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SINOPHARM GROUP has an estimated cost of capital of 12 per cent in which the management believe is applicable to the valuation of Pharmacia once it is acquired and becomes part of the group. Assume a tax rate of 20 per cent is applicable for both SINOPHARM and Pharmacia. SINOPHARM has 10 million ordinary shares in issue and the current market value of a share is $10.64.

Assume that you are a consultant with Pan Asia Consulting.

1. From the above case study and the data provided, perform a corporate and stock valuation for Pharmacia using the following approaches:

• Free Cash Flows (FCF)
• Earnings Multiple
• Sales Multiple
• BV Multiple
• Dividend Multiple
• BV per share approach (purely based on value from the balance sheet)
• MV per share approach (similar to BV per share approach except replacing BV of any assets with its MV if MV of the asset is available)

(14 marks)

B) The Pharmacia Deal SINOPHARM GROUP is an intemational pharmaceutical company that was once seen as a safe haven for investors when stock markets became volatile. It had a reputation as a well-managed and solid, but rather unexciting company operating within a strong industrial sector. However, a number of problems had emerged in recent years to damage its reputation. A major problem for the company has been its failure to develop new drugs to replace a generation of successful drugs, the patents of which had either already expired or were about to expire. Where patents had already expired, rival companies had developed competing generic drugs that had seriously damaged the company's sales and profits. To make matters worse, the company had recently launched two new products, amidst much publicity, which had to be swiftly withdrawn when patients taking the drugs complained of side effects. This led to a severe loss of confidence in the management of the company and it became clear that major changes had to be made. Key figures and ratios relating to SINOPHARM GROUP for the past five years are set out below: Year Ended 31 January Year-5 Year-4 Year-3 Year-2 Year -1 (last year) Sales (Sm) 742.6 679.9 587.2 496.4 419.3 Operating Profit ($m) 67.1 56.5 39.8 37.3 38.8 P/E ratio 16.3 22.2 16.3 11.5 9.9 In order to restore confidence in the future of the company, a majority of the members of the board of directors was replaced and Betty Huang was appointed as chief executive officer. The new board agreed that the pharmaceutical sector had become fiercely competitive in recent years and it doubted whether the company had the resources or expertise to remain a successful player within the industry. The increasing costs associated with developing new drugs, along with downward pressure, exerted by govemments, on prices for prescription drugs led the board to conclude that a change of direction was needed. Hence, it was decided that the company should reposition itself in the related healthcare market where it already had a small presence. For some years, SINOPHARM GROUP had been selling a range of antiseptics and disinfectants for use in hospitals and nursing homes. The mission of the company was restated as being "To maximize shareholder value by becoming a leading provider of healthcare products" Phamacia is a family-owned company that produces a small range of healthcare products. The main products of the company are wound dressings and surgical gloves, which are sold to hospitals, surgeries and nursing homes throughout Europe and which enjoy a reputation for their very high quality. The most recent financial statements of the company are given below: Statement of financial position (balance sheet) as at 31 January of Current Year (Year 0) $000 Non-current assets (cost less depreciation) Premises 8,346.6 Plant and equipment 4,321.1 Motor vans at cost 1.985.2 14,652.9 Current assets Inventories 1,564.7 Trade receivables 1,739.6 Cash at bank 1.888.9 5.193.2 19.846.1 Total assets Equity $1 Ordinary shares Retained profit 2.000.0 6.125.9 8.125.9 Mon currat liahilitiar Non-current liabilities 7% Loan notes 5,000.0 Current liabilities 5,763.4 Trade payables Accrued expenses 956.8 Total equity and liabilities 6.720.2 19.846.1 Information from Income statement for the year ended 31 January of Current Year (Year 0) $000 Sales revenue Less Cost of sales 50,166.8) 20,574.6 29,592.2 13,483.2 Gross profit minus Selling and distribution expenses minus Administration expenses Operating profit (EBIT) minus interest expense Earning after interest minus Taxation Net Eaming 10.986.6 5,122.4 350.0 4772.4 954.48 3817.92 Donald Jackson founded the business 35 years ago and has been the chief executive and chairman of the company since that date. However, ill health has recently forced him to consider his future and also to consider the future of the company. Although the founder has two children, neither has shown an interest in the business. The idea of allowing non-family members to manage the business was regarded by the Phamacia family as unacceptable and so the various family members, who owned all the issued shares, agreed to sell the company. When Betty Huang discovered that Pharmacia was for sale, she expressed an immediate interest in entering into negotiations with the Phamacia family. She believed that this was an outstanding opportunity to acquire a range of high quality products with a strong brand image. It provided an immediate and strong presence in markets that the board of directors of SINOPHARM GROUP had recently identified as being of particular interest. The finance director of SINOPHARM GROUP Xiaomei Sung, was the first among the new board of directors to express reservations concering the possible acquisition. Although she acknowledged the possible benefits that might accrue, she argued that SINOPHARM GROUP had no previous experience in acquiring companies and that the new board of directors had not yet developed a clear view as to how the acquisition process should be approached or managed. As a result, there was a risk that the acquisition of Pharmacia would not tum out to be as successful as Betty Huang was expecting. Xiaomei also wondered whether investors would be prepared to support the deal given the recent history of SINOPHARM GROUP. The board of directors debated the issue and, by a narrow majority, decided to support Betty's wish to enter into negotiations with the Phamacia family with a view to buying all the shares of the company. However, it was agreed that an independent firm of consultants. Pan Asia Consulting, should be appointed to advise the board throughout the period of negotiations. The finance department of SINOPHARM GROUP extracted the following latest information relating to public listed healthcare companies from a financial newspaper: Stock Stock Company Latest Dividend P/E ratio Stock Yield price price 12-month 12-month Price (S) (%) High ($) Low (S) 8.73 4.78 Sun 7.82 1.5 15.5 7.80 4.60 Clenmark 5.92 2.2 14.5 2.79 1.73 Horizon 1.94 1.7 12.5 18.20 11.95 Intas 12.70 2.9 16.8 2.66 1.28 Biocon 2.02 1.6 16.3 3.16 1.64 Avax 2.96 2.1 15.7 The finance department also provided the following ratios for each of the companies listed above: Market value*/book value Sales/market value* Sun 4.1 1.6 Clenmark 3.1 1.7 Horizon 2.9 2.5 Intas 3.8 0.9 Biocon 4.0 1.3 Avax 2.2 1.6 These values refer to the ordinary shares of each company. In the early stages of negotiation between the two companies, the following information was provided by Donald Jackson: Recently a competitor has offered to purchase the premises of Phamacia at $40 million. The sales and EBIT of Pharmacia is expected to grow at about 5% each year over the next five years. They will stabilise (zero growth) after that because the market is fairly competitive and there is little prospect of growth. The amount of capital expenditure (CAPEX) spent to replace old machinery items (non-current assets) will be more or less the same with the annual depreciation | expense of these items. Therefore, both items will offset each other. However, the company is committed to another separate CAPEX on building a new plant costing $4.8 million over the next four years. The cost of this new plant would be spread evenly over the three-year period (in other words, each year CAPEX of $1.2 million). Additional working capital needs over the next 5 years are estimated to be around $500,000 each year. No additional working capital is needed after year 5. In previous years, the total dividend paid was around $360,000 per year. B) The Pharmacia Deal SINOPHARM GROUP is an intemational pharmaceutical company that was once seen as a safe haven for investors when stock markets became volatile. It had a reputation as a well-managed and solid, but rather unexciting company operating within a strong industrial sector. However, a number of problems had emerged in recent years to damage its reputation. A major problem for the company has been its failure to develop new drugs to replace a generation of successful drugs, the patents of which had either already expired or were about to expire. Where patents had already expired, rival companies had developed competing generic drugs that had seriously damaged the company's sales and profits. To make matters worse, the company had recently launched two new products, amidst much publicity, which had to be swiftly withdrawn when patients taking the drugs complained of side effects. This led to a severe loss of confidence in the management of the company and it became clear that major changes had to be made. Key figures and ratios relating to SINOPHARM GROUP for the past five years are set out below: Year Ended 31 January Year-5 Year-4 Year-3 Year-2 Year -1 (last year) Sales (Sm) 742.6 679.9 587.2 496.4 419.3 Operating Profit ($m) 67.1 56.5 39.8 37.3 38.8 P/E ratio 16.3 22.2 16.3 11.5 9.9 In order to restore confidence in the future of the company, a majority of the members of the board of directors was replaced and Betty Huang was appointed as chief executive officer. The new board agreed that the pharmaceutical sector had become fiercely competitive in recent years and it doubted whether the company had the resources or expertise to remain a successful player within the industry. The increasing costs associated with developing new drugs, along with downward pressure, exerted by govemments, on prices for prescription drugs led the board to conclude that a change of direction was needed. Hence, it was decided that the company should reposition itself in the related healthcare market where it already had a small presence. For some years, SINOPHARM GROUP had been selling a range of antiseptics and disinfectants for use in hospitals and nursing homes. The mission of the company was restated as being "To maximize shareholder value by becoming a leading provider of healthcare products" Phamacia is a family-owned company that produces a small range of healthcare products. The main products of the company are wound dressings and surgical gloves, which are sold to hospitals, surgeries and nursing homes throughout Europe and which enjoy a reputation for their very high quality. The most recent financial statements of the company are given below: Statement of financial position (balance sheet) as at 31 January of Current Year (Year 0) $000 Non-current assets (cost less depreciation) Premises 8,346.6 Plant and equipment 4,321.1 Motor vans at cost 1.985.2 14,652.9 Current assets Inventories 1,564.7 Trade receivables 1,739.6 Cash at bank 1.888.9 5.193.2 19.846.1 Total assets Equity $1 Ordinary shares Retained profit 2.000.0 6.125.9 8.125.9 Mon currat liahilitiar Non-current liabilities 7% Loan notes 5,000.0 Current liabilities 5,763.4 Trade payables Accrued expenses 956.8 Total equity and liabilities 6.720.2 19.846.1 Information from Income statement for the year ended 31 January of Current Year (Year 0) $000 Sales revenue Less Cost of sales 50,166.8) 20,574.6 29,592.2 13,483.2 Gross profit minus Selling and distribution expenses minus Administration expenses Operating profit (EBIT) minus interest expense Earning after interest minus Taxation Net Eaming 10.986.6 5,122.4 350.0 4772.4 954.48 3817.92 Donald Jackson founded the business 35 years ago and has been the chief executive and chairman of the company since that date. However, ill health has recently forced him to consider his future and also to consider the future of the company. Although the founder has two children, neither has shown an interest in the business. The idea of allowing non-family members to manage the business was regarded by the Phamacia family as unacceptable and so the various family members, who owned all the issued shares, agreed to sell the company. When Betty Huang discovered that Pharmacia was for sale, she expressed an immediate interest in entering into negotiations with the Phamacia family. She believed that this was an outstanding opportunity to acquire a range of high quality products with a strong brand image. It provided an immediate and strong presence in markets that the board of directors of SINOPHARM GROUP had recently identified as being of particular interest. The finance director of SINOPHARM GROUP Xiaomei Sung, was the first among the new board of directors to express reservations concering the possible acquisition. Although she acknowledged the possible benefits that might accrue, she argued that SINOPHARM GROUP had no previous experience in acquiring companies and that the new board of directors had not yet developed a clear view as to how the acquisition process should be approached or managed. As a result, there was a risk that the acquisition of Pharmacia would not tum out to be as successful as Betty Huang was expecting. Xiaomei also wondered whether investors would be prepared to support the deal given the recent history of SINOPHARM GROUP. The board of directors debated the issue and, by a narrow majority, decided to support Betty's wish to enter into negotiations with the Phamacia family with a view to buying all the shares of the company. However, it was agreed that an independent firm of consultants. Pan Asia Consulting, should be appointed to advise the board throughout the period of negotiations. The finance department of SINOPHARM GROUP extracted the following latest information relating to public listed healthcare companies from a financial newspaper: Stock Stock Company Latest Dividend P/E ratio Stock Yield price price 12-month 12-month Price (S) (%) High ($) Low (S) 8.73 4.78 Sun 7.82 1.5 15.5 7.80 4.60 Clenmark 5.92 2.2 14.5 2.79 1.73 Horizon 1.94 1.7 12.5 18.20 11.95 Intas 12.70 2.9 16.8 2.66 1.28 Biocon 2.02 1.6 16.3 3.16 1.64 Avax 2.96 2.1 15.7 The finance department also provided the following ratios for each of the companies listed above: Market value*/book value Sales/market value* Sun 4.1 1.6 Clenmark 3.1 1.7 Horizon 2.9 2.5 Intas 3.8 0.9 Biocon 4.0 1.3 Avax 2.2 1.6 These values refer to the ordinary shares of each company. In the early stages of negotiation between the two companies, the following information was provided by Donald Jackson: Recently a competitor has offered to purchase the premises of Phamacia at $40 million. The sales and EBIT of Pharmacia is expected to grow at about 5% each year over the next five years. They will stabilise (zero growth) after that because the market is fairly competitive and there is little prospect of growth. The amount of capital expenditure (CAPEX) spent to replace old machinery items (non-current assets) will be more or less the same with the annual depreciation | expense of these items. Therefore, both items will offset each other. However, the company is committed to another separate CAPEX on building a new plant costing $4.8 million over the next four years. The cost of this new plant would be spread evenly over the three-year period (in other words, each year CAPEX of $1.2 million). Additional working capital needs over the next 5 years are estimated to be around $500,000 each year. No additional working capital is needed after year 5. In previous years, the total dividend paid was around $360,000 per year

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