Bruce Berkowitz of the Fairholme Fund has had outstanding returns since the inception of his Fund in 1999. In his most recent semi-annual letter, he penned, “At this time, healthcare and defense remain significant sectors for the Fund. We believe many companies in these sectors are undervalued as they offer essential services and products, have few if any substitutes and have strong cash flows. What’s more, their margins are high enough to assure a steady stream of profits but not so high as to draw in competitors. We believe they are in the sweet spot.” Fairholme has an uncanny ability to think outside the box and runs a concentrated portfolio. In that letter, the Fund showed a whopping 14.3% position in Pfizer (PFE, Financial). Why would Berkowitz make such an outsized bet?
Company Description
PFE is the largest drug company in the world, with revenues near $50 billion. Some of the products in their portfolio include the cholesterol drug, Lipitor (25% of their revenues); the arthritis pain reliever, Celebrex; and the erectile dysfunctional drug, Viagra.
Earlier this year, PFE announced that they were going to buy Wyeth and the transaction should close in short order – recently, the S&P 500 replaced Wyeth with First Solar, citing the merger closing. Why is PFE buying Wyeth? As Lipitor represents 25% of their revenues and with the patent expiring in 2011, PFE needs to replace this loss. Wyeth brings a host of strong biological products that do not face patent issues that typical drugs face. With Wyeth, Lipitor will represent 13% of PFE. Furthermore, PFE has been a successful integrator of companies and they should garner savings from cost cutting with the merger.
Generally, it takes ten to fifteen years and approximately 800 million dollars to develop a drug. PFE with its deep pockets can afford to take the risks associated with such research while smaller competitors can be devastated if one of the drugs in development is not successful. There are over 100 drugs in their pipeline including Sutent for cancer and many oncology drugs.
In addition to a robust pipeline, PFE has one of the best marketing operations in the business. This is essential to convince doctors, health organizations and Medicare to prescribe their drugs versus the competition.
Valuation and Conclusion
With the stock currently trading around 16, PFE has a market capitalization of $109 billion. Pro-forma, PFE should generate $70 billion in revenues as well as $15 billion in free cash flow. While PFE will cuts its dividend by 50% to finance the WYE transaction, the dividend will still be 4%, very healthy and stable. Furthermore, while the debt load increases to $50 billion after the acquisition, PFE is one of eight companies to have a AAA rating from S&P. PFE is a successful company that has low cost of capital and generates a lot of free cash flow. Actually PFE has averaged over 22% free cash flow margins for the last five years, resulting in over $10 billion in free cash flow for each of those years. In addition, the company has a strong 12.4% earnings yield and a wide moat around its business. Last but not least, PFE has a very high return on invested capital – having a five year average of 41%.
While there are certainly headline risks – healthcare reform, etc – as well as merger integration risks, PFE will benefit from the long term trends of an aging population.
Company Description
PFE is the largest drug company in the world, with revenues near $50 billion. Some of the products in their portfolio include the cholesterol drug, Lipitor (25% of their revenues); the arthritis pain reliever, Celebrex; and the erectile dysfunctional drug, Viagra.
Earlier this year, PFE announced that they were going to buy Wyeth and the transaction should close in short order – recently, the S&P 500 replaced Wyeth with First Solar, citing the merger closing. Why is PFE buying Wyeth? As Lipitor represents 25% of their revenues and with the patent expiring in 2011, PFE needs to replace this loss. Wyeth brings a host of strong biological products that do not face patent issues that typical drugs face. With Wyeth, Lipitor will represent 13% of PFE. Furthermore, PFE has been a successful integrator of companies and they should garner savings from cost cutting with the merger.
Generally, it takes ten to fifteen years and approximately 800 million dollars to develop a drug. PFE with its deep pockets can afford to take the risks associated with such research while smaller competitors can be devastated if one of the drugs in development is not successful. There are over 100 drugs in their pipeline including Sutent for cancer and many oncology drugs.
In addition to a robust pipeline, PFE has one of the best marketing operations in the business. This is essential to convince doctors, health organizations and Medicare to prescribe their drugs versus the competition.
Valuation and Conclusion
With the stock currently trading around 16, PFE has a market capitalization of $109 billion. Pro-forma, PFE should generate $70 billion in revenues as well as $15 billion in free cash flow. While PFE will cuts its dividend by 50% to finance the WYE transaction, the dividend will still be 4%, very healthy and stable. Furthermore, while the debt load increases to $50 billion after the acquisition, PFE is one of eight companies to have a AAA rating from S&P. PFE is a successful company that has low cost of capital and generates a lot of free cash flow. Actually PFE has averaged over 22% free cash flow margins for the last five years, resulting in over $10 billion in free cash flow for each of those years. In addition, the company has a strong 12.4% earnings yield and a wide moat around its business. Last but not least, PFE has a very high return on invested capital – having a five year average of 41%.
While there are certainly headline risks – healthcare reform, etc – as well as merger integration risks, PFE will benefit from the long term trends of an aging population.
