GlaxoSmithKline: Witty's Management Is Reason for Optimism

The recent acquisition of Stiefel Laboratories for $3.6bn (see below for details) is the largest so far under GlaxoSmithKline's (GSK) new CEO Andrew Witty and is designed to put the cash rich drug manufacturer on a safer and consistent course. Additionally, it is in line with the CEO’s approach to “grow, deliver and simplify” the company as outlined internally when he was competing for the job almost a year ago.

The Stiefel Laboratories acquisition is also in line with the CEO’s focus on bolt-on deals designed to boost cash flow and de-risk and diversify the company in contrast to making large-scale M&As. This method of expansion is designed to move away from the company's uncertainties over core innovation and core medicines. An analyst at Morgan Stanley has that Witty has “been doing pretty much what he said he would, with an appropriate response for the climate in which the industry operates."

The market turbulence in the last few months and confirmation of President Obama’s plan for healthcare reform has spurred large pharmaceutical companies such as PFE into mega mergers; however amidst all this, GSK has remained consistent in its approach.

During a time of growing divergence and strategies with the pharmaceutical industry, GSK's CEO Mr Witty has placed his company firmly on the path of diversified healthcare along the lines of JNJ and NVS, and most recently PFE as a consequence of its merger with WYE.

This strategy employed by Mr Witty has major benefits for the company, which includes a more diversified portfolio of consumer healthcare products, generic drugs, vaccines and biological medicines not to mention its core franchise of patented chemical drugs. Moreover, the company is also looking to maintain/increase future growth as it seeks to enhance its profile in emerging economies as western markets stagnate, indicating GSK could make for an excellent long term investment.

Mr Witty has also announced major cost cutting packages designed to save expenses by £1bn over the next three years. Mr Witty has continually maintained that by carrying out niche transactions instead of the previous strategy of share buy-back agreements the company’s portfolio will be better placed to perform in emerging markets given its increased diversification.

One prime example of this is a strategic alliance with Aspen of South Africa, a generic drugs manufacturer; this is designed to increase its presence in emerging markets while at the same time not committing large amount of capital in the process. Also GSK has completed a complex joint venture with PFE for both groups of HIV drugs. This deal is clever insofar as it shifts £60m of costs of GSK's profit and loss account.

Mr Witty’s management style has also been hailed as both energetic and personal and in a time of demand for openness and greater accountability, Mr Witty proceeded to move his and fellow top executive offices from the 12th floor of its HQ down to street level. Not to mention Mr Witty’s desire to see greater transparency in clinical drug trials, which is a major aspect of the GSK business. Also, Mr Witty has overseen structural changes to the management of GSK, which has involved recruitment from outside the company, one example being the appointment of Eli Lilly’s (LLY) Abbas Hussein to run its emerging market operations.

Mr Witty’s appointment as CEO of GSK represents a shift to a more internationally focused generation of pharmaceutical industry, which also includes his vast knowledge and geographical experience that will be a significant asset as the company moves further into emerging markets. Mr Witty, prior to becoming CEO, already had experience in markets spanning from Asia to Africa.

While there are many reasons why a long term investor should be optimistic about GSK, there are still signs for caution. First is its drug development pipeline, which is still to deliver a new generation of “blockbusters” as existing products come of patents, a prime example of this is the Cervarix cervical cancer vaccine drug which is still awaiting regulatory approval by the US regulators. Secondly there is still the concern that the strategy employed by Mr Witty has yet to gain investor confidence, which as a result has meant that GSK shares have underperformed against its peers in recent months.

Short term investors should be cautious in their approach as many investors are concerned about the company’s margins and the underlying issue of patents for its drugs. However, long term investors should be optimistic for the following reasons: GSK is becoming a safer and more transparent company; more secure but lower margin; increased growth with less risk, and its increasing presence in emerging markets and as a consequence diminished reliance on growth from western economies all ensuring a stable company that has the ability to grow with less risk than its rivals.

Lastly Mr Witty's vast knowledge and experience in emerging market economies can only help propel the company forward and significantly increase its growth potential at the cost of its rivals.

Stiefel Laboratories

GSK's purchase of Stiefel is designed to increase the diversification of its portfolio in healthcare products and increase in presence in dermatology products, which is also intended to shift its focus away from high-risk patented medicines. The combination of Stiefel and GSK will lead to the creation of a dermatology operation with pro-forma sales of $1.5bn, which would account for 8% of global skincare products. GSK already has sales of $550m a year in dermatology products.

Long term, Stiefel is an excellent purchase since it has a range of proprietary technologies to help safeguard intellectual property on existing brands as well as more than 15 projects in late stage development. The acquisition will generate up to $240m in annual pre-tax cost savings by 2012 after one-off charges of $325m, this may result in a minor dilution of EPS ahead of integration costs for 2009 of less than 1%, but would be accretive by 1-2% in 2010.

GSK Financials

• Forward P/E - 8.43% industry P/E 10.75 (NASDAQ DATA)
• % Dividend Yield (TTM) – 6.56%
• Free Cash Flow TTM ($m) 10,638
• ROE 5 Years - 61.17
• Total Sales 2008 - £24.3bn
• Current Price Target $37.06 ((FINVIZ))
• Current Analyst Recommendation - Market Outperform
• Earnings Growth 9.43% compared to industry growth of -2.9% (NASDAQ data)*

* drug companies

Disclosure: I hold GSK long in my stock portfolio on kaChing.

Comments

[sidney:]

you neglect the impact of SIRT based products in GSK's pipeline?

Apr 27 09:09 PM

[Chris Lau:]

Hi, nice to see your article on seekingalpha as well! Keep up the good research.

May 31 10:05 AM