Allergan PLC Valuation Jack Carroll, Richard Papaianache, and Luke Mause

11/19/2015

Table of Contents Unit 1: Company, Industry and Competitors............................................................................................... 3

Executive Summary .......................................................................................................................... 6

Business Description ........................................................................................................................ 9

Acquisitions-Divestitures ............................................................................................................... 10

Expansion/Contraction Announcements ....................................................................................... 13

New Products ................................................................................................................................ 14

Lawsuits ......................................................................................................................................... 15

Events ............................................................................................................................................. 17

Major Products .............................................................................................................................. 20

Competitors ................................................................................................................................... 21

Leadership ...................................................................................................................................... 25

Share Ownership and Compensation Plans ................................................................................... 30

The Future ...................................................................................................................................... 34

Analyst Forecasting ........................................................................................................................ 37

Unit 2: Financial Performance Analysis ..................................................................................................... 41

Executive Summary ........................................................................................................................ 44

Stock Price Performance ................................................................................................................ 46

Absolute Performance ................................................................................................................... 49

Growth Performance ..................................................................................................................... 50

Financial Performance ................................................................................................................... 52

Altman Z-Score ............................................................................................................................... 54

DuPont Analysis ............................................................................................................................. 55

Unit 3: Cost of Capital, Capital Structure Analysis and Distributions……………………………………………………56

Executive Summary ........................................................................................................................ 59

Debt................................................................................................................................................ 60

Equity ............................................................................................................................................. 63

Cost of Capital ................................................................................................................................ 65

Unit 4: Financial Statement Forecasts ....................................................................................................... 67

Executive Summary ........................................................................................................................ 70

Assumptions ................................................................................................................................... 71

Forecast Projections....................................................................................................................... 73

Altman Z-Score ............................................................................................................................... 83

DuPont Analysis ............................................................................................................................. 85

Unit 5: Cash Flow Valuation ....................................................................................................................... 86

Executive Summary ........................................................................................................................ 89

Adjusted Present Value Model ...................................................................................................... 90

Entity Valuation Model .................................................................................................................. 92

Free Cash Flow to Equity Model .................................................................................................... 95

Unit 6: Multiples Valuation Analysis ......................................................................................................... 97

Executive Summary ...................................................................................................................... 100

Multiples Comparison and Implied Valuations ............................................................................ 101

Unit 7: Summary and Conclusions ........................................................................................................... 104

Executive Summary ...................................................................................................................... 107

Summary and Conclusions ........................................................................................................... 108

Works Cited .............................................................................................................................................. 111

Appendix ................................................................................................................................................... 113

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Unit 1 Table of Contents Executive Summary ...................................................................................................................................... 6

Business Description .................................................................................................................................... 9

Acquisitions-Divestitures ........................................................................................................................... 10

Expansion/Contraction Announcements .................................................................................................. 13

New Products ............................................................................................................................................ 14

Lawsuits ...................................................................................................................................................... 15

Events ......................................................................................................................................................... 17

Major Products ........................................................................................................................................... 20

Competitors ................................................................................................................................................ 21

Leadership .................................................................................................................................................. 25

Share Ownership and Compensation Plans .............................................................................................. 30

The Future................................................................................................................................................... 34

Analyst Forecasting .................................................................................................................................... 37

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Executive Summary Current Situation In 2015 Allergan merged with Actavis (formerly Watson) and named the conglomerate Allergan. The deal itself was valued at $70.5 billion and created the world’s tenth largest pharmaceutical company by sales revenue. This acquisition resulted in an increase in stock price because Allergan was bought at a premium. Sales are estimated to increase 64% from $13 billion to $21.5 billion for 2016. Competitors

The word cloud above depicts each of Allergan’s competitors in respect to its market capitalization. Allergan’s competitors (by market cap) are Johnson & Johnson (261.4 billion), Pfizer (204.5 billion), Procter & Gamble (188.3 billion), Gilead Sciences (162.9 billion), Merck & Co. (150.8 billion), Amgen (115.3 billion), Bristol-Myers (100.2 billion), Celgine (98.3 billion), AbbVie (98 billion), Eli & Co. (92 billion), Abbott Laboratories (65.2 billion), Regeneron Pharmaceuticals

(55 billion). For reference, Allergan’s market capitalization is 117.1 billion. Products and Services Allergan specializes in developing and commercializing innovative pharmaceuticals, biologics, medical devices and over-the-counter products. Generic products, which used to account for 35% of Allergan’s business, were divested in 2015 to competitor Teva Pharmaceuticals. This gives Allergan the opportunity to focus on its more profitable Brand products which address unmet medical needs in key therapeutic categories.

Corporate Objectives

x To continue to innovate in the pharmaceutical market with $30 billion at its disposal.

x Continue to market high quantities of Botox and Restasis to maintain its current market share (the majority market share).

x Streamline SG&A while continuing to focus on revenue growth opportunities (allergan.com).

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The Market

Currently, the global pharmaceutical market is valued at $980.1 billion dollars. The pharmaceutical market grew 2.38% in sales last year and is expected to grow at a constant 4.8% for the next five years until 2020. The U.S. is currently 44.5% of the global pharmaceutical market. The market is led by Johnson & Johnson ($261.4 billion market capitalization), Pfizer ($204.6 billion market capitalization), and Procter & Gamble ($188.4 billion market capitalization). Allergan’s market capitalization is the smallest of those competitors with $73.9 billion. Both the healthcare and pharmaceutical industries outperformed the S&P 1500 index due to new drugs and research advances.

Current Challenges Due to the wide range of competitors in the pharmaceutical industry such as Johnson & Johnson, Pfizer, and Procter & Gamble, Allergan must continually innovate and expand to remain competitive in the market. To maintain its competitive market share, Allergan must continually acquire companies and its patents/products. Allergan also must maintain a high level product safety, this is crucial in a company that provides medical products because one batch of hazardous products can result in losses, lawsuits, and an overall decrease in trust for the company.

Corporate Control Although executive compensation drastically increased in 2014, Allergan paid out roughly half of the average executive compensation for the pharmaceutical industry in 2014. The Increase can also be attributed to a huge growth in stock price and a series of recent profitable acquisitions and divestitures.

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Business Description

Allergan is a company that is based in Dublin and is headquartered in the United

States, specifically in Parsippany, New Jersey. According to Allergan’s 10K it is a,

“multi-specialty healthcare company focused on developing and commercializing

innovative pharmaceuticals, biologics, medical devices and over-the-counter products

that enable people to live life to its full potential” (Allergan 10K). Allergan is also a

pioneer in specialty pharmaceutical, biologic and medical device research &

development. It operates a diversified business model in which patients are eligible for

reimbursement and “cash pay products” that can be purchased directly by the consumer

with cash. For the fiscal year approximately “62% of our product net sales were derived

from reimbursable products and 38% of our product net sales were derived from cash

pay products” (Allergan 10K).

Allergan’s key products are focused on treating, “Alzheimer’s, chronic migraine,

depression, chronic dry eye, elevated intraocular pressure, enlarged prostate,

overactive bladder (OAB), irritable bowel syndrome (IBS), cystic fibrosis (CF), retinal

disease, post-stroke spasticity, and acne and acute bacterial infections”(reuters.com).

Allergan also created a program named the patient assistance program, which helps

provide Allergan products to patients who are not able to afford them. The company is

the leading maker of eye care, skin care, and aesthetic products, the most popular of

which being Botox.

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Acquisitions-Divestitures

In November 2014, Allergan entered in a definitive agreement with Actavis, in

which Actavis was to acquire Allergan. On March 17, 2015 that acquisition was

completed and Actavis and Allergan merged to become Allergan. This transaction was

valued at $70.5 billion and created

one of the world’s top ten

pharmaceutical companies by sales

revenue according to Actavis. Actavis

is an industry leader in research &

development and operates in more

than 60 countries worldwide according to its 10K. The U.S. is the largest commercial

market for Actavis and represents more than half of its total net revenues for the last

three years. According to the president of Actavis (now CEO of Allergan) Brent

Saunders, "The combination of Actavis and Allergan creates an exceptional global

pharmaceutical company and a leader in a new industry model – Growth Pharma,"

(Actavis.com). The combination makes it an, “industry-leading global commercial

strength, with sustainable blockbuster brand franchises in key therapeutic categories

and broad commercial reach extending across approximately 100 countries”

(Actavis.com). Saunders also states that the acquisition leads to layoffs due to the

overlapping responsibilities of some departments. This leads to increased profitability if

the company maintains increased sales.

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According to Allergan’s 10K this merger with Activis created a multitude of

benefits for Actavis (now Allergan) which includes: “a significantly expanded brand

pharmaceutical portfolio supported by a world-class sales and marketing organization,

enhanced commercial opportunities across global markets, strengthened and expanded

pharmaceutical R&D pipeline, commitment to being the partner of choice for physicians,

patients and the medical community, and strong combined global leadership team with

deep experience across the business” (Allergan 10k). The combination of these two

companies results in an ample R&D budget as well as expanded senior management

from both companies.

In March 2013, Allergan acquired MAP Pharmaceuticals Inc., a publicly held

biopharmaceutical company focused on developing and commercializing new therapies

in neurology. A major product of MAP Pharmaceuticals is Semparana, which is a self-

administered, orally inhaled therapy for the treatment of acute migraines in adults. In

December 2013, Allergan sold its obesity intervention business to Apollo Endosurgery

Inc. for as much as $110 million including $75 million cash according to

MarketWatch.com. The purchase included the products Lap-Band and Orbera; Allergan

is reporting the sale as a gain on discontinued operations.

On June 17, 2015 Allergan acquired Kythera Biopharmaceuticals for $2.1 billion,

which specializes in the making of a treatment for double chins. Brent Saunders

president and CEO of Allergan states, “The acquisition of Kythera is a strategic

investment that strengthens our leading global position in aesthetics and continues to

position us for long-term growth,” (nytimes.com). Some analysts felt that the deal was

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too expensive. Ronny Gal from Brenstein Research states, “We like the fact that

Allergan is moving forward but this deal looks a bit pricey” and he might be right due to

Kythera only having peak sales of $400 million (forbes.com). In August 2015, Allergan

acquired Oculeve, which is a company that deals with chronic dry eye. Chronic dry eye

impacts a large amount of consumers, affecting 25 million patients in the United States

(Market Scope).

On September 2015 Allergan successfully completed its Naurex acquisition.

Naurex is biopharmaceutical company developing transformative therapies for disorders

of the central nervous system. According to Allergan news, it acquired Naurex for an

upfront payment of $560 million, $460 million of which is paid upon acquisition and $100

million is payable in January of 2016. There are also additional payments that are based

on R&D success and sales-threshold payments. Brent Saunders states, “The

acquisition of Naurex enhances our ability to be among the leaders in the development

of novel, game-changing therapies in mental health” and with 7% of Americans suffering

from Major Depressive Disorder, which costs the U.S. an approximate $83 billion each

year, this could be a significant market in the coming years (allergan.com).

On September 2015 Allergan is to acquire AqueSys which is a company

specializing in Glaucoma treatment. Allergan news reports this transaction being worth,

“a $300 million dollar upfront payment and regulatory approval and commercialization

milestone payments” (allergan.com). According to Saunders, “The acquisition of

AqueSys and its XEN45 program builds on Allergan's deep and long-standing

commitment to innovation in eye care” (allergan.com). Based on the numbers, this

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seems to be a wise acquisition by Allergan. The Bright Focus Foundation’s

website estimates that 60.5 million people are living with Glaucoma worldwide and this

statistic is expected to rise to 80 million by 2020.

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Expansion/Contraction Announcements

In late July of 2015, Allergan announced that it would be selling Allergan

Generics to Teva for $40.5 billion. This was due to the fact that “emerging markets

spend more on prescription drugs and more Americans gain health coverage and look

for cheaper medicines” (forbes.com). This frees up debt and gives Allergan about $30

billion that can be allocated for future acquisitions or reinvestment in the company. As a

result of this sale Allergan is able to focus on developing its higher margin brand

products. According to Morningstar analyst Michael Waterhouse the operating margin

could reach almost 30% by 2019 (Morningstar.com).

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New Products 2013

x Seri is launched

o A surgical scaffolding for “open or laparoscopic procedures”

o “Provides immediate physical and mechanical stabilization of a tissue

defect through its strength and porous construction”

2014

x Optive Fusion launches

o Offers relief for the lipid deficient dry eye sufferer

� According to allaboutvision.com 48% of Americans “regularly

experience dry eye symptoms”

o Launch locations: Germany, Austria, Poland, Scandinavia, Turkey, and

Greece

x Ganfort launches

o Glaucoma treatment launched in China

o This came after a setback in 2013 when India’s patent appeals board

revoked Allergan’s patent for Ganfort

2015

x September:

o Allergan is granted FDA approval to launch three extended release

products similar to Mucinex

o Sales for Mucinex DM and Mucinex Maximum Strength were $67 million

and $104 million respectively

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Lawsuits

Allergan’s been involved in a number of Botox lawsuits throughout the years as

well as a dropped case with Valeant and billionaire hedge fund manager William

Ackman. “In 2010, Allergan plead guilty to charges that it misbranded Botox, and

admitted that its marketing tactics led physicians to use Botox for unapproved uses

such as headaches, pain and cerebral palsy in children from 2000 to 2005. Allergan

agreed to pay penalties of $600 million” (yourlawyer.com). These lawsuits can be

detrimental to Allergan and potentially hurt Allergan’s reputation, which in turn, deters

potential investors.

In 2010, Allergan paid $15 million to an Oklahoma City Doctor who suffered from

botulism poisoning after using Botox. Later that year, Allergan agreed to settle a

wrongful death lawsuit filed on behalf of a 70 year old woman who died in 2008 from

Botox use. According to Bloomberg Business News, “Allergan Inc. was ordered by a

Virginia jury to pay $212 million to a 67-year-old man Douglas M. Ray who said he got

permanent brain damage after being injected with Botox to treat cramps and tremors in

his hand in 2007” (Bloomberg.com). Douglas M. Ray was left disabled, however

Allergan denied that there was any connection between the botox injection and Mr. Ray

becoming disabled.

In April of 2015 a woman from Burlington, VT sued Allergan for her parent’s

death, allegedly being caused by the treatment of cerebral palsy with botox. According

to cbsnews.com, the litigation is still pending and Vermont precedent is not on

Allergan’s side. In another Vermont case, a Vermont jury awarded Joshua Drake’s

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parents $6.75 million after their son developed epilepsy following Botox injections for his

cerebral palsy. While Botox is one of Allergan’s most profitable product categories, it

can clearly cause problems due to the amount of lawsuits arising from it.

Earlier this year, “Allergan accused the pair of Valeant and William Ackman for

insider trading. Mr. Ackman’s Pershing Square Capital Management LP and Valeant are

withdrawing claims that Allergan made false statements about Valeant’s business

model, according to people familiar with the matter” (wsj.com). Which was then further

reviewed by the SEC. Neither party admitted fault and each company paid its own legal

costs.

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Events

On October 2014 is was reported that Allergan paid $24 million to doctors and

hospitals for five months in 2013 to cover consulting and speaking fees, grants, meals,

and travel expenses. This was the second highest amount paid to medical providers in

drug and medical device manufacturers that reside in California. In 2014 CFO of

Allergan, Jeff Edwards, resigned to spend more time with his family. His replacement is

Jim Hindman, former senior vice president for treasury, risk, and investor relations.

Investors took no concern over the matter but wondered why it was during an attempted

acquisition by Valeant Pharmaceuticals.

According to prnewswire.com, Allergan entered into an agreement with Teva

Pharmaceutical Industries who will, “acquire Allergan's global generic pharmaceuticals

business for $40.5 billion. Allergan received $33.75 billion in cash and $6.75 billion in

Teva stock. In addition, Allergan retains 50 percent of Teva's future economics from

generic lenalidomide (Revlimid®)”. According to the CEO of Allergan, the agreement,

“will accelerate Allergan's evolution into a branded Growth Pharma leader, enable a

sharpened focus on expanding and enhancing our global branded pharmaceutical

business” (Saunders). Allergan announced that a portion of the extra cash, yet to be

determined, is being used to pay down debt.

On October 29, 2015 Allergan and Pfizer began talks on a possible merger

between the two pharmaceutical companies. The merger seems pretty likely according

to an article posted in November 2015. The main reason Pfizer is considering this

purchase is because of the current tax codes in the United States. Allergan conducts

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part of its business abroad at its international office in Dublin, Ireland and the lower tax

rate could be advantageous to Pfizer. “Pfizer Chief Executive Ian Read said the

company is at a ‘tremendous disadvantage’ under the U.S. corporate tax code and

added Pfizer is competing against foreign companies ‘with one hand tied behind our

back” (WSJ.com).

According to an article on Forbes.com, the corporate tax rate in Ireland is 12.5%

while the federal rate here in the United States is 35%. Building off the preference for

lower taxes the Wall Street Journal reported that, “if a deal were to be struck, it would

add anti-wrinkle treatment Botox, dry-eye treatment Restasis and other popular Allergan

drugs to Pfizer’s arsenal of patent-protected medicines” (WSJ.com). There is one big

obstacle that is involved in this deal as well. The obstacle is the agreed price. To further

contribute to this problem, Pfizer questions Allergan’s true value during the transactional

period. The Wall Street Journal goes on to say that, “Other issues could include the

extent to which Pfizer would want to lay off employees and close facilities; the fate of

Allergan CEO Brent Saunders; and the general makeup of a combined company’s

management team” (WSJ.com). This deal would be the largest transaction of the year.

The Wall Street Journal claims, “Pfizer’s market value is about $216 billion. If a deal is

struck, it would easily surpass Anheuser-Busch InBev’s $104 billion preliminary

agreement to buy giant beer rival SABMiller PLC, which currently ranks as 2015’s

largest announced deal” (WSJ.com).

Furthering the Valeant Pharmaceuticals conflict, on November 12, 2015, Brent

Saunders was asked if he was interested in acquiring Valeant after its stock fell from a

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series of bad news, particularly over inflated drug prices. Citron Research also

compared Valeant to Enron in this situation. This was after the fact that Valeant made a

hostile takeover bid of Allergan, which didn’t go through and led to an investigation by

the SEC of Valeant due to rumors of insider trading. The hostile takeover fell through

due to Valeant not being able to borrow enough money to acquire Allergan. Brent

Saunders stated when asked about buying Valeant, “The things we look to buy are

really first-in-class drugs, growth assets… there are a few of those in Valeant but there

are also a lot of older medicines. It does not fit perfectly with the business model and

the types of things we’ve been buying” (biospace.com).

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Major Products

According to Allergan’s website, its two major product categories are “brand” and

“generic” products. The Allergan Brand portfolio delivers treatments that address

significant unmet medical needs in key therapeutic categories” (allergan.com). Within

those categories its products can be split into specialty pharmaceuticals and medical

devices. In 2014 specialty pharmaceuticals accounted for 85.06% of total revenues and

medical devices accounted for the other 14.94% (csimarket.com). The top performing

pharmaceutical categories are eye care pharmaceuticals and Botox/neuromuscular

drugs accounting for roughly 47% and 31% of total revenues respectively. Botox

dominates the neuromodulator market with 76% of the market share according to

Morningstar.com.

R&D is by far the largest single SG&A expense, accounting for 27.3% of

Allergan’s total SG&A expense on its 2014 income statement. Valeant and Teva’s R&D

as a percentage of SG&A were 10.8% and 22.7% in 2014 respectively. In comparison

to these similar pharmaceutical companies, Allergan’s SG&A expense is high. In

addition, Allergan’s SG&A expense increased an annual average of 82.8% from 2010 to

2014.

According to the Wall Street Journal, Allergan’s recent deal with Teva “provides it

with cash to pay down debt and allows the company to focus more on lucrative brand-

name drugs” (WSJ.com). As a result Allergan is reducing its 40 manufacturing facilities

to a lean 12 plants focused on high growth branded drugs.

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Competitors

Currently, the global pharmaceutical market

is valued at $980.1 billion dollars. The word

cloud (left) depicts each of Allergan’s

competitors in respect to its market

capitalization and as one can see, J&J and

Pfizer are the biggest competitors in the

market. Compared to last year the

pharmaceutical market increased 2.38%. The U.S. is currently 44.5% of the global

pharmaceutical market. According to Mergent Online, Allergan’s competitors (by

market cap) are Johnson & Johnson (261.4 billion), Pfizer (204.5 billion), Procter &

Gamble (188.3 billion), Gilead Sciences (162.9 billion), Merck & Co. (150.8 billion),

Amgen (115.3 billion), Bristol-Myers (100.2 billion), Celgine (98.3 billion), AbbVie (98

billion), Eli & Co. (92 billion), Abbott Laboratories (65.2 billion), Regeneron

Pharmaceuticals (55 billion). For reference, Allergan’s market capitalization is 117.1

billion.

Leaders of Competition

The dominant competitor in the pharmaceutical preparation manufacturing

industry in the U.S. is Johnson & Johnson (J&J). J&J is headquartered in New

Brunswick, New Jersey and was founded in 1886. J&J is the, “world's sixth-largest

consumer health company, contains the most comprehensive medical devices

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business, acknowledged as the sixth-largest biologics company, and is known as the

fifth-largest pharmaceuticals company in the world” (jnj.com). These are amazing

accomplishments for a company to acquire.

J&J’s most popular consumer products in

the company are, “Band-aid bandages,

Johnson baby products, Acuvue contact

lenses, Neutrogena skin care products,

Clean & Clear face wash, and Tylenol

medications”, and all are known as being high quality products (pharmainfo.net). J&J

also generates yearly revenues of $65 billion and in 2014 and beat out every competitor

in this regard. The known products, exceptional services, great quality, and sheer size

of this company makes it deserving of being number one in the pharmaceutical industry.

Pfizer is on its way to becoming number one in the

pharmaceutical industry, if the merger between Pfizer

and Allergan becomes complete. Pfizer specializes in

developing and manufacturing drugs and vaccines

for oncology, immunology, cardiac ailments, endocrinology, neurology, and many more;

totalling over 100 currently sold products. Pfizer is dedicated to corporate social

responsibility and states that it really cares about the world and the people in it. Pfizer is

not far behind J&J in annual revenue with $59 billion in 2014 and the anticipated merger

with Allergan would increase this number to almost $80 billion in 2015.

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Procter & Gamble, which was founded in 1905, is one of

the biggest providers of consumer packaged goods. Its

products are sold in over 180 countries and possesses an

amazing amount of globally recognized brands such as

Tide, Bounty, and Crest. The company operates primarily in five segments which are:

beauty, grooming, health care, home care, and family care. P&G averages over $80

billion in yearly sales. In the healthcare segment the company holds approximately a

20% global market share and is a huge competitor to Allergan.

Abbott Laboratories is headquartered in Illinois and was

founded in 1888. The company develops medical tests

that are used for diagnosing and monitoring health

conditions and operates in more than 130 countries.

Abbott is also accredited with developing the first HIV

blood-screening test in 1985. Abbott’s annual revenues

measure around $40 billion.

Celgene Corporation is a competitor of Allergan,

headquartered in New Jersey, and founded in 1986.

The company focuses on manufacturing innovative

medicines for cancer, autoimmune, and other

inflammatory disorders. Its mission is to deliver life-

changing medicine therapies for patients worldwide. Its

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annual revenue is estimated to be almost $84 billion.

Eli Lilly is headquartered in Indianapolis and came into

being in 1876. Eli is the largest pharmaceutical company

in terms of developing and distributing psychiatric

medication. The company widely known for its polio vaccine, penicillin, and insulin. It

operate in 125 countries and generate an annual revenue of around $17 billion.

Merck & Company is a

pharmaceutical company

headquartered in New Jersey and

was founded in the year of 1917. According to Yahoo, “Merck & Co serves drug

wholesalers and retailers, hospitals, government entities and agencies, physicians,

physician distributors, veterinarians, distributors, animal producers, and managed health

care providers” (yahoo.com). The company focuses on developing new therapies to

prevent disease. Merck & Co’s average annualized revenue is $44 billion.

Headquartered in Foster City, California

and founded in 1987, Gilead is a

biopharmaceutical company that

discovers, develops, and

commercializes medicines in unmet medical needs throughout the world. The primary

focus is on developing antiviral drugs for treating patients infected with hepatitis B,

influenza, cancer, and HIV. Its annual revenue for 2014 was $7.75 billion.

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Leadership

Paul Bisaro is the Executive Chairman of Allergan. He

possesses a strong background in pharmaceuticals, serving

as CEO of Actavis for 7 years and working under various

different capacities at Barr Pharmaceuticals for 15 years. He

became executive chairman in October 2013

(allergan.com).

The CEO and President of Allergan, Brenton Saunders,

also holds extensive experience in pharmaceuticals as well

as facilitating large mergers between pharmaceutical

companies. (allergan.com) Before working in

pharmaceuticals Mr. Saunders worked in the healthcare

industry in both compliance and risk.

“Bob Stewart is the President, Generics, and Global

Operations of Allergan. Previously, Mr. Stewart served as

Chief Operating Officer of Actavis since July 2014 and

President, Global Operations and Executive Vice President,

Global Operations, since August 2010.

26

“Paul Navarre is the president of international brands.

Prior to assuming his current role, Mr. Navarre most recently

served as Corporate Vice President & President, Europe,

Africa and Middle East (EAME) of Allergan since July 2013.

Previously, Mr. Navarre held various leadership positions at

Allergan including Vice President, Neurosciences EAME and

Vice President, Ophthalmology EAME.

“Mr. Meury joined Actavis in July 2014 as Executive Vice

President, Commercial, North American Brands. Prior to

joining Actavis, he served as Executive Vice President,

Sales and Marketing, Forest Laboratories, Inc. He joined

Forest in 1993 and held positions in Marketing, New

Products, Business Development, and Sales. Most recently,

as Executive Vice President, Sales and Marketing” (Allergan.com).

“Previously, Mr. Schaison served as Corporate Vice

President and President of U.S. Medical of Allergan since

September 2013. Before joining Allergan, Mr. Schaison held

various leadership positions at Clarins. (Allergan.com)

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“Dr. Nicholson joined Actavis as Senior Vice President,

Global Brands R&D in August 2014. Previously, he served

as Chief Technology Officer and EVP, R&D for Bayer

CropScience from March 2012 to August 2014; Vice

President of Licensing and Knowledge Management at

Merck from 2009 to December 2011; and Senior Vice

President, responsible for Global Project Management and

Drug Safety at Schering-Plough from 2007 to 2009 (Allergan.com).

“Ms. Hilado was appointed Actavis’ CFO on December 8,

2014. Prior to joining Actavis, Ms. Hilado served as Senior

Vice President, Finance and Treasurer for PepsiCo, Inc.

since 2009. Before joining PepsiCo, she previously served

as Vice President and Treasurer for Schering-Plough

Corporation from 2008 to 2009. (Allergan.com)

“Previously, Mr. Bailey served as Senior Vice President,

Chief Legal Officer, General Counsel and Corporate

Secretary of Forest Laboratories, Inc. He previously served

from 2007 to 2013 as Executive Vice President, Law,

Policy and Communications at Bausch + Lomb.

(Allergan.com)

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“Prior to joining Actavis, Ms. Ling served as Senior Vice

President and Chief Human Resources Officer for Forest

Laboratories, Inc. Ms. Ling joined Forest in January 2014

from Merck & Co., Inc., where she served as Senior Vice

President, Human Resources, for the company’s Global

Human Health and Consumer Care businesses worldwide.

(Allergan.com).

“Prior to joining Actavis, Mr. Kellerman spent 20 years

with PricewaterhouseCoopers LLP (PwC) in leadership

roles of increasing responsibility, most recently 10 years as

Partner in the company’s Pharmaceutical & Life Sciences

Advisory practice. Mr. Kellerman was responsible for

helping lead the firm’s Governance, Risk & Compliance

practice. (Allergan.com).

“Previously, Mr. Kirk served as Actavis’ Senior Vice

President, Corporate Business Development since May

2012. He joined Actavis (then Watson) in 2009 as Vice

President, Integration. Before joining Watson, Mr. Kirk

served as Senior Vice President, Global Controller and

Chief Accounting Officer for Barr Pharmaceuticals, Inc.,

which was subsequently acquired by Teva

Pharmaceuticals. (Allergan.com)

29

“Officer since July 1, 2014. In this role, he led the

integration of Forest Laboratories following its acquisition

by Actavis. He also co-led the integration of Allergan. Prior

to joining Actavis, Mr. Kelly was Senior Vice President,

Chief Communications Officer, Public Affairs and Investor

Relations at Forest Laboratories (Allergan.com).

Sanjiv Patek was appointed Chief Strategy Officer

effective March 17, 2015

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Share Ownership and Compensation Plans

For the past 5

years, restricted

stock awards

accounted for a

large part of the

total executive

compensation. In 2014 of the total 131.5M payed out in executive compensation, 88.3M

of it was restricted stock award.

Paul M. Bisaro, Executive Chairman (Insider)

Bisaro was involved with the following companies: Zimmer Biomet Holdings, Inc.,

Allergan Plc, Zoetis, and Inc. Bisaro. In 2014 Bisaro was compensated $35M, which

consists of a $1M salary, a $2.7M bonus, $25M in stock awards, and $6.4M in option

awards. This was a major increase from 2013’s compensation which was $11.3M. The

major difference was due to the major increase in stock awards & call options.

Brenton L. Saunders, President, Chief Executive Office and Director (Insider)

Saunders was involved with the following organizations: Overlook Hospital

Foundation, Pharmaceutical Research & Manufacturers of America, University of

Pittsburgh, Bausch & Lomb Holdings, Inc., and Allergan Plc. Saunders previously

served as CEO and president of Forest in 2011 and became CEO of Allergan in 2014.

Saunders in 2014 was compensated $36M, which consists of a $.5M salary, a $1.5M

bonus, $26M in stock awards, and $8.5M in option awards.

31

Ms. Maria Teresa CFO, Executive Vice President (Insider)

Corporate affiliations include Pepsico, Actavis, Allergan, Merch Sharp,

and Dohme Pharma. Teresa joined Allergan in 2014 from Pepsico where she served

as Senior Vice President. In 2014 was compensated $10.1M, which consists of a

$30,000 salary,$8.7 M in stock awards, and $1.4M in option awards.

Mr. Robert A. Stewart, Chief Operating Officer, Executive Vice President (Insider)

Stewart joined Allergan in 2009 where he started as Senior Vice President of

Global Operations and moved his way into the position that he is today. Stewart in 2014

was compensated $12.6M, which consists of a $.7M salary, $8.4M in stock awards, and

$2.1M in option awards. This was a major increase from 2013’s compensation which

was $5.2M. The major difference was due to the major increase in stock awards &

change in title.

Board of Directors

The Board of Directors consists of twelve individuals and their past and present

affiliations: Paul Bisaro (Chairman Of Board) (Insider), Brenton Saunders(CEO)

(Insider), Fred Weiss (Outsider), Christopher Bodine (Outsider) ,Catherine Klema

(Outsider), Ronald Taylor, James Bloem (Outsider), Nesli Basgoz (Outsider),

Christopher Coughlin (Outsider), Michael Gallagher (Director) (Insider), Peter

McDonnell (Director) (Insider), Patrick Sullivan (Outsider). The board of directors

primarily consist of outsiders, which creates benefits and negatives. The benefit is that

there is an outside eye in looking at the company which can help the company generate

new ideas, and the board are not incentivized to lie or to change company policies that

32

may benefit them. The negative is that they might not be as incentivized as insiders are

due to share compensation plans and the possibility of being fired if the company does

not perform well.

Insider and Institutional Share Ownership

Paul Bisaro holds an ownership of 421,755 shares and recently engaged in

buying and selling shares, but mostly buying. Brenton Saunders holds an ownership of

125,275 shares and recently engaged in buying & selling shares, but mostly selling.

Michael Gallagher possesses over a 5% ownership holding 1,858 shares and recently

bought shares. Peter Mcdonnell maintains 5% ownership holding 2,891 shares and

recently bought shares as well. In terms of the activity of all insider trading the chart

below summarizes it for 2014-2015.

In terms of overall ownership, 89.87% is owned by institutions, 45.24% is owned

by funds and .17% is owned by insiders as shown in the graph below in millions of

dollars.

Allergan’s market share is only $103,691M and the numbers don't add up in

terms of dollars and percentages. This is because institutional funds are not mutually

exclusive, so total percentage owned may exceed 100% (morningstar.com). In the

33

graph below it is clear that the number of shares owned by institutional investors

increased dramatically. This shows that the company is growing and needs more equity

to fund that growth. Institutions and funds are funding that growth.

Compared to PFE, TEVA, & JNJ, AGN’s percentage of equity earned in each of the

three categories is greater than its comparables. This signals that the three categories

overlap each other significantly in AGN.

Looking at whether the comparables JNJ, TEVA, and PFE insiders are buying,

selling, or holding, PFE’s insiders increased their positions in PFE stock. PFE’s board of

directors is made up mostly of outsiders. TEVA’s board consists of mostly insiders;

however, none of TEVA’s equity ownership is owned by the insiders.

34

The Future

Financial Analysis

Over the past fiscal year, Allergan became more prevalent among investors and

analysts. Multiple sources including the Wall Street Journal, MarketWatch, and Yahoo!

Finance, are estimating quarterly earnings per share to be $4.30. This is very similar to

last quarter’s earnings per share and if this trend continues, the annual amount is

forecasted to

total $18.00.

Estimated sales

for the current

quarter are $5.7

billion with

estimated sales

for the following

quarter to be

$5.9 billion. The estimates for sales of the current year is $21.5 billion, up 64% from last

years sales of about $13 billion. The following graph, courtesy of Capital Cube, depicts

Allergan’s revenue history over the past five quarters, comparing the value to the peer,

or competitor(s) median:

35

Allergan stock

is a strong buy right

now. On MarketWatch

and the Wall Street

Journal, 18 out of 21

analysts recommended buying Allergan stock right now. All of the analysts for Yahoo!

Finance recommend buying with some even saying to strongly buy. Even for the past

three months, analysts’ buy rating is unchanged. This can be illustrated by the following

graph provided by MarketWatch:

Allergan’s earnings per share increased every quarter since 2014. Current

earnings per share are up by 8% since Q2 2014. Allergan met its EPS forecast goals

which increases confidence and trust for the public. Brenton Saunders, CEO and

President of Allergan exclaimed that, “Allergan delivered exceptional results. Our

performance was powered by operational excellence and double-digit growth across our

Brand and Global Generics business, while continuing outstanding momentum on the

integration of Actavis and Allergan. We also achieved important R&D milestones that

will help fuel both our branded and generics businesses in the future” (Monica Gerson,

Allergan Q2 Earnings Beat Estimates, benzinga.com). Allergan’s financial life wasn’t

always satisfactory though. The following chart, also from Capital Cube, demonstrates

36

the earnings history of Allergan compared to its competitors:

Although competitors are beating Allergan in total earnings, there is a positive slope

trending towards the median line. Allergan brought in more and more revenue over the

past two years, which helps the positive trend continue.

37

Analyst Forecasting

Allergan opened their doors 60 years ago. The company saw the economy dip

and rise a number of times within these 60 years. Investors want to know the future of

the company and the nature of futur. “We imagine Allergan will remain a transitional

company over the near term as management is likely already contemplating its next

strategic move. Meanwhile, recent deals for Kythera, Oculeve, Naurex, and Merck’s oral

CGRP candidates bolster the company’s aesthetic, dry-eye, anti-depressant, and CNS

franchises, respectively, and support additional long-term growth opportunities in an

already healthy pipeline” (analysisreport.morningstar.com).

Allergan is mostly growing by acquisitions. To build off these acquisitions,

Allergan creates products that generate consistent sales for the next five years. As

explained in this quote, most of its products are doing quite well, “Other than the

Lumigan, Namenda, and Asacol franchises, nearly all of Allergan’s branded products

posted double-digit growth during the quarter. We anticipate organic growth will remain

healthy, led in particular by Allergan’s ophthalmic, aesthetic, and therapeutic Botox

segments” (analysisreport.morningstar.com). This is great new for Allergan.

Analysts from Morningstar don’t expect Allergan to change its model anytime

soon since “cost synergies appear to be on track as underlying profitability in Allergan’s

segments remains stable” (morningstar.com). As mentioned before, Allergan utilized

acquisitions to grow and progress the company, which turned it into a pharmaceutical

giant. Recently, Allergan decided to sell its generics segment to Teva. Analysts expect

this to deleverage the balance sheet with ample cash to pursue more acquisitions,

38

these are not believed to be large acquisitions though. Allergan remains focused on

expanding with small acquisitions and licensing partnerships in order to expand its

branded pipeline and sales force productivity. This leads investors to believe that

Allergan is diversifying its portfolio with defensible products, a broad pipeline, and future

potential acquisitions, which sustains healthy earnings growth.

Building off Allergan's core products, “Allergan’s considerable scale in niche

markets of ophthalmology and aesthetics offers a long runway for growth thanks to

defensible products (especially Botox) and an attractive pipeline”

(analysisreport.morningstar.com). It is also worth mentioning that these dealings offer a

lower tax rate. A note about the pharmaceutical industry itself, it’s on the rise. According

to Ed Silverman of the Wall Street Journal, “global prescription drug sales appear

poised to take off and grow 4.8% annually over the next five years, reaching $987 billion

by 2020.” Silverman goes on to discuss how any fears that the pharmaceutical industry

might be heading towards a slowdown after the last two years of phenomenal growth

can be put to rest for now.

The industry growth can be partially attributed to increased R&D productivity and

a rising number of regulatory approvals. These actions are providing analysts with a

positive outlook for the industry in general. Within the pharmaceutical spectrum,

Allergan possesses an industry-leading portfolio in the specialty markets of

ophthalmology and aesthetics. These specialty markets are powerful for Allergan,

because of higher barriers to entry and lower risk of generic competition than most

pharmaceutical products.

39

Returning to Michael Waterhouse, an Equity Analyst for Morningstar, he

summarized Allergan’s management,

“We think management will mostly preserve Allergan’s historical product

innovation, which should help keep pricing and market share healthy,

supplemented by acquisitions and partnerships to enhance the portfolio and push

into new therapeutic categories. With over $30 billion in cash at its disposal

following the generic unit sale, acquisitions should eventually improve growth

opportunities and increase product diversification, which helps minimize patent

cliff concerns” (morningstar.com).

Since Allergan isn’t facing much patent danger with its most predominant products,

Botox and Restasis, sales are expected to continue to grow. Analysts increased the fair

value estimate from $330 to $370 just from the sale of the generics unit to Teva.

Forecasts indicate that Allergan is expected to exceed $14 billion in branded sales in

2016.

Michael Waterhouse also believes “the company can maintain near 11% organic

growth over the next five years thanks largely to high growth from Allergan’s legacy

products in addition to new product launches” (morningstar.com). Segment margin is

expected to remain high as the company gains salesforce productivity and refocuses

research dollars on higher return products. Including mid-single-digit growth and a

segment operating margin near 5% in the distribution segment. Also, sale of the

generics segment by early 2016 results in a company-wide operating margin reaching

nearly 30% by 2019 as cost synergies and sale of the lower margin generics unit lead to

40

margin expansion over the medium term. Overall, sales are expected to increase for the

next five years, profits to increase and become positive in three to five years, and share

price to gradually move towards $400 in six to eight years.

Unit 2 Table of Contents Executive Summary .................................................................................................................................... 44

Stock Price Performance ............................................................................................................................ 46

Absolute Performance ............................................................................................................................... 49

Growth Performance .................................................................................................................................. 50

Financial Performance ............................................................................................................................... 52

Altman Z-Score ........................................................................................................................................... 54

DuPont Analysis .......................................................................................................................................... 55

44

Executive Summary

Stock Price Performance The above graph shows Allergan’s stock price growth compared to four top competitors over five years. Compared to its peers, Allergan now boasts the highest stock price and experienced the most growth in stock price, due to an increase in new product sales during 2013 and 2014. Allergan’s annualized growth rate in stock price from 2009 to 2015 was 157.4%, compared to smaller percentage growth rates of Pfizer (14.5%), Merck (11.4%), Johnson & Johnson (9.6%), and Procter & Gamble (3.1%). Growth Performance In 2014 Allergan’s sales growth rate was 50.53% which was driven by new product sales from recent acquisitions. Allergan’s average annualized growth rate is 36.5% for the past five years. Allergan’s sector, Healthcare Products, received an annual average

of 8.97% growth rate over the past five years, while the industry growth in Pharmaceuticals received an average of -2.94% of growth over the last five years (sterns.edu). The U.S. market averages an annual 2.125% growth rate over the past five years. The average sales growth for competitors in 2014 was: Merck & Co 11.92%, P&G 1.02%, J&J 3.75%, and Bayer 2.9%. It is to be noted that Merck & Co’s sales growth rate was 70% in

2010 and due to the outlier its average growth rate is much higher than the other years.

45

Financial Performance: When looking at the five year averages Allergan’s areas of concern are its EBIT, EBITDA, Net PPE as a percentage of total assets, operating margin, ROA, ROE, and ROI. The only ratio that balances out between years is net profit margin. Allergan’s ratios are below its competitors due to its constant changing capital structure and negative net income. While this is a concerning, with a growth rate as high as Allergan's is,it is understandable.

DuPont Analysis & Altman’s Z score Looking at the DuPont analysis, Allergan’s ROE averaged -8.09% because Allergan’s net income was negative in 2014. The industry average was 18.15% and the median was 12.65%. Allergan’s asset turnover averaged -4.33%. The industry average was 6.67% and the median was 5.54%. According to the Altman z-score Analysis Allergan is safe from imminent bankruptcy. However Allergan is not necessarily in a grey zone between safety and health. However, looking at the industry median, it is likely that certain industries such as pharmaceuticals may trend toward lower z-scores. This suggests that Allergan might be within a “healthy financial situation” range when compared to other pharmaceutical companies.

46

Stock Price Performance

Allergan’s stock price started growing consistently after the recession in 2008.

Prior to that, the stock grew from $17.88 on April 1, 1997 to $65.85 on July 1, 2001. The

price then fell to $29.93 on November 1, 2001 where it hovered at the range of $21.00

to $46.00 for eight years. On January 1, 2009 Allergan’s stock price opened up at

$26.68. Since that date, its price grew to reach its record high of $340.34 on July 1,

2015 and closed at $331.15 that same day.

Since July 1, the price fell and closed at $278.58 on October 5, 2015. In that six

year span and compared to the peak, the price grew by 1175.6%, an average annual

growth rate of 195.93% since January 1, 2009. In that six year span and compared to

the current price, the price grew by 944.2%, and an average annual growth rate of

157.37%, since January 1, 2009. However, from the peak price to the current price, the

stock fell by 18.1%.

47

Comparable companies to Allergan are Pfizer Inc, Merck & Co., Inc, Johnson &

Johnson, and Procter & Gamble Co. The graph below from nasdah.com shows

Allergan’s stock price growth over five years compared to its competitors on the NYSE:

Compared to its peers, Allergan’s stock was the only one to rise consistently for

five years. On January 1, 2009 Pfizer’s stock price opened at $17.88. The price then fell

to $12.28 on February 1, 2009 but rose to its peak price of $36.46 on July 1, 2015. On

October 5 2015, Pfizer’s stock price closed at $33.48. Compared to Allergan, and

comparing current price to the opening price in 2009, Pfizer’s stock price only grew by

87.2% and contained an average annual growth rate of 14.53%. Whereas Allergan’s

stock price grew by 944.2%, and an average annual growth rate of 157.36%.

On January 1, 2009 Merck’s stock price opened at $30.46. The price then fell to

$24.20 on February 1, 2009 but rose to its peak price of $60.89 on May 1, 2015. On

48

October 5, 2015, Merck’s stock price closed at $51.23. Compared to Allergan, and

comparing current price to the opening price in 2009. Merck’s stock price only grew by

68.2%, an average annual growth rate of 11.36% whereas Allergan’s stock price grew

by 944.2%, an average annual growth rate of 157.36%.

On January 1, 2009, Johnson & Johnson’s stock price opened at $60.13. The

price then fell to $50.00 on February 1, 2009, but rose to its peak price of $108.25 on

November 1, 2014. On October 5, 2015, Johnson & Johnson’s stock price closed at

$94.76. Compared to Allergan, and comparing current price to the opening price in

2009. Johnson & Johnson’s stock price only grew by 57.6%, and the average growth

rate was 9.6%.

On January 1, 2009, Procter & Gamble’s stock price opened at $61.69. The price

then fell to $47.09 on March 1, 2009, but rose to its peak price of $91.09 on December

1, 2014. On October 5, 2015, Procter & Gamble's stock price closed at $73.22.

Compared to Allergan, and comparing current price to the opening price in 2009.

Procter & Gamble’s stock price only grew by 18.7%, an average annual growth rate of

3.12%.

Compared to these competitors, Allergan boasts the highest share price and the

highest growth percentage since January of 2009. However, Allergan’s price to earnings

ratio is the lowest among the competitors at -29.9 with Pfizer, Merck, Johnson &

Johnson, Procter & Gamble, holding price to earnings ratios of 23.5, 14.8, 16.5, and

29.7 respectively.

49

Absolute Performance

From 22 years of annual average historical stock prices, Allergan’s arithmetic

mean for percentage growth was 1.57%. This growth rate aligns with the movement of

the stock, because the price remained between a range of $20 to $50 for the first 17

years of its existence. It's occurred recently, specifically in the last three years, when the

stock price experienced its highest annual growth. This describes why the standard of

deviation is 9.3%. To be more specific the standard of deviation value is skewed

because of the recent growth of Allergan’s stock from $86.39 in January 2012 to

$331.15 in June 2015. The coefficient of variation was 5.91, meaning that the variance

is high for these coefficients.

This value is also affected by the increase in stock price over the past three

years. From the arithmetic mean, $100 would grow to $101.57 in one year based on the

average annual growth of the stock. Alternatively, the geometric mean return was

1.12%. The value is acceptable because the geometric mean must be equal to or less

than the the arithmetic mean. The geometric mean return is more useful for the

valuation of the stock because it accounts for compounding over the period of time.

Therefore, $100 would more realistically grow to $101.12 based on geometric mean

return.

50

Growth Performance

When looking at

the growth

performance,

Allergan’s top

comparables were

considered. The

industry numbers

are comprised of

fifty comparable firms. When considering the sales revenue growth rate of Allergan

compared to other companies Allergan is vastly superior. In 2014 Allergan’s growth rate

was 50.53% as compared to the average of its comparables which was -2.65% (and a

median of -5.89%). This isn’t a fluke either, Allergan’s average annualized sales growth

rate is 36.5% for the past five years. In 2014 Allergan’s competitors growth rates were:

P&G 0.58%, Merck & Co. -6.84%, J&J 6.08%, and Bayer 5.05%. The U.S. market as a

whole rose 2.4% in 2014. This year Healthcare received an average of 11% sector

growth and the average industry growth was -2.34%(newyorktimes.com).

Allergan’s sector, Healthcare Products, received an annual average of 8.97%

growth rate over the past five years, while the industry growth in Pharmaceuticals

received an average of -2.94% of growth over the last five years (sterns.edu). The U.S.

market averages an annual 2.125% growth rate over the past five years. The average

51

sales growth for competitors in 2014 was: Merck & Co 11.92%, P&G 1.02%, J&J 3.75%,

and Bayer 2.9%. It is to be noted that Merck & Co’s sales growth rate was 70% in 2010

and due to the outlier

its average growth

rate is way higher

than the other years.

Allergan is a leader in

the industry when it

comes to revenue

growth, but in the

long-term it is expected to match the industry growth rate. With Actavis merging with

Allergan in 2015, revenue growth was very high for Allergan. The upcoming merger with

Pfizer may bring sales growth down to a more sustainable rate. The previous data was

provided by Mergent Online.

52

Financial Performance

Below is the competitor/industry ratio analysis for 2014.

The current ratio shows that Allergan is similar to its competitors at a current ratio

of 1.37 an average of comparables at 1.69 and median of comparables at 1.6. Taking a

look at the EBITDA percentage margin, Allergan’s EBITDA margin is at -8.26% in 2014.

This is worrying considering that the compared to its competitors which averaged

21.91%, with a median of 20.44% that year. Gross margin percentage seems to be on

the low end compared to its competitors but nothing concerning. Inventories as a

percentage of total assets is quite low (3.95%) considering the average (10.44%) and

median (5.995%), but considering the inventory turnover (3.26) is close to the

comparable average (3.09) it seems to be fine for 2014.

The top areas of concern regarding 2014 are net current assets as a percentage

of total assets, net PPE as a percentage of total assets, net profit margin, operating

margin, ROA, ROE, and ROI. Allergan is considerably lower in each of these categories

compared to its competitors, even negative in some. While it is concerning to be low on

so many ratios, Allergan is significantly growing and its capital structure is constantly

53

changing. Not only that but its net income is negative, and its PPE rose dramatically

over the past recent years.For better comparison, these are the average annualized

numbers for the past five years:

When looking at the five year averages Allergan’s areas of concern are its EBIT,

EBITDA, net PPE as a percentage of total assets, operating margin, ROA, ROE, and

ROI. The only ratio that balances out between years is net profit margin. As said before

Allergan’s ratios are below its competitors due to its constant changing capital structure

and negative net income. While this is a concerning, with a growth rate as high as

Allergan's is, it is understandable.

54

Altman Z-Score:

The Altman z-score

for public

companies gives

Allergan a bit of a

grey area rating

somewhere in

between a “healthy

financial situation”

and imminent bankruptcy. However, Allergan might be in a better position than this

suggests. The z-score analysis only uses two equations, one for public and one for

private companies. Taking this into consideration it is likely that certain industries such

as pharmaceuticals may trend toward lower z-scores. This suggests that Allergan might

be within a “healthy financial situation” range when compared to other pharmaceutical

companies.

55

DuPont Analysis:

ROE = Profit Margin (Profit/Sales) * Total Asset Turnover (Sales/Assets) * Equity

Multiplier(Assets/Equity)

The DuPont analysis is an alternative method for measuring ROE. Using the

DuPont method, Allergan’s ROE for 2014 was -8.09%. Obviously a negative ROE is

never a good sign, however the expectation for Allergan’s massive sales growth to

continue is enough to prop up its share price until sales take off. The industry average

for 2014 was 18.15%. This shows that pharmaceuticals as an industry is able to

provide ample returns on equity compared with the S&P 500 average ROE (non

DuPont) of 13.99% in 2014. However, the median DuPont ROE of the Pharmaceutical

industry was 12.65% in 2014, which may be a better measure of an industry ROE

because there are a few companies with massive returns on equity. What really brings

down Allergan’s ROE relative to its competitors is the asset turnover which was -4.33%

in 2014. If Allergan can maintain its equity multiplier, increase its profit margin, and total

asset turnover then the DuPont ROE is expected to be very strong in the coming years.

Unit 3 Table of Contents Executive Summary .................................................................................................................................... 59

Debt ............................................................................................................................................................ 60

Equity .......................................................................................................................................................... 63

Cost of Capital ............................................................................................................................................ 65

59

Executive Summary Debt and Equity

Allergan’s capital structure is 35.5% debt and 65.5% equity, making its current debt to equity ratio 0.55. Over the past ten years, Allergan historically averages a 0.62 debt to equity ratio. This is trending toward the sector and industry averages where the debt to equity ratios are 0.5 each. Forecasts indicate that Allergan aims to follow the industry and sector trends for the next twenty years. Allergan’s target percentage for financing long-term debt of the company is 30%, with long-term equity being 70%. This target percentage allows the company to acquire other companies or sell off parts of its company. MV and BV

Allergan’s total book value of equity in 2014 was $28.3 billion while its total market value of equity in 2014 was $118.2 billion. In 2014, Allergan’s market value of equity to book value of equity was 4.17. Long term debt to equity is expected to increase from 2015 until 2025 when it becomes a constant ratio of 0.3. WACC

Allergan’s WACC is calculated out to be 7.26% with the heaviest weight coming from cost of equity which is 9.77%.

From CAPM the weighted average cost of capital can be calculated: WACC = wdebtkdebt(1 - Tax) + wequitykequity

The WACC is projected to change due to the capital restructuring of Allergan. Allergan is moving towards its target long-term debt of 30% which would make the long-term debt to equity ratio be 0.43. Allergan’s debt to equity ratio was 0.55 in 2014 and is moving more towards the sector and industry average which is 0.5. Allergan is a company with betas greater than one showing that it is more volatile than the market. The five year beta, unlevered beta, and re-levered beta are 1.15, 1.06, and 1.38 respectively. These values are fair because of the possible merger announced by Pfizer and the overall declining sales growth in the pharmaceuticals industry during 2014.

60

Debt

The primary component of Allergan’s overall debt is long term debt. Currently,

Allergan’s long-term debt finances 11.08% of the company. While short term debt

finances 0.7% of the company. From 2005 to 2011, Allergan averaged an annual value

of $1 billion in debt. Over the past three years, Allergan’s debt rose to $6.2 billion in

2012, $8.5 billion in 2013, and $14.8 billion in 2014. Allergan’s debt to equity ratio for

the year ending 2014 was 0.55. Allergan’s debt to equity ratio historically remained less

than one with the exception of 2012. The following graph depicts this relationship of

debt to equity:

61

With the exception of

2012, Allergan’s

debt to equity ratio is

very close to the

industry average for

the past ten years.

The following graph

demonstrates

Allergan’s debt to equity ratio compared to the pharmaceuticals sector:

The graph also indicates that Allergan is moving more towards the sector

average for debt to equity. Allergan is planning to stay on that track and moving towards

a 0.5 debt to equity ratio

because this structure

allows Allergan to grow and

acquire other companies or

sell off parts of its own

company. These

transactions attribute to

Allergan’s stock price rising and increased sales. The same thing can be said for how

Allergan compares to the average debt to equity ratios of the healthcare industry:

62

Currently Allergan in on track to remain at a 0.5 debt to equity ratio, which mirrors

the Healthcare industry average almost exactly and enables sustainable growth for the

company in the next five years.

Allergan’s target percentage for financing long-term debt of the company is 30%.

Allergan’s target debt accounted for the strong stock price price growth but also

includes the fact that Allergan is 66.67% equity. The company does not plan to change

its capital structure, therefore a target debt of 30% is acceptable for Allergan.

63

Equity

As stated earlier, Allergan is primarily equity. The main component of Allergan’s

equity in 2014 was its additional paid in capital which was about $28.9 billion. Allergan’s

total book value of equity in 2014 was about $28.3 billion after accounting for deficits in

other appropriated reserves and retained earnings. Allergan’s market value of equity in

2014 was $118.2 billion. Although Allergan experienced increased sales net income

broke even or was negative over the past three years while stockholder’s equity

doubled each year for the past three years. The following graph demonstrates this

interaction while also including Allergan’s return on equity:

Furthermore, the risk-free treasury rate used was 2.87%. This thirty year treasury value

was taken from treasury.gov and is being used because Allergan is expected to grow or

acquire companies for the next twenty years. The market risk premium used was 6%.

The market risk premium typically resides between 5% and 7%. The S&P 500 reported

an 8.3% average annualized return for the last 30 years, meaning the market risk

64

premium would be 8.3% - 2.87% equal 5.43%. The market risk premium of 6% was

used because of slow economic recovery since the financial crisis of 2008 and because

pharmaceutical sales faltered in 2014. Total equity is projected to increase 10.5% every

year for the next fifteen years.

65

Cost of Capital

Cost of capital is referred to the cost of funds used for financing the company.

From CAPM the weighted average cost of capital can be calculated:

WACC = wdebtkdebt(1 - Tax) + wequitykequity

The WACC for Allergan is calculated to be 7.26%. Allergan’s long term cost of debt is

2.47% while it’s cost of equity is 9.77%. This indicates that Allergan’s weight is greater

in the the equity side of the company. To calculate the cost of equity for Allergen the

following formula was used:

re = rf + (rm - rf)

The beta used to calculate the cost the equity was the five year beta of 1.15. Overall, a

beta greater than 1 reflects a company with greater-than-average volatility. Allergan’s

beta is greater than one and thus it is more volatile.

When calculating the unlevered beta, the following equation was used:

Unlevered =1 + [(D/E) (1-T) + P/E]

The unlevered beta was calculated to be 1.06. The preferred stock component is zero

because Allergan’s equity is only common stock. This unlevered beta for Allergan is

greater than 1 as well, suggesting Allergan is more volatile. By relevering the beta:

Relevered = Unlevered[1 + [(D/E) (1-T) + P/E]

The new, relevered beta based on the industry weights is 1.38. This beta is 0.32 greater

than the unlevered beta due to the volatility of the industry as well as the fact that Pfizer

is in the process of possibly buying Allergan.

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Capital Structure

Currently Allergan is 64.5% equity and 35.5% debt with a debt to equity ratio of

0.55. Historically, Allergan’s average total debt to equity ratio is 0.62 for the past

decade. Overall, the pharmaceutical industry is moving toward a 0.5 debt to equity ratio

and Allergan is following this trend.

Distributions

Allergan possesses no preferred stock and stopped paying dividends as of 2009.

Unit 4 Table of Contents Executive Summary .................................................................................................................................... 70

Assumptions ............................................................................................................................................... 71

Forecast Projections ................................................................................................................................... 73

Altman Z-Score ........................................................................................................................................... 83

DuPont Analysis .......................................................................................................................................... 85

70

Executive Summary Assumptions:

x Debt to Equity ratio target: 0.5 x Long-term ROIC vs. WACC

o WACC= 7.26% o L/T ROIC= 8.08%

x Time until long-term: 15 years x Management effectiveness: “Exemplary”

Sales Forecast: The sales forecast includes the first three quarters of 2015 and Q4 as the average of the first three. Allergan is expected to increase sales at a decreasing rate until the long-term rate is achieved in ten years. Valuation: According to the model, the price at 12/31/2014 was $259.07. The actual closing price on that date was $257.41. The estimated price for the target date is $353.88 which is $56.56 higher than the closing price on the target date of $297.32, implying that the stock is undervalued. Morningstar analyst Michael Waterhouse estimates Allergan’s fair value at $370 per share.

Altman Z-Score: The horizon Altman z-score (calculations shown in the table to the right) gives Allergan a score of 2.32 which would normally be considered in a grey area, “possibly in danger of bankruptcy”. However, the z-score benchmarks do not seem to be a very good indicator for pharmaceutical companies and therefore this is a strong number. The pro forma 2015 z-score is 1.13. DuPont ROE: Allergan’s ROE is expected to increase 90% in 2015 over its 2014 number. And the horizon ROE is expected to be 1.45% which is a number held down significantly by Allergan’s projected equity multiplier decreasing by more than half over the 20 year period.

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Assumptions

Capital Structure: For the last 10 years Allergan’s debt to equity ratio is

trending toward .5, which is the target debt to equity ratio. However in the recent

divestiture of Allergan’s generics brand to Teva pharmaceuticals, Allergan announced it

would be using some of the cash to pay down long term debt. This would mean a lower

debt to equity ratio except that Pfizer began talks with Allergan regarding a merger on

October 29th. If the merger goes through, Allergan’s debt to equity ratio is forecasted to

mirror Pfizer’s average debt to equity ratio of .5.

Long-Term ROIC: The long-term ROIC is 8.08% and the WACC is

7.26%. Driven down by competition, the long-term ROIC of a company is almost

always assumed to be equal to its WACC. However, pharmaceuticals are an interesting

industry in the fact that competition is fierce but there are very high barriers to

entry. Because Allergan is focused only on brand name pharmaceuticals, it is

forecasted to be able to maintain an ROIC over WACC in the long term. Drug patents

last 20 years after the invention of the drug, and the drugs usually take 8 years of

testing to pass FDA regulations. If Allergan can continue its trend of innovation and

smart acquisitions, those 12 years after FDA testing regulations of exclusive production

are expected to provide the company with the edge it needs to keep its ROIC above

WACC.

Time Until Long-Term: The time until long term is 10 years because generally,

the pharmaceutical industry is volatile and riddled with mergers and

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acquisitions. Therefore a time until long-term set at longer than ten years does not

provide as accurate forecasts.

Risk-Free Rate: The risk free rate is 2.87%, which is the current yield on 30 year

treasuries. The 30 year rate was used because Allergan is expected to experience huge

growth and be in business for more than 30 years.

Management Effectiveness: Allergan’s management is very effective and the

stock price growth reflects this. Morningstar analyst Michael Waterhouse rates

management’s shareholder stewardship as “exemplary”. This rating was partially

attributed to “Allergan’s recent decision to divest its generics division to Teva, which

looks smart given the price” (morningstar.com). Not only that, but considering that the

front-runner for CEO of the conglomerate after the merger between Allergan and Pfizer

is Brent Saunders which shows that Pfizer trusts Allergan’s management.

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Forecast Projections

This chart above shows Allergan’s historical ratios that were used to predict the

starting, long-term, and fade rates for each projection. For each ratio the analyst used

different reasoning for each projection that is described in depth throughout this unit. In

almost every case the starting rate is different than the long-term rate because

Allergan’s recent structure is constantly changing due to divestitures, acquisitions, and

most recently a bid to buyout by Pfizer pharmaceuticals.

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Sales:

Starting Rate: The 2015 total sales were computed using the quarterly data for

the first three quarters of 2015. The starting rate is the growth rate used from 2014 to

reach the projected 2015 sales. This rate of 43.7% is the beginning of Allergan’s sales

increasing at a decreasing rate.

Long-Term Rate: The long-term rate is the annualized global pharmaceutical

industry average over the last 10 years, 6.78%.

Fade Rate: The fade rate is .3 because the sales growth rate is decreasing (from

50.5% in 2014 to 43.7% in 2015). Sales are expected to grow at a decreasing rate until

slowly leveling to the long term rate.

COGS/Sales:

Starting Rate: Using the data from the first three quarters of 2015 to project the

2015 COGS, a starting rate of 36.13% was calculated to yield the 2015 projection.

75

Long-Term Rate: The long-term rate is the industry average. This is an

accurate gauge of what Allergan is expected to be able to decrease its COGS/sales to

over 10 years.

Fade Rate: The fade rate is -0.1 because the expectation is that COGS slowly

fades toward the industry average.

SG&A/Sales:

Starting Rate: Again, the starting rate was calculated extrapolating the first three

quarters. The rate as a percentage of sales is low historically speaking, however this

likely is a result of the Activis-Allergan merger that occurred in 2014. According to the

WSJ, many management positions became redundant after the management teams of

both companies combined. These layoffs would result in lower administration

expenses.

Long-Term Rate: The rate chosen is the industry average rate which is a great

estimate of Allergan’s long term SG&A expense.

Fade Rate: The fade rate is .2 because Allergan’s costs are so far below the

industry average in the short term and in the long term the SG&A/Sales rate is expected

to approach the industry average.

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Depreciation/ Net PP&E:

Starting Rate: The starting rate was a result of analysis of the first three quarters

of 2015.

Long-Term Rate: The industry average for depreciation as a percentage of net

PP&E is 45%, however Allergan is consistently making acquisitions to remain

competitive and is able to depreciate those new purchases. The long-term rate is 100%

to account for the current very high rate of depreciation as a result of

Allergan continuing to make large acquisitions.

Fade Rate: A fade rate of .3 is an accurate representation of the accelerated

depreciation being used by Allergan.

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Cash/Sales:

Starting Rate: Allergan rapidly decreased the amount of cash on its balance

sheet for the last 10 years. This is likely a result of operating efficiency, so the starting

rate is equal to the 2014 rate.

Long-Term Rate: The long-term rate is higher than the starting, but still low

compared to the historical rate (9.5%) to reflect that the low cash in 2014 was partially

attributable to both operating efficiency and other factors unique to 2014.

Fade Rate: The fade rate is .5 to reflect that Allergan’s projections are expected

to increase cash reserves to a more sustainable number quickly in the next few years.

Inventory/Sales:

Starting Rate: Using the average inventory from the first three quarters the

projected 2015 inventory is $2,398.6 million, which as a percentage of projected 2015

sales is 12.78%

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Long-Term Rate: The historical inventory as a percentage of sales oscillates

between two ranges. The 2015 pro forma inventory is even lower, showing that this

downtrend may be a result of increased efficiency. Because of this increased efficiency

the long term rate is projected to be lower than the historical average (20.58%) at 16%

which is higher than the starting rate to allow for volatility.

Fade Rate: The fade rate is -.1 because the inventory is expected to rise slowly

to the long-term rate.

Accounts Receivable/Sales:

Starting Rate: Throughout the third quarter, 2015 average inventory is 98.95%

which is higher than 2014. Therefore the accounts receivable/sales starting rate is

forecasted to be 28.25%.

Long-Term Rate: The long term rate is an 50/50 weighted average of the

historical average rate and the 2015 pro forma rate to target the weight towards the

current structure of the company rather than the historical.

Fade Rate: The fade rate is .1 to show a gradual decline from the current rate to

the long-term rate because it likely takes time to reign in accounts receivable to a

sustainable level.

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Other Short-Term Operating Assets/Sales:

Starting Rate: The starting rate is 29.55% which reflects a 154% increase in

other short term operating assets from the Q4 2014 to Q3 2015.

Long-Term Rate: The long term rate is 30% because it is projected that

Allergan’s new business model requires constant acquisitions and growth, which results

in high short-term operating assets in the long term.

Fade Rate: The fade rate’s effect is negligible because the starting rate and

long-term rates are only 0.45% apart.

Net PP&E/Sales:

Starting Rate: In 2014 the average net PP&E for the first three quarters was a

close estimate of net PP&E on the December 2014 balance sheet. Using this formula

the 2015 net PP&E was determined to be $2,409 million or 28.15% of the 2015 pro

forma sales.

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Long-Term Rate: The long-term is 20% because the historical average since

2005 is 23%. Also the brand pharmaceutical business’ profit margin is higher than

generics (which was divested) so the new PP&E required is lower as a percentage of

sales.

Fade Rate: The fade rate is .4 because Allergan needs to make investments in

PP&E in order to maintain sales growth; many of Allergan’s asset purchases are lumpy

assets which require larger investments in the short term to support long-term growth.

Other Long-Term Operating Assets:

Starting Rate: The starting rate is 604.39% to reflect an increase in goodwill and

intangible assets reported on the third quarter balance sheet. The third quarter number

is fairly indicative of the fourth quarter for the past 5 years, so this is an accurate

estimate.

Long-Term Rate: The long-term rate is 18% because the assets are being

depreciated and amortized using accelerated depreciation over a 10 year period. Once

these assets are depreciated the level of other long-term operating assets are expected

to return to the historical average of 122%.

Fade Rate: The fade rate is .3 to reflect the accelerated depreciation.

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Accounts Payable/Sales:

Starting Rate: The starting rate is 4.10% is derived from the average A/P for the

first three quarters.

Long-Term Rate: The long-term rate is 9.48%, because this is the industry

average. This number is also only slightly higher than Allergan’s historical average of

7.9%.

Fade Rate: The fade rate is .1 because the expectation is that the rate slowly

levels off at the industry average.

Accruals/Sales:

Starting Rate: The starting rate is the same as the 2014 rate (4.05%) because

the forecast is that accruals are expected to remain consistent with 2014 numbers.

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Long-Term Rate: The long term rate is 4% because there is a downtrend in

accruals for the last 10 years and 4% is the floor which is expected to hold for the next

10 years.

Fade Rate: The fade rate effect is negligible on valuation because the starting

rate is only 0.05% higher than the long-term rate.

Other Current Liabilities/Sales:

Starting Rate: The starting rate is 22.28% which is the same as the 2014

historical rate. This is because the balance sheet from the first three quarters of 2015

indicate that the level is expected be the same on the Q4 2015 balance sheet.

Long-Term Rate: The long-term rate is set at the industry average of

9.18%. This drop is more consistent with that of a larger company that Allergan is

expected to become over the next 10 years.

Fade Rate: The fade rate is .1 because the forecast shows the rate dropping

more quickly in the short term and slowly fading to the long-term rate.

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Altman Z-Score

The Altman Z-Score is a gauge of a company’s likelihood of bankruptcy. A score above

3.0 means the company is not likely to go into bankruptcy while a score of below 1.8

means the company is likely to go into bankruptcy. In between 3.0 and 1.8 is a bit of a

grey area.

Allergan’s one year z-score (2015) is 1.1253, this score represents a company

that is likely to go into bankruptcy. However the method for determining whether the z-

score means that a company is in financial distress may not work well for

pharmaceuticals. As

discussed in unit two,

the z-score of many of

Allergan’s competitors

are also in the lower range. This could mean that most pharmaceutical companies are

in danger of financial distress, but more likely it means that pharmaceutical companies

in general are prone to lower z-scores.

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In addition,

the horizon z-score

for Allergan is

2.33. This is nearly

double the one year z-score which shows that Allergan is expected to become much

more stable in maturity. Despite the fact that this score is below the recommended 3.0,

if the assumption that pharmaceutical companies are prone to lower z-scores could

suggest that this is infact a strong z-score for Allergan’s industry.

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DuPont Analysis

ROE = Profit Margin (Profit/Sales) * Total Asset Turnover (Sales/Assets) *

Equity Multiplier (Assets/Equity)

Allergan’s pro forma DuPont ROE for 2015 is -0.20% which is an increase of

90% from 2014. The number remains negative because of Allergan’s slightly

negative pro forma profit margin of -0.084%. The pro forma asset turnover for

Allergan is 0.145. Allergan’s top eight closest competitors by market

capitalization averaged an asset turnover of .56 in 2014. Allergan obviously

needs to better monetize its assets. The projections assume that Allergan aims

to better monetize its assets with a horizon asset turnover of 0.356; however, the

horizon DuPont ROE is 1.45%. Despite a huge increase in asset turnover,

Allergan’s equity multiplier is projected to decrease by more than half which

holds down the ROE. The profit margin increases to 5.28% at the horizon from a

projected -0.084% in 2015, which increases the ROE significantly.

Unit 5 Table of Contents Executive Summary .................................................................................................................................... 89

Adjusted Present Value Model .................................................................................................................. 90

Entity Valuation Model .............................................................................................................................. 92

Free Cash Flow to Equity Model ................................................................................................................ 95

89

Executive Summary Looking at the model, one can see the pricing of Allergan’s stock through

different valuation methods. The date that all of the values for stock is 11/15/2015. The price of a share using the FCFE model is $395.55 per share, EV model is $393.29 per share, APV model is $245.35 per share, and the DFCF model measures it to be $353.88. Each model priced AGN stock over its price at the end of 2014 ($257.41), except the APV model. This is because the APV model requires volatile dividend payments and/or frequent stock issuances, of which Allergan performs neither. So the APV method is a weak tool of valuation for this particular stock. The FCFE method is also not the best due to Allergan’s changing capital structure, but gives a valuation very similar to the EV model. The EV method works very well with Allergan due to its constantly changing capital structure from acquisitions and divestitures which the EV model is unaffected by its choice of capital structure. And the one that is most accurate for Allergan. The DFCF model is also extremely accurate due to the amount of information and different considerations that go into it. Regardless, most models suggest that Allergan currently is a “buy”, which is the same conclusion in most analyst reports.

Drivers of Value For Each Model

90

Adjusted Present Value Model

The APV model, “separates the investment decision from the financing decision

by breaking the traditional DCF into two parts. The first part (the investment decision)

discounts unlevered cash flows to present at an equity rate of return. The second part

(the financing decision) discounts the interest tax shield to the present value at a rate of

return that reflects the risk in actually achieving these tax benefits (the risk free rate).

The two parts are then summed to derive the value of the entire enterprise”

(acuitasinc.com).

In simpler terms, the APV is equal to the present value of its cash flows if the

company was financed entirely by equity, plus the present value of the tax shields

achieved from debt financing. This model works great with companies with a non-

constant capital structure, but there is a huge disadvantage to this valuation model. This

model requires volatile dividend payments and/or frequent stock issuances, of which

Allergan performs neither, therefore this is not the best model to use in this situation.

APV Per Share=Vop + Vinv - Debt

Shares

APV Per Share=$112,279M + $171M - $15781M 394M

APV Per Share = $245.35

91

Drivers of Value for the APV

The three main drivers for the Adjusted Present Value method are:

x The first value driver is PV of discounted cash flows at the equity rate of return.

x The second value driver is Savings from the interest tax shield, which impacts

the calculation of FCF’s significantly.

x The last value driver is the re-levered cost of equity which was found by using

the target percentages of long-term debt, short-term debt, and preferred stock,

and multiplying them by the costs of each respectively. Then those numbers are

subtracted from the unlevered cost of equity and the whole equation is divided by

the target percentage financed with equity. The numbers are shown below in the

APV model.

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Entity Valuation Model

Another evaluation method is the entity valuation method. This method helps find

the enterprise value of a firm, which is the price that a company would pay to acquire

the firm.

Enterprise Value=MV of E+Debt-Cash

A simple way to think of the equation is Enterprise Value= Net cost acquiring

firm’s equity, taking its cash, and paying off debt. In essence, it's equivalent to owning

the unlevered (debt-free) business. The method is useful for comparing firms with

differing capital structures, since the enterprise value is unaffected by its choice of

capital structure. This method works very well with Allergan due to its constantly

changing capital structure from acquisitions, and buyouts.

In Allergan’s situation the enterprise value would be

93

Enterprise Value= $139,428M + $15,782M - $250M

Enterprise Value= $154,960M

Per share, Allergan’s enterprise value would be:

Enterprise Value Per Share= Enterprise Value # of Shares

Enterprise Value Per Share = $154,960M

394M

Enterprise Value Per Share = $393.29

Drivers of Value Entity Valuation The following are the major drivers of value for Allergan considering the Entity Valuation

Method.

x The biggest value driver is the market value of equity for Allergan. Considering

much of Allergan’s growth is from acquiring other companies and products this

comes as no surprise. The second is the value of debt. This is not such a huge

94

driver for value for Allergan considering its current D/E ratio is .55, but for other

companies this could be a huge driver if levered with more debt. The reason debt

is added is because as companies acquire other companies, debt is also

acquired.

x The third value driver is cash. While small, it still changes the enterprise value for

our firm. The reason cash is subtracted off is because it is used to pay off debt

when an acquisition occurs.

95

Free Cash Flow to Equity Model

The Free Cash Flow To Equity Model (FCFE) looks at all the cash flows left over

after, “meeting all financial obligations, including debt repayments, and after covering

capital expenditures and working capital needs”(stern.edu). FCFE works great when the

post-merger capital structures are constant, this is because changing capital structure

can cause the cost of equity to change. Unfortunately Allergan’s capital structure is

changing, which makes the FCFE model not the most precise tool available to evaluate

the company.

The FCFE equation is as follows:

FCFE= NI + Depreciation - CapX - Change In NWC + Change in Net Borrowing

Using Allergan’s information, the FCFE’s equal:

FCFE= -$1631M + $2828M - $2806M- $723M + $6696M

FCFE =$4364M

To figure out the value of the operations the following formula was used:

Vops= FCFE (1+g) (ke-g)

Using Allergan’s information, the value of operations can be calculated:

Vops= $4364M (1+.0678) (.0977-.0678)

Vops = $155,848.8M

Vops Per Share= $155,848.8M

394M

Vops Per Share = $395.55

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Drivers of Value FCFE The drivers of value for the FCFE method are

x Net Income, which is the base number of the FCFE model and is heavily

weighted in the calculation.

x Depreciation itself is not a value driver but the tax savings that arise from

depreciation are. These help save cash and are considered a cash inflow, which

contributes to FCF’s.

x Capital expenditures are cash outflows to the model and brings the FCF’s down

a lot.

x Change in NWC ((New CA-CL) - (Old CA-CL)) is the lowest driver value for

Allergan’s FCFE model.

x Change in net borrowing consists of debt repayment, which is a cash outflow,

and new debt, which is a cash inflow). This is the heaviest weight in model and is

the main reason why the Vops is so high.

x The growth rate is an important value driver and the long-term growth rate of

6.78% from the excel model was used.

x Cost of Equity differentiates the FCFE model from the FCF model. For the model

9.77% was used, found in the WACC calculation

Unit 6 Table of Contents Executive Summary .................................................................................................................................. 100

Multiples Comparison and Implied Valuations ....................................................................................... 101

100

Executive Summary x The multiples analysis is based on Allergan’s eight closest pharmaceutical

competitors by market share x Allergan’s current stock price is $300.04 per share (shown in blue) x Allergan was

given an implied value based on a comparison to competitors using each of the six valuation ratios (implied valuations by ratio shown in red)

x The average of the six different implied values (shown below) is $307.70 which is only 2.45% higher than the current stock price.

x Despite the multiples valuation being very close to the current market price,

Allergan is forecasted to grow significantly in the next few years, therefore the DCF valuation may be a more accurate measure of value because it discounts the pro forma numbers to the present. Future growth is not necessarily captured by the multiples valuation analysis because Allergan’s growth numbers are expected to be much stronger than the industry average (43.7% vs. 6% projected in 2015)

101

Multiples Comparison and Implied Valuations Allergan Multiples vs. Competitor Multiples

P/E Ratio (Current):

The Price/Earnings ratio of Allergan, measured by current earnings, is

21.46. This is low compared to the average of Allergan’s closest competitors which is

26.21. This gives Allergan an implied value of $366.45 per share which is $66.41

higher than the current market price. For Allergan the current earnings are a better

gauge of value than historical earnings. This is because the company posted negative

earnings for the past two fiscal years, however the earnings in the first three quarters of

2015 have been strong and the forecast is that this trend will continue. The average

P/E ratio is the best measure for Allergan’s competitors because earnings is fairly

universal and a comprehensive indicator of value for a firm; it is better to have the

outliers impact price.

102

P/E Ratio (TTM):

Using the trailing twelve month earnings for Allergan, the stock’s implied value is

$262.74 per share. The reason the trailing twelve month earnings gives an implied

valuation $103.71 per share lower than the current earnings is Allergan’s historical

earnings are not particularly strong compared to its competitors but its future earnings

are forecasted to be very strong.

Price/Sales (TTM):

The median price/sales ratio of Allergan’s competitors is 3.30 compared to

Allergan’s 5.1. In this case the median is a better gauge than average because other

than a few outliers, most of the companies are very close to 3.30. Using these

numbers, Allergan’s implied price per share is 194.14. This is very far below the current

market price of $300.04. One of the reasons for this is that sales growth is usually a

better indicator of value than absolute sales. Allergan’s sales growth last year was

50.53% vs. its competitor’s average of 19.36%.

P/FCF (TTM):

Price to free cash flow is a good measure of value for a firm because the free

cash flows are the funds that are available to be paid back to shareholders and

bondholders. The median is a better gauge of the competitors than the average

because Bristol Myers Squibb Co. brings up the average significantly with its 99.61

price to free cash flow ratio. The median ratio is 29.49 and Allergan’s is 36.44 giving an

implied value of $242.79 per share.

103

P/EBITDA (TTM):

Allergan’s price to EBITDA ratio is 42.91 vs. the average competitor ratio of

14.76 gives Allergan an implied value of $103.20. This number is $196.84 lower than

the current market price. Measuring value with EBITDA provides a low implied

valuation for the same reasons that the trailing twelve month earnings provided a low

implied valuation. However, using EBITDA provides a much lower value because

Allergan paid very little in taxes and used massive depreciation and amortization write-

offs in the last three years. These are advantages for Allergan that are not reflected in

EBITDA.

Price/Book (TTM):

Allergan’s price to book ratio is 1.6. The median for its competitors is

3.60. Median is the best gauge because there are two very high outliers that bring up

the average and compared to the S&P 500 price to book ratio of 2.79, 3.60 looks to be

more accurate. With these numbers, Allergan’s implied value is $675.09, a full $375.05

higher than the current market price. Although the stock may not be quite that valuable,

the ratio provides insight into the fact that Allergan’s price has a lot of room to grow

relative to its book value of equity.

104

Conclusion

None of the ratios

are a perfect

measure of value

for Allergan;

however an

average of the

implied value from

each ratio gives a

price of $307.40 per share. This is only $7.36 higher than the current market price of

$300.04 which shows that when used in conjunction, these ratios are a good measure

of value for the firm. Given this information, Allergan’s stock can be considered fairly

valued because the average implied value is only $7.36 or 2.45% higher than the

current stock price.

Unit 7 Table of Contents Executive Summary .................................................................................................................................. 107

Summary and Conclusions ....................................................................................................................... 108

107

Executive Summary Allergan is a global pharmaceutical company headquartered in New Jersey. It’s competitors include P&G, J&J, Merck & Co, and Pfizer. Earlier this year, Allergan and Actavis merged which prompted the stock price of Allergan to rise. This past month, Allergan and Pfizer met to discuss a buyout or merger. This transaction would create the biggest pharmaceutical company in the world. With strong leadership and a growing stock price, Allergan possesses the ability to become even larger and more successful. Allergan’s stock price increased over the past five years, with the biggest activity starting in 2013 and continuing through today. Allergan’s stock price reached its highest price all time this year and remains stable around that price. This increase in stock prices is attributed to the increase in average annual sales. Throughout 2014, sales increased 50.53% compared to the past five years where sales increased by 36.5%. Allergan’s current capital structure is 35.5% debt and 65.5% equity, making its current debt to equity ratio 0.55. Allergan wants to move towards the industry and sector debt to equity ratio which is 0.5. Maintaining a 0.5 debt to equity ratio allows Allergan to participate in acquisitions or sell of part of itself. To reach this 0.5 debt to equity ratio, Allergan plans to modify its capital structure where long-term equity increases to 70% while still maintaining a WACC close to the current WACC which is 7.26%. Allergan’s ratios are not as strong as anticipated for a company with the level of growth that Allergan previously experienced. However, the current and forecasted future growth is expected to create a large impact on the valuation than the current and historical ratios. Looking at the models valuation chart that predicts stock prices for 11/15/2015, we see that each model evaluates Allergan stock differently. Considering the strengths and weaknesses of each model, DFCF model is considered to be the most accurate with the EV model coming in a close second. The APV, FCFE, & multiples models were determined to be the most inaccurate when it came to valuing Allergan’s future stock prices. Due to all the factors listed in this analyst report, Jack Carroll, Richard Papaianache, and Luke Mause conclude Allergan stock to be undervalued and are rating it as a “buy.”

108

Summary and Conclusions

Allergan is a global pharmaceutical company that climbed its way into the top ten

companies alongside competitors such as P&G, J&J, Merck & Co, and Pfizer. Its

merger with Actavis skyrocketed the company in the pharmaceutical industry and the

potential merger with Pfizer can create new possibilities in growth for the company. With

an excellent management team, including Brent Saunders, and a huge increase in

executive compensation this company doesn’t seem to be disappearing anytime soon.

Forecasts are strong for this company, for example Michael Waterhouse, a morningstar

analyst, recommends Allergan’s stock as a strong buy. The factors aligned in this

analysis indicate strong potential for the company to grow and expand in the next five

years.

Allergan’s stock experienced substantial growth since 2013 with expected sales

growth of 43.70% in 2015. This was due to new product sales resulting from

acquisitions which in turn led to a 50.53% sales growth rate in 2014. Allergan’s stock

price experienced the most growth compared to its competitors and now possesses the

highest stock price. The possible merger with Pfizer is expected to increase the stock

price as well. Allergan’s ratios are not as strong as anticipated for a company with the

level of growth that Allergan previously experienced. However, the current and

forecasted future growth is expected to create a larger impact on the valuation than the

current and historical ratios.

Looking at the DuPont analysis, Allergan’s ROE was -8.09% in 2014, this can be

attributed to Allergan’s negative net income in 2014. According to the Altman z-score

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analysis, Allergan is safe from imminent bankruptcy, but not healthy as a company

according to the z-score, unless considering the pharmaceutical industry which can

have lower z-scores. These two measures of value are not as accurate taking into

account Allergan’s changing capital structure and negative net income.

Allergan’s capital structure is 35.5% debt and 65.5% equity, making its current

debt to equity ratio 0.55. Over the past ten years, Allergan historically averages a 0.62

debt to equity ratio. Allergan’s target percentage for financing long-term debt of the

company is 30%, with long-term equity being 70%. This target percentage allows the

company to acquire other companies or sell off parts of its company.

Allergan’s WACC is calculated out to be 7.26% with the heaviest weight coming

from cost of equity which is 9.77%. The WACC is projected to change due to the capital

restructuring of Allergan. Allergan is moving towards it’s target long-term debt of 30%

which would make the long-term debt to equity ratio be 0.43 mimicking its competitors

long-term debt to equity ratio. Allergan is a company with three calculated betas greater

than one showing that it is more volatile than the market. These values are fair because

of the possible merger announced by Pfizer and the overall declining sales growth in the

pharmaceuticals industry during 2014.

Allergan’s DCF valuation is the most accurate valuation model. The discounted

financial statement forecasts give the most accurate valuation for the company because

they discount expected future earnings. The reason that Allergan’s stock experienced

such growth is because of its high sales growth (50.53% in 2014) and expectations of

sustained high growth (43.70% pro forma sales in 2015). The 12/31/2014 price in the

110

model is a mere $1.66 per share higher than the actual 12/31/2014 closing price. The

target date price is $352.45 per share which implies that the stock price is undervalued

by $56.56, and that the stock is considered a strong buy.

When looking at the different models Allergan’s stock was better to suited to

some models than others. Each model above predicted Allergan’s share price for at the

date of 11/15/2015. Considering Allergan’s

changing capital structure, non-dividend

business model, and non-frequent stock

issuances, the DFCF model is the best model to

evaluate Allergan. The DFCF model discounts future cash flows as opposed to, the

multiples analysis valuation which uses current and past data to provide a valuation.

The problem with using current and past data vs. future data is that Allergan’s value is

in the expectations for huge sales growth and a rebound from negative 2013 and 2014

income.

Another amazing model to evaluate Allergan is the EV model as changing capital

structures don’t affect the EV value. On the other hand the APV and FCFE model which

are affected by non-constant capital structures and other factors are not the best

models of evaluation for Allergan stock price. Giving all this information regarding

evaluation models, Allergan is considered a strong buy.

Due to all the factors listed in this analyst report, Jack Carroll, Richard

Papaianache, and Luke Mause conclude Allergan stock to be undervalued and are

rating it as a “buy.”

111

Works Cited actavis.com

acuitasinc.com

agn.client.shareholder.com

allaboutvision.com

allergan.com

analysisreport.morningstar.com

bankrate.com

beta.finance.yahoo.com

benzinga.com

biospace.com

brightfocus.org

businessinsider.com

capitalcube.com

cbsnews.com

csimarket.com/Industry/industry_growth_rates.php

data.worldbank.org

factiva.com

finance.yahoo.com

forbes.com

globalbb.onesource.com

infogr.am/app

112

jnj.com

markets.on.nytimes.com

Market Scope®, 2011 Report on the Global Market for Dry Eye Products; 2011, 1-148.

MarketWatch.com

mergentonline.com

money.cnn.com

Morningstar.com

nasdaq.com

NYSE.com

NYTimes.com

ocregister.com

pages.stern.nyu.edu

pharmainfo.net

quotes.wsj.com

reuters.com

technomic.com

TheStreet.com

Thomsonone.com

treasury.gov

wallstreetoasis.com

wsj.com

yourlawyer.com

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Appendix AGN Model (It is worthy to note that some rows with no numbers have been hidden to better show the graphs)

Historical Balance Sheet-Assets

Historical Balance Sheet Liabilities & Equity

114

Historical Income Statement

115

Condensed Income Statement

Comprehensive Balance Sheet Assets

116

Balance Sheet Comprehensive Liabilities & Stockholders Equity

Comprehensive Statement of Cash Flows

117

118

Condensed Income Statement

Condensed Balance Sheet

119

Condensed statement of cash flows

120

Historical Free Cash Flow

121

Historical Ratio Analysis

122

Historical Values for Ratios Used to Project Financial Statements

123

WACC

124

125

Inputs

126

127

128

Projections and Valuation

Income Statement

129

Forecasted and Projected Balance Sheet

130

Projections & Forecasting Valuation

131

Projections & Valuations Calculating Value

132

Projections & Valuation Selected Ratios

133

Projections & Valuations Statement Of Cash Flows

134

Price Per Share AGN Model vs. APV Model

135

Comparison Report Ratios 2014 & 2013 & 2012

136

Comparision report Ratios 2011 & 2010 & 2009

137

Comparision Report Ratios Averaged Over the years

Sales Growth Comparison Report 2014 & Average % over the years

2013

138

Sales Growth Comparison report 2012 & 2011 & 2010 & 2009

139

140

Historical Stock Pricing Allergan

141

142

143

144

145

APV Model Unlevered Cost Of Equity To Releveled Cost Of Equity

146

APV Calculating Value