Post Pitch (abbreviated version)

Major Drugs

Historically, the major drugs industry has fought patent expiration and a weak product pipeline by acquisition. Between 2000 and 2010, several major acquisitions took place that changed the competitive landscape of the industry. Much of the acquisition strategy was to refill product pipelines and defend revenues against cheaper generic drugs entering the marketplace. Pfizer, Merck, and Bristol Myers Squibb all made significant acquisitions. Over the past two years, some of the best selling drugs in history have come off patent, and that impact is only now beginning to be reflected in these company’s income statements.

Notable drugs losing patent protection:

·         Pfizer: Lipitor (world's #1 selling drug) (off patent 2012)

·         Abbott: Humira (world's #2 selling drug) (off patent 2013)

·         Bristol Myers Squibb: Plavix (off patent 2012)

·         Forest Labs: Lexapro (off patent 2012)

And while the knowledge of these drugs coming off patent has been known for several years, the issue has only recently come to the forefront, albeit without slowing the pharmaceutical industry's overall stellar recent performance.

With such a long time horizon for potential drugs to reach the marketplace, major drug companies have very few options to grow organically, and therefore must return to their acquisition model for revenue growth. While these purchases can be accretive to diversifying revenues, it also creates a bloated, complex company with an inevitable conglomerate discount. This leads to firms, while biding their time between purchases, to digest their acquisitions and look for ways to return capital back to shareholders; either through payouts (dividends and buybacks) or financial engineering (asset sales and divestitures). 

In the 2000’s Pfizer went on an acquisition spree that ended up making it the largest drug manufacturer in the world. Since that period, Pfizer has undergone several divestitures and increased its dividend and buyback policy significantly. There has even been discussion of the possibility of splitting the firm in two, similar as to what Abbott Laboratories completed this year; one consisting the R&D, patent protected drug portfolio, and the other the generic drug manufacturing.

   

More recently, these same firms have been divesting unwanted assets to better manage their larger companies, and shoring up cash for another round of significant investment. Several major restructurings have taken place in the last 3 years:

·         Abbott Laboratories: Complete split into 2 separate firms: patent protected and generic business

·         Pfizer: Sale of division by IPO, asset sales, increase buyback and dividend

·         Bristol Myers:   Spin off unit, asset sales

Regardless of whether Pfizer makes a decision, the major drug manufacturer’s cash hoard is at record levels. Nearly $70 Billion sits on the balance sheet of Pfizer, Merck, Eli Lilly and Johnson and Johnson combined. With these companies in the same competitive landscape, and all being affected by a patent loss and an insufficient product pipeline to replace the golden period of patent drugs, it can be expected that there will be a return to the acquisition spree in the future for the major drug companies.

With the aforementioned focus on acquisitions, an emphasis should be placed on the Biotechnology sector. There are very few other sectors for drug manufacturers to acquire from when looking to replace a large portion of revenues. While the investment in an individual Biotechnology firm can be akin to purchasing a lottery ticket due to the unpredictability of drug regulation, approval and effectiveness, a holding of small or mid capitalization Biotechnology index would appear attractive.

100K email

A few months ago I ran into a old professor. We had a nice quick conversation, and at the end, he asked me what to do with some of his free cash. I gave him my best idea at that time in a 5 minute pitch. I hadn't heard from him since but today I got a email saying he purchased $100K worth of shares in my suggestion about a month ago. I was so astounded while reading the email I couldn't stop smiling. Talk about a vote of confidence.

Premature Accumulation

Lots of men suffer from it. Your partner will put on a brave face for you, tell you your doing fine, but they notice it as well. It been a problem for men for a long, long time. It affects young men, old men, experienced men; in effect, all men. Tempers flare when the issue is brought up. It can cause your partner to be unsatisfied with your relationship, and your ego be left bruised. Untreated, it can lead to a lack of success and happiness.

Yes, I am talking about...premature accumulation. Noted sufferers of the syndrome include Bruce Berkowitz of Fairholme Funds.

There is a solution though. Its simple and straightforward in concept. It is anything but easy to implement.

The action plan involves two steps.

Step 1: Have cash of hand.

Step 2: Follow Seth Klarman's advice. "Value…is not quite enough. Buying low is a start…but you need the patience, discipline and grit to buy lower and still lower if the opportunity presents itself, shutting out the extraneous noise coming from within the market and over the airwaves.”

That is all there is to it. Your premature accumulation problems have been solved. And you didn't even have to talk to your doctor.

Lotta Value

Loews has completely revamped and re branded its corporate website and corporate mascot. It seems their years of subtly explaining corporate value are gone. I do really wish that they would quite bringing up their 1990's tanker purchases. Yes, I understand you got a good deal. But what have you done for me lately? The biggest financial collapse since the great depression came and went, and I didn't see a single purchase made. Come on now.

Einstein

"It's not that I'm so smart, it's just that I stay with problems longer."

I think this applies directly with investing. If you look at the great investors out there, time and dedication has been spent understanding their investments.

Toyota Industries

There have been many cases where a growing economy have not led to gains in the accompanying stock market. Japan over the last 20 years is a perfect example of this. With the Bank of Japan's decision to deliver unparalleled monetary stimulus, the Japanese economy has received quite a bit of recent attention. Considering the 75% decline over the last 20 years in the Japanese equity markets, the recent run-up still leaves a lot of room for recovery.

I came across the investment thesis of Toyota Industries in Orbis Funds 2012 annual report. I found it absolutely fascinating. Definitely worth taking a look at.

http://www.orbisfunds.com/Reports/Orbis%20Equity%20Annual%20Reports%202012.pdf