Novice Investing - Examining Your King

Date: Tuesday 13th 2008f May 2008 07:28:59 AM

Examining Your King - 10/29/2007

By: Novice Investing Staff

With King Pharmaceuticals (KG) trading at a price we feel is undervalued, let's take a deeper look at its 2006 annual report, understand its business and then construct a pro forma income statement of King Pharmaceuticals in the coming year. King is a pharmaceutical company that is involved many stages of manufacturing such as: Research & Development, the manufacturing of products itself, packaging, distribution, quality control, sales and marketing, business development and regulatory management. It is focused in three therapeutic areas: cardiovascular/ metabolic, neuroscience and hospital/ acute care products.

King Pharmaceuticals concentrate on two main strategy to generate growth. One is to acquire novel brand pharmaceutical in various stages of development. Another is to extend the life cycle of the product. This can be achieved by several methods such as: securing additional drug usages from the US. Food and Drug Administration (FDA), producing different package sizes, developing new dosage, developing new product formulation.

Most of King's revenue came from what it called Branded Pharmaceuticals (86.7%) , followed by Meridian Medical Technologies (8.28%), Royalties (4.04%), Contract Manufacturing (0.8%) and other (0.11%). Branded Pharmaceuticals are marketed based on the three therapeutic areas mentioned earlier; cardiovascular/ metabolic, neuroscience and hospital/ acute care products. Below table summarizes King's Branded Pharmaceuticals portfolio for year 2006:

Cardiovascular	Revenue 2006($ M)	Usage
Altace	653.0	hypertension, stroke risk reduction
Levoxyl	111.8	thyroid hormone
Cytomel	42.0	thyroid hormone
Corgard	9.6	angina pectoris (hypertension)
Corzide	6.1	diuretic combination tablet (hypertension)
Neuroscience
Skelaxin	415.2	muscle relaxant
Sonata	85.8	insomnia
Hospital
Thrombin	246.5	aid to hemostasis
Bicillin	42.8	antibiotic for deep muscular injection
Intal	15.0	anti-inflammatory agent for asthma
Synercid	14.7	antibiotic for skin complications
Brevital	6.0	anesthetic for rectal and intramuscular use

Now, the question is whether King will continue to execute this kind of revenue for the near future. We have made pro forma income statement for King which includes estimate for their main revenue stream.

Revenue Estimation

Latest news from King is not encouraging at all. After losing the case on Altace, King is facing generic threat on several of its biggest revenue driver, mainly Skelaxin and Thrombin. With that in mind, while revenue for 2007, 2008 period is stellar, coming into 2009 at latest, King's revenue stream will start to deteriorate. Mainly, we should expect Altace revenue to drop 75%, Skelaxin 20%, Thrombin 10%. However, revenue for Altace in trailing 12 months ended in June 2007 has risen to $ 900 Million. We will use this base for our calculation. For other smaller franchise, we would assume 0% change from 2006 revenue level and therefore, King's expected revenue for branded pharmaceutical is as follows:

Cardiovascular	Revenue 2009($ M)
Altace	225.0
Levoxyl	111.8
Cytomel	42.0
Corgard	9.6
Corzide	6.1
Neuroscience
Skelaxin	332.2
Sonata	85.8
Hospital
Thrombin	221.8
Bicillin	42.8
Intal	15.0
Synercid	14.7
Brevital	6.0
Total	1112.8

We will assume other business units with the same revenue as 2006 therefore, total revenue for King is: branded pharmaceuticals + meridian medical technologies + royalties + contract manufacturing + others = $ 1112.8 Million + 164.7 Million + 80.3 Million + 16.5 Million + 2.18 Million = $ 1376.5 Million.

Gross Profit Estimation

In 2006, gross profit at King Pharmaceutical is 78%. We will use this figure for our calculation as well.

SG&A Estimation

Latest work force reduction as much as 20% total, will bring King's cost down a bit. Analysts expect this cut to result in a cost saving of $ 75 Million. Therefore, selling general administration will be reduced as such and for our pro forma income statement, Selling General & Administration expense will be $ 638.97 Million. Meanwhile, we will keep Research & Development Expense flat at $ 143.6 Million.

Interest & Income tax expense

King has more cash than long term debt as of late. Therefore, we will peg interest expense as $0. As for income tax, King tax bracket varied between 32-35% in the previous fiscal years. Our calculation will assume a tax rate of 33%.

Shares Outstanding Estimation

We will assume flat shares outstanding compared to previous years.

With these assumptions in mind, EPS for King Pharmaceutical came in to be $ 0.82 per share. With recent treasury bond trading at 5%+ yield, we feel that real price of stock reaches fair value when it is trading at a P/E of 14. (14x $ 0.82 = $ 11.48 per share) With $ 604 Million ($2.49 per share) in positive net cash, we can calculate fair value of King's stocks to be:

Real price = stock price - (cash+ short-term investment)+ long-term debt.

Stock price = $ 11.48 + $ 2.49 - $ 0 = $ 13.97/share.

This is a rough idea on the fair value of King Pharmaceutical. Recently, King's stock is trading at $ 10.50 per share, which is less than 50% below fair value. We will buy King stock for our sample portfolio when it is trading close to $ 9.31 per share.

END

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Pro Forma Income Statement for AH	Fiscal year 2009
Revenue	$ 1377 M
Cost of Goods Sold	$ 302 M
Gross Profit	$ 1075M
SG & A	$ 639 M
Research & Development	$ 143 M
Interest Expense	$ 0 M
Profit Before Tax	$ 293 M
Income Tax Expense	$ 93 M
Net Income	$ 200 M
Shares Outstanding	243 million shares
EPS Estimate	$ 0.82

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