Value Investor's  Instablog

Today Bernie Madoff was sentenced to 125 years in prison. To send him off here are a few tips for Madoff on going to prison, bullet points are borrowed from a prison blog Top 10 prison survival:

1. Keep your mouth shut Shouldn't be a problem Madoff ran his scam for years before he was eventually caught. In fact the folklore around Madoff was that if an investor cornered him at a public function and pushed him to talk about their investment that he would pickup the phone and have their investment canceled.
    
2. Don't get involved with gambling Running a ponzi scheme is a lot like gambling, you never know when the house is going to call in your chips, for Madoff that day came on December 11th 2008 when FBI officers took Madoff into custody. Hopefully he has had his fill of gambling.
    
3. Don't borrow unless you can pay back Not so good with this one. If you borrow in prison the interest rate is phenomenal and payment means are, well, lets say nontraditional. Madoff has left investors with a whopping 65 Billion dollars in unpaid debt, likely much of it will never be fully recovered.
    
4. Develop a skill that is useful to other inmates I'd recommend teaching United States Fraud laws as I am sure he is well versed with it... now.
    
5. Don't be a loner find a group Bernie has the gift of the gab, the first groups he targeted when starting out his scam were people from the New York Jewish community. He probably won't find a huge populations of older Jewish men in prison, or really want them to have his back though.

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This week we are reviewing Bristol-Myers Squibb as a possible stock acquisition. To do so we will use the Buffett four filters we discussed in a previous article.

About the Company

Bristol-Myers Squibb Company (BMY) is engaged in the discovery, development, licensing, manufacturing, marketing, distribution and sale of pharmaceutical and nutritional products. The Company had two segments: Pharmaceuticals and Nutritionals. The Pharmaceuticals segment is made up of the global pharmaceutical and international consumer medicines business. The Nutritionals segment consists of Mead Johnson Nutritionals (Mead Johnson), primarily an infant formula and children’s nutritionals business. In January 2008, the Company completed the divestiture of Bristol-Myers Squibb Medical Imaging (Medical Imaging) to Avista Capital Partners L.P. In June 2008, BMS acquired Kosan Biosciences, Inc., a developer of oncology products. In August 2008, the Company completed the divestiture of its ConvaTec business to Cidron Healthcare Limited, an affiliate of Nordic Capital Fund VII and Avista. In December 2008, BMS completed the sale of its brand business in Egypt to GlaxoSmithKline.

Filter 1: Recent Insider Buying

Sigal Elliot EVP, CSO & President R&D Huet Jean-Marc EVP & CFO

Filter 1 Conclusion

Strong insider buying by key roles in the company- very positive signs.

Filter 2: Graham Fundamentals

Filter 2 Conclusion

Strong on main Graham valuations, EPS Growth Rate is weak meaning they have underperformed in their ability to generate growing earnings over the last 5 years. Compared to the sector that is achieving 5.22% they are not performing well. Price to book is also inflated meaning we are paying a premium for the value of the company. In comparison to its competition in the sector that is 2.11 they are overpriced.

Filter 3: Sustainable Competitive Advantage

Patents are the main area of advantage for a drug company so it is worth looking at some short hand notes about the largest drugs that Bristol carries, and when the patents expire.

Plavix

Plavix is marketed worldwide in nearly 110 countries, with sales of US$5.9 billion in 2005. It had been the 2nd top selling drug in the world for a few years as of 2007 and was still growing by over 20% in 2007. In 2006, generic clopidogrel was briefly marketed by Apotex, a Canadian generic pharmaceutical company before a court order halted further production until resolution of a patent infringement case brought by Bristol-Myers Squibb. The court ruled that Bristol-Myers Squibb's patent was valid and provided protection until November 2011. Generic clopidogrel is also produced by several pharmaceutical companies in India at significantly lower retail prices, up to 1/30th of the price. Counterfeit Plavix is in circulation, as with many popular medicines. Wikipedia Link

Abilify

The patent on aripiprazole expires on October 20, 2014; however, due to a pediatric extension, a generic will not become available until at least April 20, 2015. Barr Laboratories initiated a patent challenge under the Hatch-Waxman Act in March 2007. This challenge is still in court as of 11 December 2008. Wikipedia Link

Reyataz

Patent Expiration Sep 30, 2011 source

Sustiva

Patent Expiration Aug 7, 2012 source

Baraclude

Patent Expiration Feb 21, 2015 source

Filter 3 Conclusion

Diverse solid products. As with many drug companies they sell their product at a premium and once patents expire generics are quick to rush in. 2011 a number of these patents expire so there will likely be an infusion of R&D over the next few years to get new products to the market place to replace older ones.

Filter 4: Able and Trustworthy Managers

James M. Cornelius: Chairman of the Board, Chief Executive Officer

“We’ve recast our business portfolio to focus on medicines for serious disease. We’ve addressed our cost structures to be a leaner, stronger, more effective company, and we’ve accelerated innovation through our string of pearls business development execution” … “we continue to make headway against our goal of improving our gross margins, pre-tax margins, and net income margins, and again in the quarter, we saw improvement in all three.” source

Lamberto Andreotti : President, Chief Operating Officer, Director

“We are retaining the scope and resources of a traditional pharmaceutical company and adopting the agility of a biotech company,” says Lamberto. “We are creating an environment that puts a premium on innovation and speed. One of the biggest changes is our shift to a business model that embraces partnerships and opportunities that don’t fit within the traditional pharma model. This means we’re less focused on doing everything on our own. Instead, we’re selecting those things that we need to do ourselves, and doing them better and differently. In the process, we’re accelerating the things that make us very competitive in this changed environment.” source

Jean-Marc Huet : Chief Financial Officer, Executive Vice President

“We had broad-based growth in the first quarter across the entire portfolio driven by Plavix, Abilify, our virology business, as well as our newer products.” source

Filter 4 Conclusion

It is tough to get a sense of the management at this point. They do appear to understand the investor/management relationship and do seem to understand how to set a strong corporate direction. Are they trustworthy- hard to say at this point.

Final conclusions- what are your thoughts?

The writer of this article currently holds no positions in BMY

I have had a bit of a chance to catch up on some reading recently, one of the books I read through was Garrett Gunderson’s Killing Sacred Cows: Overcoming the Financial Myths That Are Destroying Your Prosperity. In Gunderson’s book he suggests individuals look at investing in the same way that banks. As Gunderson puts it banks mitigate investment risk in personal loans by doing the following:

• Check your credit.
• Secure their investments with collateral
• Require a down payment
• Determine the interest rate
• Determine the payment
• Determine the time period for each investment
• Verify your work history and income
• Have an exit strategy that allows them to be profitable, or to at least return their initial capital, in almost any scenario imaginable.
• Transfer their risks to the borrower in any way possible.

The goal then from the bank is to remove risk, and securing the loan all by investing in the individual, knowing that individual, and creating firewalls to secure the investment.

This looks very similar to Benjamin Graham’s discussion in the first chapter of his Intelligent Investor where Graham talks of the differences between investing and speculating:

 

"An investment operation is one which, upon thorough analysis promises safety of principal and an adequate return. Operations not meeting these requirements are speculative."

P. 18, Benjamin Graham’s The Intelligent Investor.

 

In thinking about the current financial crisis it seems to me that what really lead to our current predicament is that banks stopped investing and started speculating. They lost track of what they were so good at and started making decisions based on limited information and partial data.

Let’s look at the list again and reflect on the what banks have actually done over the last few years:

• Check your credit.
  No limited credit checks were preformed and massive overstating of income occurred.
   
• Secure their investments with collateral.
  No, sometime collateral was not required at all.
   
• Require a down payment.
  No, sometimes another loan was made to create the down payment.
  
  
  
• Determine the interest rate.
  No, some loans had interest rates that were set and then reset later so the consumer or lender never really knew what the rate was going to be.
   
• Verify your work history and income.
  No, not at all.
   
• Have an exit strategy that allows them to be profitable, or to at least return their initial capital, in almost any scenario imaginable.
  Obviously not.
   
• Transfer their risks to the borrower in any way possible.
  Laughably no.

This lead to the crisis, now we are in essentially a credit freeze where gaining access to funds is difficult if not impossible. I would argue that it is not because banks are fearful to loan money, they simply do not have the tools they once had to assess the safety of the investments. Those tools were thrown out piece by piece over the last few years and installing them back again, or creating a new set of tools is difficult.
Understand, the industry went through a massive change to get to where it currently is and that getting back to what it was so efficient at in the past does not happen overnight.

Disclosure: No Positions