The Long Case for Pfizer

In the January 31 edition of Value Investor Insight, Fairholme Capital's Bruce Berkowitz described why he sees value in Pfizer (PFE):

Your largest holding, Pfizer [PFE], has certainly been in the news of late. Has that impacted your positive view at all?

BB: The short answer is no. The concerns about Pfizer are well-known: Lipitor is going off patent, its costs are too high, the government is going to take away its profits, etc. As has been happening a lot lately, we disagree strongly with the market’s view about how that all plays out.

With respect to the revenue hit from blockbusters like Lipitor going off-patent, how does your view differ?

BB: In a couple of ways. The first is that we don’t believe Pfizer is going to lay down and concede billions and billions in revenue to generics without a fight. If you look at the company’s global manufacturing footprint, which you don’t read about in The Wall Street Journal, you can see a boom in hiring and in gearing plant and facilities to the manufacture of what they call established brands. Three years from now when there’s big generic competition for Lipitor, if Pfizer can sell the name brand at a reasonable price premium to generics, why wouldn’t people buy it? A generic drug is not exactly the same as the real deal – it may or may not be as effective – and if people discriminate in the type of chocolate they put in their mouth, we think they’ll do the same with drugs critical to their health. Beyond that, what’s to stop Pfizer from competing with its own generic versions of branded products?

A second big issue is that the market seems to give Pfizer little credit for having the most powerful drug distribution system in the world. That makes it the ideal partner for any bright young company with a potential blockbuster and, as we’ll see with Wyeth (WYE), even for established companies that can get wider and more efficient distribution by plugging into Pfizer’s system. [CEO] Jeffrey Kindler understands that big pharma’s not-created-here syndrome has to go. Taking advantage of that through partnerships, joint ventures and acquisitions can go a long way to replacing sales and profits lost to generics.

Have recent cost-savings announcements gone far enough in your estimation?

BB: We’ll see. I do believe Kindler is a very smart operator, with a great pedigree and a clear understanding that there are billions in savings at a company the size of Pfizer. He has also proven to be an under-promise, over-deliver kind of guy, so we’re optimistic he’ll do the right things in fitting the cost structure to the business opportunities.

You spoke earlier about the effects of new government regulation on managed-care companies. Does that view translate to Pfizer as well?

BB: I’m not saying that change isn’t necessary and desirable, but that the government can’t push so hard that companies like Pfizer or UnitedHealth (UNH) lose the incentive to innovate and improve. The government can cut checks, but if it wants a thriving and first-class healthcare system, it can only do it with the support and participation of the pharmaceutical and health-insurance industries.

Is the environment likely to be tougher for everyone? Yes. But the company is priced as if it’s headed over the cliff, when we don’t think it is.

At just above $15, how inexpensive do you consider the shares?

BB: Before the Wyeth deal was announced and assuming that Lipitor goes away – which is incorrect – we never saw the company earning less than $2 per share in free cash flow. After a first pass at looking at the Wyeth deal, we’re now seeing a steady-state level of per-share free cash flow of around $2.50.

So at $15, the shares trade at a 6x multiple of free cash flow and a free cash flow yield of more than 16% – for a solid investment grade credit! Compare that to the 2-3% you can get on long-term Treasuries and something has to give. Either Treasuries are going to go way down in price and way up in yield, or, when markets start to regain some confidence, Pfizer’s stock price is going to go way up and the free cash flow yield will go back down into the single digits where it belongs. We’re betting on the latter.

We’ve calculated what we think is the liquidation value of the company if you just ran off their existing products until patent expiration, and the net present value of that alone is higher than the current stock price. That’s assuming generics take 100% of their business. That’s assuming their pipeline – and now Wyeth’s – is valued at zero. That just doesn’t make sense.

Comments

[Rob Viglione:]

Let's throw into this analysis a forward P/E of 6.1, profit margin 17%, operating margin twice that, ROE 12%, and a forward dividend yield of 8.8% (courtesy of Yahoo Finance). This is priced to head off a cliff. If half of what Berkowitz says is true then this might not be a bad value play...

Feb 16 04:12 AM

[mouth:]

I wan to believe this analysis, but since 2001 PFE has been in a continual slide- $60 down to less than $15 per share. Markets don't lie. Markets don't care. They are what they are. Where is the good news. Where is the turnaround news? Is this the bottom?
8% dividend.Mergers semm to work sometimes but ones this large only work if they in fact establish a continual monopoly. Otherwise they are years in trying to meld themselves. Oh how easy the culture meld between the two. How often do the expected savings not translate into cash.
Again I hope that PFE is at the bottom of it's slide, but The market seems to be waiting for the hammer to fall.
Finally, until the entire market bottoms, "who knows, only the shadow knows"

Feb 16 12:47 PM

[Ohad Hammer:]

Very nice interview, clear and simple.
imo, Berkowitz is right on the money.
The pharma industry is facing a patent cliff, but it doesn't mean companies like Pfizer will actually fall off a cliff. It will still generate plenty of cash and will be able to utilize its huge global footprint.
Can't say I follow every investigational agent in the company's pipeline, but it seems to have quite a few interesting drugs, particularly in the pain/inflammation area.
I am still a little bit worried about their oncology pipeline, especially the lack of antibody based drugs. They do seem to have a deep and broad small molecule pipeline, but most of it is early stage. The Wyeth deal doesn't help a lot on the oncology front, although Wyeth has a very interesting conjugate with strong data in NHL. For some reason, the company is not too public about it.

Ohad Hammer

Feb 16 02:56 PM

[pharma guy:]

". . . Three years from now when there’s big generic competition for Lipitor, if Pfizer can sell the name brand at a reasonable price premium to generics, why wouldn’t people buy it? . . . "

With that statement Mr. Berkowitz demonstrated a frightening ignorance as to the operating realities of the pharmaceutical marketplace. This is an absolutely laughable thesis that demonstrates complete lack of understanding of how drugs are prescribed, paid for, regulated, and consumed.

while I am sure Mr. Berkowitz is skilled in other matters, you should run, not walk, from the advice offered here wrt. investments in the lifescience space.

Feb 16 05:43 PM

[Adam Sharp:]

What about their balance sheet? That's the big red flag for me. Piles of debt, much of it due very soon.

Plus $4b in unfunded pension liabilities (as of q3 08), $37b of intangibles, $21b of goodwill. All a bit worrying. Yes, lots of those intangibles are probably valuable patents. But I haven't done the research, and a company with that much debt isn't something I'd want to own right now.

Feb 16 05:58 PM

[drone:]

The short case for Pfizer:

I lost my shirt on this stock, sold it and won't be buying anytime soon at any price.
Lipitor is coming off patent.
Pfizer will put up a fight for its patents, costing it billions of dollars.
Goodbye juicy dividend and all that cash going to Wyeth shareholders.
At $15 the shares have come a long way down for any time frame you care to mention. Not good.
Do you want to wait around for liquidation value or move on?
I bought at a previous liquidation value only to learn that there was a newer and lower liquidation value.

All this I gleaned from this dumbass article without reading any balance sheet.

Feb 16 06:05 PM

[drone:]

The long case for GE, give us your long case for that one, dickhead.

Feb 16 06:12 PM

[another.ana...:]

"A generic drug is not exactly the same as the real deal – it may or may not be as effective "

This piece of BS should---if you own the stock as I do @ $16.00---scare the ever loving S**T out of you.

Ayuh

Feb 16 06:54 PM

[drone:]

In Thailand generic viagra is way more potent and pennies a pill. Sold over the counter, available on every street corner. No side effects except sleep and a big smile.


On Feb 16 06:54 PM another.anal.ist wrote:

>
> "A generic drug is not exactly the same as the real deal – it may
> or may not be as effective "
>
> This piece of BS should---if you own the stock as I do @ $16.00---scare
> the ever loving S**T out of you.
>
> Ayuh

Feb 16 08:53 PM

[mouth:]

I want do believe this analysis, but PFE has been steadily going down.

Feb 16 08:57 PM

[jepittman:]

The primary reason a company like Pfizer is a value is because of the comments above. People are scared. It is understandable. Investors have been losing money in Pfizer (and many other great companies) for YEARS. Valuations for Pfizer and many other companies are approaching absurd levels and as the author says something will happen fairly soon to trigger an adjustment. There are no good alternatives to quality risk assets. Treasury rates are at multi decade lows. Ditto CDs and money market yields. Determined risk aversion by the investing public is at levels experienced only by a few very old investors. The result is near absurd values for high quality companies with massive long term earning power. Opportunities to cherry pick companies of this quality IMO only happens on extremely rare occasions. We will almost certainly look back on these months as one of those rare times.

Feb 16 10:13 PM

[donzelion:]

Concur with Jepittman and Berkowitz.

Sure, Pfizer lost money while Citibank, AIG, and others were earning profits hand over fist. Yet the fact that Pfizer is down 75% from its highs of 9 years ago doesn't make it a worse investment than any other equity (bear in mind that during those 9 years, you earned dividends which, if reinvested, would have put you ahead of the stock market).

That said, my take on Berkowitz's points:
(1) Concur about Lipitor's post-patent prospects. Margins will certainly degrade over time, but Lipitor is not aspirin, and for this drug, the distribution network (esp. the doctor relationships) will matter a great deal. The issue has nothing to do with "manufacturing/industr... - making the pills costs pennies...it's getting the pharmacists to sell someone's specific set of pills that costs real money.

(2) Concur re cost savings. Will it help? Who knows? Impossible to say. If you believe that Pfizer was squandering money years ago, then you might reconsider in view of the supposed savings.

(3) In terms or government regulation, Berkowitz does not refer to one key feature of the PFE + Wyeth deal: size = political clout (at least until one becomes an antitrust targt). Most governments that neglect patent enforcement (Thailand, among many others) might suddenly find themselves a bit more enthusiastic if, for instance, measles or malaria vaccines were held up...

(4) Value. I view value in terms of risk, not price. At $15, with a 3% dividend, is Pfizer safer than treasuries? Nope. Does it offer more potential reward than treasuries do today? You betcha. Is it as safe as gold? Probably not, but it offers better dividends, and immense potential.

Pfizer should be an easy buy, unless you despise management for some reason.(PFE amounts to about 2% of my total portfolio, or 10% of the exploratory portion of my portfolio, since the core is all tied to broad index ETFs per my core'n'explore strategy).

Feb 17 07:24 AM

[The Big Dog:]

Re: generic drugs, Mr. Berkowitz left out one inportant player - the HMOs. Once Lipitor can be manufactured generically, the HMOs will dictate what they're willing to pay. If Pfizer can't match their competitors, it will be a mute point whether customers will want their product over generic brands. At the buy point, the big dogs rule!

Feb 18 12:07 PM

[Adam Sharp:]

Have you PFE bulls really studied their balance sheet? It's not so rosy, IMO. They have a lot of debt. They have a large amount of unfunded pension liabilities. Go ahead, thumbs down me, and keep buying PFE. But their cash-cow, lipitor, will shrink soon. And debt will have to be paid off, or refinanced at higher cost.

Jepittman - do you really believe there are "no good alternatives" to stocks like Pfizer? How about good companies with ZERO debt and tons of cash? I'd say INTC, GOOG, and AAPL are good alternatives. Having a clean balance sheet is most important to me in this environment.

Feb 18 08:42 PM