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 (NYSE: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.