 $0 $0 $0 $0 $0 $0 Assets of discontinued businesses held for sale $0 $0 $1,627 $1,571 $0 $182 $0 $0 $0 $0 $0 $0 $0 $0 $0 $0 Total current assets $16,311 $17,187 $19,212 $24,781 $29,741 $39,694 $46,564 $53,832 $63,424 $63,424 $69,767 $70,348 $77,383 $85,121 $93,633 $102,996 Long-term loans and investments $1,764 $2,529 $5,724 $5,161 $6,142 $3,873 $0 $0 $0 $0 $0 $0 $0 $0 $0 $0 Property, plant and equipment, less accumulated depreciation $8,685 $9,425 $9,783 $10,712 $18,287 $18,385 $18,381 $18,352 $19,027 $19,027 $20,930 $21,104 $23,215 $25,536 $28,090 $30,899 Goodwill, less accumulated amortization: 2000-$300; 1999-$256 $1,870 $1,791 $1,689 $1,200 $22,306 $23,756 $0 $0 $0 $0 $0 $0 $0 $0 $0 $0 Identifiable intangible assets, less accumulated amortization $0 $0 $0 $0 $36,350 $33,251 $0 $0 $0 $0 $0 $0 $0 $0 $0 $0 Other assets, deferred taxes and deferred charges $2,742 $2,578 $2,745 $4,502 $3,949 $4,725 $0 $0 $0 $0 $0 $0 $0 $0 $0 $0 Total non-current assets $15,061 $16,323 $19,941 $21,575 $87,034 $83,990 $75,973 $68,514 $63,424 $63,424 $69,767 $70,348 $77,383 $85,121 $93,633 $102,996 Total assets $31,372 $33,510 $39,153 $46,356 $116,775 $123,684 $122,537 $122,346 $126,848 $126,848 $139,533 $140,696 $154,765 $170,242 $187,266 $205,993 Liabilities and Shareholders Equity Current Liabilities Short-term borrowings, including current portion of long-term debt $5,299 $4,289 $6,263 $8,669 $8,818 $11,266 $14,924 $18,098 $19,373 $19,732 $21,705 $21,886 $24,075 $26,482 $29,130 $32,043 Accounts payable $1,889 $1,719 $1,411 $1,620 $2,601 $2,672 $2,985 $3,232 $3,459 $3,524 $3,876 $3,908 $4,299 $4,729 $5,202 $5,722 Dividends payable $349 $696 $819 $926 $1,300 $1,418 $0 $0 $0 $0 $0 $0 $0 $0 $0 $0 Income taxes payable $748 $850 $775 $2,231 $1,919 $1,963 $0 $0 $0 $0 $0 $0 $0 $0 $0 $0 Accrued compensation and related items $905 $982 $1,026 $1,084 $1,753 $1,939 $0 $0 $0 $0 $0 $0 $0 $0 $0 $0 Accrued litigation settlements $0 $0 $0 $0 $1,402 $264 $0 $0 $0 $0 $0 $0 $0 $0 $0 $0 Other current liabilities $2,706 $3,445 $2,866 $3,448 $5,864 $6,872 $0 $0 $0 $0 $0 $0 $0 $0 $0 $0 Liabilities of discontinued businesses held for sale $0 $0 $569 $577 $0 $64 $0 $0 $0 $0 $0 $0 $0 $0 $0 $0 Total current liabilities $11,896 $11,981 $13,729 $18,555 $23,657 $26,458 $29,849 $36,196 $42,898 $45,806 $50,387 $50,807 $55,887 $61,476 $67,624 $74,386 Long-term debt $1,774 $1,123 $2,609 $3,140 $5,755 $7,279 $6,567 $7,110 $7,611 $7,752 $8,527 $8,598 $9,458 $10,404 $11,444 $12,588 Pension benefit obligations $0 $0 $0 $0 $2,861 $2,821 $0 $0 $0 $0 $0 $0 $0 $0 $0 $0 Postretirement benefit obligation other than pension plans $515 $564 $587 $623 $1,451 $1,450 $1,672 $1,810 $1,937 $1,973 $2,171 $2,189 $2,407 $2,648 $2,913 $3,204 Deferred taxes on income $485 $380 $398 $364 $13,238 $12,632 $0 $0 $0 $0 $0 $0 $0 $0 $0 $0 Other noncurrent liabilities $2,752 $3,386 $3,537 $3,724 $4,436 $4,766 $0 $0 $0 $0 $0 $0 $0 $0 $0 $0 Total non-current liabilities $5,526 $5,453 $7,131 $7,851 $27,741 $28,948 $29,849 $28,440 $26,292 $24,665 $27,131 $27,358 $30,093 $33,103 $36,413 $40,054 Total liabilities $17,422 $17,434 $20,860 $26,406 $51,398 $55,406 $59,698 $64,636 $69,190 $70,471 $77,518 $78,164 $85,981 $94,579 $104,037 $114,440 Shareholders Equity $0 $0 $0 $0 $0 $0 $0 $0 $0 $0 $0 $0 $0 $0 $0 $0 Preferred stock, without par value; $0 $0 $0 $0 $219 $193 $0 $0 $0 $0 $0 $0 $0 $0 $0 $0 Common stock, $.05 par value $332 $337 $340 $341 $435 $438 $0 $0 $0 $0 $0 $0 $0 $0 $0 $0 Additional paid-in capital $5,943 $8,895 $9,300 $9,368 $66,396 $67,098 $67,098 $0 $0 $0 $0 $0 $0 $0 $0 $0 Retained earnings $18,459 $19,599 ($2,650) ($1,786) ($1,898) $35,492 $43,267 $52,781 $62,890 $74,011 $86,244 $99,700 $114,502 $130,784 $148,694 $168,395 Accumulated other comprehensive expense ($1,045) ($1,515) ($11,378) ($16,341) ($29,352) $2,278 $0 $0 $0 $0 $0 $0 $0 $0 $0 $0 Employee benefit trusts ($2,888) ($3,382) $24,430 $30,243 $29,382 ($1,229) ($1,229) $0 $0 $0 $0 $0 $0 $0 $0 $0 Treasury stock, shares at cost: 2000- 435; 1999-413 ($6,851) ($7,858) ($1,749) ($1,875) $195 ($35,992) ($35,992) $0 $0 $0 $0 $0 $0 $0 $0 $0 Total shareholders equity $13,950 $16,076 $18,293 $19,950 $65,377 $68,278 $62,840 $57,710 $57,658 $56,377 $62,015 $62,531 $68,785 $75,663 $83,229 $91,552 Total liabilities and shareholders equity $31,372 $33,510 $39,153 $46,356 $116,775 $123,684 $122,537 $122,346 $126,848 $126,848 $139,533 $140,696 $154,765 $170,242 $187,266 $205,993 58
  • Pro-forma Balance Sheet Actuals Forecasts 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 Assets Current Assets Cash and cash equivalents 7.52% 3.28% 2.65% 4.05% 1.30% 1.46% Short-term investments 12.84% 17.20% 19.36% 23.02% 8.93% 14.62% Accounts receivable, less allowance for doubtful accounts: 17.11% 16.38% 12.25% 12.48% 7.51% 7.57% 8.00% 9.50% 10.00% 11.00% 11.00% 11.00% 11.00% 11.00% 11.00% 11.00% Short-term loans 0.87% 0.42% 0.69% 0.86% 0.33% 0.53% Inventories 0.00% 0.00% 2.58% 2.44% 0.00% 0.00% Finished goods 3.66% 3.57% 0.00% 0.00% 1.98% 0.00% Work in process 3.11% 3.21% 2.71% 2.46% 1.90% 0.00% Raw materials and supplies 1.48% 1.29% 1.05% 0.87% 1.12% 0.00% Total inventories 8.25% 8.06% 6.35% 5.78% 5.00% 5.38% 5.50% 5.50% 5.50% 5.50% 5.50% 5.50% 5.50% 5.50% 5.50% 5.50% Prepaid expenses and taxes 5.41% 5.95% 3.62% 3.88% 2.39% 2.38% Assets of discontinued businesses held for sale 0.00% 0.00% 4.16% 3.39% 0.00% 0.15% Total current assets 51.99% 51.29% 49.07% 53.46% 25.47% 32.09% 38.00% 44.00% 50.00% 50.00% 50.00% 50.00% 50.00% 50.00% 50.00% 50.00% Long-term loans and investments 5.62% 7.55% 14.62% 11.13% 5.26% 3.13% Property, plant and equipment, less accumulated depreciation 27.68% 28.13% 24.99% 23.11% 15.66% 14.86% 15.00% 15.00% 15.00% 15.00% 15.00% 15.00% 15.00% 15.00% 15.00% 15.00% Goodwill, less accumulated amortization: 2000-$300; 1999-$256 5.96% 5.34% 4.31% 2.59% 19.10% 19.21% Identifiable intangible assets, less accumulated amortization 0.00% 0.00% 0.00% 0.00% 31.13% 26.88% Other assets, deferred taxes and deferred charges 8.74% 7.69% 7.01% 9.71% 3.38% 3.82% Total current assets 48.01% 48.71% 50.93% 46.54% 74.53% 67.91% 62.00% 56.00% 50.00% 50.00% 50.00% 50.00% 50.00% 50.00% 50.00% 50.00% Total assets 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% Liabilities and Shareholders Equity Current Liabilities Short-term borrowings, including current portion of long-term debt 30.42% 24.60% 30.02% 32.83% 17.16% 20.33% 25.00% 28.00% 28.00% 28.00% 28.00% 28.00% 28.00% 28.00% 28.00% 28.00% Accounts payable 10.84% 9.86% 6.76% 6.13% 5.06% 4.82% 5.00% 5.00% 5.00% 5.00% 5.00% 5.00% 5.00% 5.00% 5.00% 5.00% Dividends payable 2.00% 3.99% 3.93% 3.51% 2.53% 2.56% Income taxes payable 4.29% 4.88% 3.72% 8.45% 3.73% 3.54% Accrued compensation and related items 5.19% 5.63% 4.92% 4.11% 3.41% 3.50% Accrued litigation settlements 0.00% 0.00% 0.00% 0.00% 2.73% 0.48% Other current liabilities 15.53% 19.76% 13.74% 13.06% 11.41% 12.40% Liabilities of discontinued businesses held for sale 0.00% 0.00% 2.73% 2.19% 0.00% 0.12% Total current liabilities 68.28% 68.72% 65.81% 70.27% 46.03% 47.75% 50.00% 56.00% 62.00% 65.00% 65.00% 65.00% 65.00% 65.00% 65.00% 65.00% Long-term debt 10.18% 6.44% 12.51% 11.89% 11.20% 13.14% 11.00% 11.00% 11.00% 11.00% 11.00% 11.00% 11.00% 11.00% 11.00% 11.00% Pension benefit obligations 0.00% 0.00% 0.00% 0.00% 5.57% 5.09% Postretirement benefit obligation other than pension plans 2.96% 3.24% 2.81% 2.36% 2.82% 2.62% 2.80% 2.80% 2.80% 2.80% 2.80% 2.80% 2.80% 2.80% 2.80% 2.80% Deferred taxes on income 2.78% 2.18% 1.91% 1.38% 25.76% 22.80% Other noncurrent liabilities 15.80% 19.42% 16.96% 14.10% 8.63% 8.60% Total non-current liabilities 31.72% 31.28% 34.19% 29.73% 53.97% 52.25% 50.00% 44.00% 38.00% 35.00% 35.00% 35.00% 35.00% 35.00% 35.00% 35.00% Total liabilities 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% Shareholders Equity Preferred stock, without par value; 0.00% 0.00% 0.00% 0.00% 0.33% 0.28% Common stock, $.05 par value 2.38% 2.10% 1.86% 1.71% 0.67% 0.64% Additional paid-in capital 42.60% 55.33% 50.84% 46.96% 101.56% 98.27% Retained earnings 132.32% 121.91% -14.49% -8.95% -2.90% 51.98% Accumulated other comprehensive expense -7.49% -9.42% -62.20% -81.91% -44.90% 3.34% Employee benefit trusts -20.70% -21.04% 133.55% 151.59% 44.94% -1.80% Treasury stock, shares at cost: 2000- 435; 1999-413 -49.11% -48.88% -9.56% -9.40% 0.30% -52.71% Total shareholders equity 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 59
  • Statement of Cash Flows Actuals(Millions) Forecasts(Millions) 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 Operating Activities Income from continuing operations $4,972 $3,718 $7,788 $9,126 $3,910 $11,361 $11,580 $13,213 $14,746 $16,221 $17,843 $19,627 $21,590 $23,749 $26,124 $28,736 Adjustments to reconcile income from continuing operations to net cash provided by operating activities: Cumulative effect of a change in accounting principle $0 $0 $0 $410 $30 $0 $0 $0 $0 $0 $0 $0 $0 $0 $0 $0 Discontinued operations $0 $0 ($251) ($278) ($16) $22 $0 $0 $0 $0 $0 $0 $0 $0 $0 $0 Harmonization of accounting methodology $0 $0 ($175) $0 $0 $0 $0 $0 $0 $0 $0 $0 $0 $0 $0 $0 Loss on sale of animal health feed-additive products $0 $85 $0 $0 $0 $0 $0 $0 $0 $0 $0 $0 $0 $0 $0 $0 Trovan inventory write-off $310 $0 $0 $0 $0 $0 $0 $0 $0 $0 $0 $0 $0 $0 $0 $0 Merger-related in-process research and development charge $0 $0 $0 $0 $5,052 $1,071 $0 $0 $0 $0 $0 $0 $0 $0 $0 $0 Costs associated with the withdrawal of Rezulin $0 $102 $0 $0 $0 $0 $0 $0 $0 $0 $0 $0 $0 $0 $0 $0 Gain on sale of business $0 $0 $0 ($77) ($3,885) ($51) $0 $0 $0 $0 $0 $0 $0 $0 $0 $0 Gains on sales of product lines $0 $0 $0 ($34) ($87) ($12) $0 $0 $0 $0 $0 $0 $0 $0 $0 $0 Gains on sales of equity investments $0 ($216) ($17) $0 $0 $0 $0 $0 $0 $0 $0 $0 $0 $0 $0 $0 Asset impairment charges $0 $0 $0 $63 $2,820 $702 $0 $0 $0 $0 $0 $0 $0 $0 $0 $0 Depreciation and amortization $905 $968 $972 $1,036 $4,078 $5,093 $4,632 $3,524 $2,359 $2,595 $2,855 $3,140 $3,454 $3,800 $4,180 $4,598 Deferred taxes and other $213 ($265) $193 ($385) ($104) ($1,579) $0 $0 $0 $0 $0 $0 $0 $0 $0 $0 Charges to write-down equity investments $0 $0 $0 $0 $16 $40 $0 $0 $0 $0 $0 $0 $0 $0 $0 $0 Other $0 $0 $0 $0 $604 $555 $0 $0 $0 $0 $0 $0 $0 $0 $0 $0 Changes in assets and liabilities, net of effect of businesses divested: Accounts receivable ($1,274) ($498) $81 ($963) ($904) ($465) $0 $0 $0 $0 $0 $0 $0 $0 $0 $0 Inventories ($278) ($436) ($110) ($129) ($202) ($542) ($618) ($705) ($786) ($865) ($952) ($1,047) ($1,151) ($1,267) ($1,393) ($1,533) Prepaid and other assets ($127) $365 $106 ($1,423) ($905) ($640) $0 $0 $0 $0 $0 $0 $0 $0 $0 $0 Accounts payable and accrued liabilities $378 $807 ($412) $461 $670 ($708) $0 $0 $0 $0 $0 $0 $0 $0 $0 $0 Income taxes payable $144 $1,315 $332 $1,736 ($550) $805 $0 $0 $0 $0 $0 $0 $0 $0 $0 $0 Other deferred items $250 $250 $354 $321 $1,198 $688 $0 $0 $0 $0 $0 $0 $0 $0 $0 $0 Net cash provided by operating activities $5,493 $6,195 $8,861 $9,864 $11,725 $16,340 $15,440 $15,856 $16,712 $17,951 $19,746 $21,721 $23,893 $26,282 $28,910 $31,801 Investing Activities Purchases of property, plant and equipment ($2,493) ($2,191) ($2,105) ($1,758) ($2,641) ($2,601) ($3,860) ($4,404) ($4,915) ($5,407) ($5,948) ($6,542) ($7,197) ($7,916) ($8,708) ($9,579) Proceeds from disposals of property, plant and equipment $83 $91 $0 $0 $0 $0 $0 $0 $0 $0 $0 $0 $0 $0 $0 $0 Purchases of short-term investments, net of maturities ($9,270) ($7,982) ($14,218) ($12,652) ($9,931) ($17,499) $20,072 $22,903 $25,560 $28,116 $30,927 $34,020 $37,422 $41,164 $45,281 $49,809 Proceeds from redemptions of short-term investments $7,785 $6,592 $12,808 $9,781 $12,060 $11,723 $13,124 $15,856 $19,661 $21,628 $23,790 $26,169 $28,786 $31,665 $34,831 $38,315 Purchases of long-term investments ($40) ($618) ($3,708) ($2,877) ($1,883) ($1,329) $0 $0 $0 $0 $0 $0 $0 $0 $0 $0 Proceeds from redemptions of long-term investments $42 $346 $80 $3,477 $356 $1,570 $0 $0 $0 $0 $0 $0 $0 $0 $0 $0 Increases in long-term loans ($41) ($220) $0 $0 $0 $0 $0 $0 $0 $0 $0 $0 $0 $0 $0 $0 Purchases of other assets ($253) ($174) ($227) ($528) ($788) ($327) $0 $0 $0 $0 $0 $0 $0 $0 $0 $0 Proceeds from sales of other assets $193 $184 $132 $272 $360 $6 $0 $0 $0 $0 $0 $0 $0 $0 $0 $0 Proceeds from sales of businesses $26 $193 $8 $220 $5,602 $1,276 $0 $0 $0 $0 $0 $0 $0 $0 $0 $0 Cash and cash equivalents acquired through acquisition of Pharmacia $0 $0 $0 $0 $1,789 $0 $0 $0 $0 $0 $0 $0 $0 $0 $0 $0 Other investing activities $62 $26 $95 ($273) ($86) $22 $0 $0 $0 $0 $0 $0 $0 $0 $0 $0 Net cash used in investing activities ($3,906) ($3,753) ($7,135) ($4,338) $4,838 ($9,422) $9,264 $10,571 $11,797 $12,977 $14,274 $15,702 $17,272 $18,999 $20,899 $22,989 Financing Activities Proceeds from issuances of long-term debt $14,025 $18 $1,837 $603 $600 $2,586 $0 $0 $0 $0 $0 $0 $0 $0 $0 $0 Repayments of long-term debt ($14,046) ($529) ($151) ($374) ($439) ($664) $0 $0 $0 $0 $0 $0 $0 $0 $0 $0 Increase in short-term debt $2,134 $1,247 $2,344 $2,815 $194 $2,466 $2,934 $3,876 $4,915 $5,407 $5,948 $6,542 $7,197 $7,916 $8,708 $9,579 Decrease in short-term debt ($14) ($2,427) ($519) ($539) ($946) ($288) $0 $0 $0 $0 $0 $0 $0 $0 $0 $0 Proceeds from common stock issuances $62 $59 $62 $66 $0 $0 $0 $0 $0 $0 $0 $0 $0 $0 $0 $0 Purchases of common stock ($2,542) ($1,005) ($3,665) ($4,996) ($13,037) ($6,659) ($6,948) ($7,047) ($6,882) ($7,570) ($8,327) ($9,159) ($10,075) ($11,083) ($12,191) ($13,410) Cash dividends paid ($1,820) ($2,197) ($2,715) ($3,168) ($4,353) ($5,082) ($4,632) ($4,581) ($5,112) ($5,623) ($6,185) ($6,804) ($7,484) ($8,233) ($9,056) ($9,962) Stock option transactions and other $574 $1,129 $711 $594 $1,072 $1,012 $0 $0 $0 $0 $0 $0 $0 $0 $0 $0 Net cash used in financing activities ($1,627) ($3,705) ($2,096) ($4,999) ($16,909) ($6,629) ($6,485) ($6,166) ($5,898) ($6,488) ($7,137) ($7,851) ($8,636) ($9,499) ($10,449) ($11,494) 60
  • Pro-forma Statement of Cash Flows FORECASTS 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 Operating Income $6,945,000,000 $5,781,000,000 $9,984,000,000 $11,796,000,000 $3,263,000,000 $14,007,000,000 $ 15,439,704,000.00 $ 17,617,805,100.00 $ 19,661,470,491.60 $ 21,627,617,540.76 $ 23,790,379,294.84 $ 26,169,417,224.32 $ 28,786,358,946.75 $ 31,664,994,841.43 $ 34,831,494,325.57 $ 38,314,643,758.13 Operating Activities Income from continuing operations 71.59% 64.31% 78.00% 77.37% 119.83% 81.11% 75.00% 75.00% 75.00% 75.00% 75.00% 75.00% 75.00% 75.00% 75.00% 75.00% Adjustments to reconcile income from continuing operations to net cash provided by operating activities: 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% Cumulative effect of a change in accounting principle 0.00% 0.00% 0.00% 3.48% 0.92% 0.00% Discontinued operations 0.00% 0.00% -2.51% -2.36% -0.49% 0.16% Harmonization of accounting methodology 0.00% 0.00% -1.75% 0.00% 0.00% 0.00% Loss on sale of animal health feed-additive products 0.00% 1.47% 0.00% 0.00% 0.00% 0.00% Trovan inventory write-off 4.46% 0.00% 0.00% 0.00% 0.00% 0.00% Merger-related in-process research and development charge 0.00% 0.00% 0.00% 0.00% 154.83% 7.65% Costs associated with the withdrawal of Rezulin 0.00% 1.76% 0.00% 0.00% 0.00% 0.00% Gain on sale of business 0.00% 0.00% 0.00% -0.65% -119.06% -0.36% Gains on sales of product lines 0.00% 0.00% 0.00% -0.29% -2.67% -0.09% Gains on sales of equity investments 0.00% -3.74% -0.17% 0.00% 0.00% 0.00% Asset impairment charges 0.00% 0.00% 0.00% 0.53% 86.42% 5.01% Depreciation and amortization 13.03% 16.74% 9.74% 8.78% 124.98% 36.36% 30% 20% 12% 12% 12% 12% 12% 12% 12% 12% Deferred taxes and other 3.07% -4.58% 1.93% -3.26% -3.19% -11.27% Charges to write-down equity investments 0.00% 0.00% 0.00% 0.00% 0.49% 0.29% Other 0.00% 0.00% 0.00% 0.00% 18.51% 3.96% Changes in assets and liabilities, net of effect of businesses divested: Accounts receivable -18.34% -8.61% 0.81% -8.16% -27.70% -3.32% Inventories -4.00% -7.54% -1.10% -1.09% -6.19% -3.87% -4.00% -4.00% -4.00% -4.00% -4.00% -4.00% -4.00% -4.00% -4.00% -4.00% Prepaid and other assets -1.83% 6.31% 1.06% -12.06% -27.74% -4.57% Accounts payable and accrued liabilities 5.44% 13.96% -4.13% 3.91% 20.53% -5.05% Income taxes payable 2.07% 22.75% 3.33% 14.72% -16.86% 5.75% Other deferred items 3.60% 4.32% 3.55% 2.72% 36.71% 4.91% Net cash provided by operating activities 79.09% 107.16% 88.75% 83.62% 359.33% 116.66% 100% 90% 85% 83% 83% 83% 83% 83% 83% 83% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% Investing Activities 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% Purchases of property, plant and equipment -35.90% -37.90% -21.08% -14.90% -80.94% -18.57% -25.00% -25.00% -25.00% -25.00% -25.00% -25.00% -25.00% -25.00% -25.00% -25.00% Proceeds from disposals of property, plant and equipment 1.20% 1.57% 0.00% 0.00% 0.00% 0.00% Purchases of short-term investments, net of maturities -133.48% -138.07% -142.41% -107.26% -304.35% -124.93% 130.00% 130.00% 130.00% 130.00% 130.00% 130.00% 130.00% 130.00% 130.00% 130.00% Proceeds from redemptions of short-term investments 112.10% 114.03% 128.29% 82.92% 369.60% 83.69% 85.00% 90.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% Purchases of long-term investments -0.58% -10.69% -37.14% -24.39% -57.71% -9.49% Proceeds from redemptions of long-term investments 0.60% 5.99% 0.80% 29.48% 10.91% 11.21% Increases in long-term loans -0.59% -3.81% 0.00% 0.00% 0.00% 0.00% Purchases of other assets -3.64% -3.01% -2.27% -4.48% -24.15% -2.33% Proceeds from sales of other assets 2.78% 3.18% 1.32% 2.31% 11.03% 0.04% Proceeds from sales of businesses 0.37% 3.34% 0.08% 1.87% 171.68% 9.11% Cash and cash equivalents acquired through acquisition of Pharmacia 0.00% 0.00% 0.00% 0.00% 54.83% 0.00% Other investing activities 0.89% 0.45% 0.95% -2.31% -2.64% 0.16% Net cash used in investing activities -56.24% -64.92% -71.46% -36.78% 148.27% -67.27% 60.00% 60.00% 60.00% 60.00% 60.00% 60.00% 60.00% 60.00% 60.00% 60.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% Financing Activities 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% Proceeds from issuances of long-term debt 201.94% 0.31% 18.40% 5.11% 18.39% 18.46% Repayments of long-term debt -202.25% -9.15% -1.51% -3.17% -13.45% -4.74% Increase in short-term debt 30.73% 21.57% 23.48% 23.86% 5.95% 17.61% 19.00% 22.00% 25.00% 25.00% 25.00% 25.00% 25.00% 25.00% 25.00% 25.00% Decrease in short-term debt -0.20% -41.98% -5.20% -4.57% -28.99% -2.06% Proceeds from common stock issuances 0.89% 1.02% 0.62% 0.56% 0.00% 0.00% Purchases of common stock -36.60% -17.38% -36.71% -42.35% -399.54% -47.54% -45.00% -40.00% -35.00% -35.00% -35.00% -35.00% -35.00% -35.00% -35.00% -35.00% Cash dividends paid -26.21% -38.00% -27.19% -26.86% -133.40% -36.28% -30.00% -26.00% -26.00% -26.00% -26.00% -26.00% -26.00% -26.00% -26.00% -26.00% Stock option transactions and other 8.26% 19.53% 7.12% 5.04% 32.85% 7.22% Net cash used in financing activities -23.43% -64.09% -20.99% -42.38% -518.20% -47.33% -42.00% -35.00% -30.00% -30.00% -30.00% -30.00% -30.00% -30.00% -30.00% -30.00% 61
  • Appendix E: Cost of Debt Estimation Short Term Borrowings: Short Term Borrowings (Millions) Value Weighted Principal Rate Weight Rate Commercial Paper 9,109 1.30% 87.93% 1.14% Other Short Term Borrowings 1,250 11.25% 12.06% 1.36% Short Term Borrowings 10,359 100.00% 2.5%* *Given in 2004 10-K Long Term Borrowings: Long Term Debt (Millions) Maturity Date Principal Rate Weight Value Weighted Rate Libor based floating rate Jan-06 1,000 1.80% 13.74% 0.25% Feb-05 771 5.63% 10.59% 0.60% Dec-28 749 6.60% 10.29% 0.68% Feb-14 742 4.50% 10.19% 0.46% Mar-07 686 2.50% 9.42% 0.24% Apr-09 644 5.63% 8.85% 0.50% Japanese Yen Mar-08 586 0.80% 8.05% 0.06% Dec-18 528 6.50% 7.25% 0.47% Mar-09 294 3.30% 4.04% 0.13% Mar-18 294 4.65% 4.04% 0.19% Jan-08 266 6.00% 3.65% 0.22% Debentures, Notes, borrowings, and mortgages 719 6.00% 9.88% 0.59% Total Long Term Debt** 7,279 4.38% **Does not include amounts due within one year Balance Sheet Debt: 62
  • Percent of Total Computed Interest Value Weighted LIABILITIES (Millions) Liabilties Rate Rate Current Liabilities Short-term borrowings 10,359 24.22% 2.50% 0.006 Current Portion of Long term Debt 907 2.12% 4.38% Accounts payable 2,672 6.25% 0.00% 0.000 Dividends payable 1,418 3.32% 0.000 Income taxes payable 1,963 4.59% 0.00% 0.000 Accrued compensation and related items 1,939 4.53% 6.00% 0.003 Accrued litigation settlements 264 0.62% 2.50% 0.000 Other current liabilities 6,872 16.07% 2.50% 0.004 Liabilities of discontinued businesses held for sale 64 0.15% 4.38% 0.000 Total current liabilities 26,458 61.86% Long-term debt 7,279 17.02% 4.38% 0.007 Pension benefit obligations 2,821 6.60% 6.00% 0.004 Postretirement benefit obligation other than pension plans 1,450 3.39% 10.00% 0.003 Deferred taxes on income**** 0 0.00% 0.00% 0.000 Other noncurrent liabilities 4,766 11.14% 6.00% 0.007 Total non-current liabilities 16,316 38.14% Total liabilities 42,774 100.00% 12,632 Weighted Average Cost of Debt 3.45% Appendix F: Regression Analysis: Two Year: SUMMARY OUTPUT (2003-2005) Regression Statistics Multiple R 0.24624658 R Square 0.060637378 Adjusted R Square 0.019795525 Standard Error 0.049704838 Observations 25 ANOVA df SS MS F Significance F Regression 1 0.003668025 0.003668025 1.484687235 0.235393985 Residual 23 0.056823132 0.002470571 Total 24 0.060491157 Coefficients Standard Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0% Intercept -0.01071184 0.010508607 -1.01933928 0.318645059 -0.032450545 0.011026874 -0.032450545 0.011026874 X Variable 1 0.435905178 0.357745797 1.218477425 0.235393985 -0.304148384 1.175958739 -0.304148384 1.175958739 63
  • Three Year: SUMMARY OUTPUT (2002-2005) Regression Statistics Multiple R 0.483692549 R Square 0.233958482 Adjusted R Square 0.212071581 Standard Error 0.047112706 Observations 37 ANOVA df SS MS F Significance F Regression 1 0.023726333 0.023726333 10.68942956 0.002421708 Residual 35 0.077686246 0.002219607 Total 36 0.101412579 Coefficients Standard Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0% Intercept -0.00989422 0.007748099 -1.27698686 0.210014035 -0.025623699 0.005835257 -0.025623699 0.005835257 X Variable 1 0.594927185 0.18196445 3.269469309 0.002421708 0.225519715 0.964334656 0.225519715 0.964334656 Five Year: SUMMARY OUTPUT(2000-2005) Regression Statistics Multiple R 0.363164555 R Square 0.131888494 Adjusted R Square 0.116658468 Standard Error 0.055936169 Observations 59 ANOVA df SS MS F Significance F Regression 1 0.027095158 0.027095158 8.659767915 0.004697853 Residual 57 0.178344733 0.003128855 Total 58 0.20543989 Coefficients Standard Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0% Intercept 0.000298867 0.007319511 0.040831495 0.967572919 -0.0143582 0.014955934 -0.0143582 0.014955934 X Variable 1 0.458094958 0.155669089 2.942748361 0.004697853 0.146372986 0.76981693 0.146372986 0.76981693 64
  • Appendix G: Intrinsic Valuation Methods: Discounted Dividends: Pfizer Inc. (Amounts in millions of dollars except per share data) Forecast Years 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 Terminal Dividends (Millions) $4,631.91 $4,580.63 $5,111.98 $5,623.18 $6,185.50 $6,804.05 $7,484.45 $8,232.90 $9,056.19 $9,961.81 Present Value Factor 0.952 0.907 0.864 0.823 0.784 0.747 0.711 0.677 0.645 Present Value of Dividends 4,411.76 4,155.56 4,417.18 4,627.97 4,848.81 5,080.19 5,322.61 5,576.60 5,842.71 Present Value of Future Dividends Per Share $0.61 $0.57 $0.61 $0.64 $0.67 $0.70 $0.73 $0.77 $0.80 $1.37 Total Present Value of Forecast Future Dividends $6.08 Continuing (Terminal) Value (assume no growth) $45.73 Present Value of Continuing (Terminal) Value $29.50 Estimated Value per Share $35.58 FV - April 05 $36.02 Earnings Per Share $1.70 $1.93 $2.09 $2.30 $2.53 $2.78 $3.06 $3.36 $3.70 Dividends per share $0.64 $0.63 $0.70 $0.77 $0.85 $0.93 $1.03 $1.13 $1.24 Book Value Per Share $9.37 $8.62 $7.92 $7.91 $7.74 $8.51 $8.58 $9.44 $10.38 $11.42 Shares Outstanding 7,286.00 Actual Price per share $26.15 Estimated Ke 4.99% growth rate 0.02 Sensitivity Analysis g 0 0.015 0.03 0.045 Ke 0.03 $35.48 $64.88 N/A N/A 0.04 $28.13 $41.36 $94.29 N/A 0.05 $23.72 $31.28 $50.18 $182.50 0.06 $20.78 $25.68 $35.48 $64.88 0.07 $18.68 $22.12 $28.13 $41.36 65
  • Discounted Free Cash Flows: Pfizer Inc. (Amounts in millions of dollars except per share data) Forecast Years 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 Cash Flow from Operations $15,440 $15,856 $16,712 $17,951 $19,746 $21,721 $23,893 $26,282 $28,910 $31,801 Cash Provided (Used) by Investing Activities ($10,036) ($11,011) ($11,797) ($12,652) ($13,085) ($13,085) ($14,393) ($15,832) ($17,416) ($19,157) Free Cash Flow (to firm) 5,404 4,845 4,915 5,299 6,661 8,636 9,499 10,449 11,494 12,644 discount rate (4.07% WACC) 0.961 0.923 0.887 0.853 0.819 0.787 0.756 0.727 0.698 Present Value of Free Cash Flows 5,193 4,473 4,361 4,517 5,457 6,798 7,185 7,594 8,027 Total Present Value of Annual Cash Flows 53,605 Continuing (Terminal) Value (assume no growth) 610,813 Present Value of Continuing (Terminal) Value 426,558 Value of the Firm (end of 1987) 480,163 Book Value of Debt and Preferred Stock 55,599 Value of Equity (end of 2004) 424,564 Estimated Value per Share 58.27 FV - April 05 58.98 Earnings Per Share $1.70 $1.93 $2.09 $2.30 $2.53 $2.78 $3.06 $3.36 $3.70 Dividends per share $0.64 $0.63 $0.70 $0.77 $0.85 $0.93 $1.03 $1.13 $1.24 Book Value Per Share $9.37 $8.62 $7.92 $7.91 $7.74 $8.51 $8.58 $9.44 $10.38 $11.42 Actual Price per share $26.15 Shares Outstanding 7,286.00 Sensitivity Analysis g WACC 4.07% 0 0.015 0.03 0.045 Growth Rate 2.00% WACC 0.03 $44.50 $88.83 N/A N/A 0.04 $30.23 $48.52 $121.68 N/A 0.05 $21.75 $31.34 $55.31 $223.10 0.06 $16.14 $21.85 $33.26 $67.50 0.07 $12.18 $15.86 $22.29 $36.45 66
  • Discounted Residual Income: Pfizer Inc. Forecast Years 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 Terminal Beginning BE (per share) 9.37 10.44 11.74 13.13 14.66 16.34 18.18 20.21 22.45 EPS $1.70 $1.93 $2.09 $2.30 $2.53 $2.78 $3.06 $3.36 $3.70 DPS $0.64 $0.63 $0.70 $0.77 $0.85 $0.93 $1.03 $1.13 $1.24 Ending BE (per share) 9.37 10.44 11.74 13.13 14.66 16.34 18.18 20.21 22.45 24.91 "Normal" Income 0.47 0.52 0.59 0.66 0.73 0.82 0.91 1.01 1.12 Residual Income (RI) 1.24 1.41 1.50 1.64 1.80 1.97 2.15 2.36 2.58 2.58 Present Value of RI 1.18 1.28 1.30 1.35 1.41 1.47 1.53 1.60 1.67 BV Equity (per share) 2004 9.37 Total PV of RI (end 2004) 12.78 Sensitivity Analysis Continuation (Terminal) Value 51.72 g PV of Terminal Value (end 2004) 33.37 0 0.015 0.03 0.045 EstimatedValue Per Share (2004) 55.52 Ke 0.03 $103.17 $180.52 N/A N/A FV - April 2005 56.19579 0.04 $73.13 $102.67 $220.84 N/A 0.05 $55.37 $69.62 $105.24 $354.58 Ke 0.0499 0.06 $43.75 $51.49 $66.97 $113.42 Growth 0 0.07 $35.60 $40.12 $48.01 $65.39 67
  • Discounted Abnormal Earnings Growth: Pfizer Inc. Perp Forecast Years 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 EPS $1.70 $1.93 $2.09 $2.30 $2.53 $2.78 $3.06 $3.36 $3.70 DPS $0.64 $0.63 $0.70 $0.77 $0.85 $0.93 $1.03 $1.13 $1.24 DPS invested at 4.99% $0.03 $0.03 $0.04 $0.04 $0.04 $0.05 $0.05 $0.06 Cum-Dividend Earnings $1.97 $2.12 $2.33 $2.57 $2.82 $3.11 $3.42 $3.76 Normal Earnings $1.79 $2.03 $2.19 $2.41 $2.65 $2.92 $3.21 $3.53 Abnormal Earning Growth (AEG) $0.18 $0.09 $0.14 $0.15 $0.17 $0.19 $0.20 $0.22 $0.00 PV Factor 0.952 0.907 0.864 0.823 0.784 0.747 0.711 0.677 PV of AEG $0.17 $0.08 $0.12 $0.13 $0.13 $0.14 $0.15 $0.15 Core EPS $1.70 Total PV of AEG $1.07 Continuing (Terminal) Value $0.00 PV of Terminal Value $0.00 Total PV of AEG Average Perpetuity $2.77 Capitalization Rate (perpetuity) 0.0499 Value Per Share pv $55.52 Dec-04 fv $ 56.20 5-Apr Ke 0.0499 Sensitivity Analysis g 0 g 0 0.015 0.03 0.045 Ke 0.03 $62.03 $62.03 $62.03 $62.03 Actual Price per share $26.15 0.04 $59.20 $59.20 $59.20 $59.20 0.05 $55.49 $55.49 $55.49 $55.49 0.06 $52.60 $52.60 $52.60 $52.60 0.07 $50.80 $50.80 $50.80 $50.80 68
  • Long Run Return on Equity based on P/B Ratio: Year Net Income Shareholder Equity ROE Ke Growth Rate Equity (BV) Price, Estimated 1999 $4,952 $13,950 0.35 4.99% 2.00% 9.37 99.42182305 2000 $3,726 $16,076 0.23 2001 $7,788 $18,293 0.43 2002 $9,126 $19,950 0.46 2003 $3,910 $65,377 0.06 2004 $11,361 $68,278 0.17 2005 $12,407 $62,840 0.25 Sensitivity Analysis 2006 $14,094 $57,710 0.30 g 2007 $15,222 $57,658 0.35 0 0.015 0.03 0.045 2008 $16,744 $56,377 0.40 Ke 0.03 $105.34 $201.30 N/A N/A 2009 $18,418 $62,015 0.40 0.04 $79.00 $120.78 $287.90 N/A 2010 $20,260 $62,531 0.40 0.05 $63.20 $86.27 $143.95 $547.69 2011 $22,286 $68,785 0.40 0.06 $52.66 $67.10 $95.97 $182.56 2012 $24,515 $75,663 0.40 0.07 $45.14 $54.90 $71.98 $109.54 2013 $26,966 $83,229 0.40 2014 $29,663 $91,552 0.40 Average $15,090 $55,018 0.337 69
  • Appendix H: Method of Comparables: Price to Earnings (Forward) P/E Forward PFIZER 16.4 ABBOTT LABS 22.4 BRISTOL-MYERS SQ 17.6 NOVARTIS AG 20.7 MERCK 11.8 Average 18.125 Average w/o Outliers 20.233 Valuation $ 33.89 Valuation w/o outliers $ 37.84 Price to Earnings (Trailing) P/E Trailing PFIZER 31.3 ABBOTT LABS 23.9 BRISTOL-MYERS SQ 18.6 NOVARTIS AG N/A MERCK 20.2 Average 20.9 Average w/o Outliers 20.9 Valuation $ 39.08 Valuation w/o outliers $ 39.08 Price to Book 70
  • P/B PFIZER 2.66 ABBOTT LABS 5.27 BRISTOL-MYERS SQ 4.3 NOVARTIS AG 3.43 MERCK 3.81 Average 4.2025 Average w/o Outliers 3.847 Valuation $ 38.87 Valuation w/o outliers $ 35.58 Dividends to Price D/P PFIZER 3.1 ABBOTT LABS 2.3 BRISTOL-MYERS SQ 4.7 NOVARTIS AG 1.6 MERCK 4.9 Average 3.375 Average w/o Outliers 4.800 Valuation $ 31.22 Valuation w/o outliers $ 44.40 Price to Sales 71
  • P/S PFIZER 4.1 ABBOTT LABS 3.63 BRISTOL-MYERS SQ 2.24 NOVARTIS AG 3.88 MERCK 3.07 Average 3.205 Average w/o Outliers 3.527 Valuation $ 23.11 Valuation w/o outliers $ 25.43 Price to Earnings Growth PEG PFIZER 1.08 ABBOTT LABS 2.04 BRISTOL-MYERS SQ 2.82 NOVARTIS AG 1.73 MERCK 1.69 Average 2.07 Average w/o Outliers 1.820 Valuation $ 24.84 Valuation w/o outliers $ 21.84 72