Forest Labs - The Wall Street Journalonline.wsj.com/public/resources/documents/MarisAnalyst1027.pdf · 4.01.2010 · which Forest Laboratories sells. The company also faces competition

The group of companies that comprise CLSA are affiliates of Calyon Securities (USA) Inc.

Please see important disclosures on pages 32 - 33.

A bridge too far: initiatingcoverage with a Sell ratingForest Labs has a low PE multiple, strong cashflows, no debt and a

robust pipeline. However, looming patent expirations, deteriorating core

products and Street models that appear to unrealistically forecast SG&A

and R&D expenses dramatically declining in patent expiry years suggest

investors are better off waiting for the pipeline to mature or shares to

get cheaper. A potential activist could be hovering, which is an upside

risk. We initiate with a SELL and a DCF-derived target of US$28, implying

13% downside.

Cheap, but for big reasons

Forest trades at 9.6x earnings and 2.4x sales on CY09CL and has US$10 per

share in cash and no debt. However, in the next five years, two products

representing 87% of current sales go off patent and, often overlooked, core

trends for these key products appear weak. In our view, the in-license model is

not scalable and Forest is seeing the downside of success in this model.

Core trends are mostly poor

Several of Forest's core products do not appear to be performing well, with

volume declines recently accelerating for Lexapro and growth slowing for

Namenda. This may be related to resources being diverted to Savella, launched

in April, and some modest formulary changes with Lexapro. Is the issue sales

management or promotion sensitivity to the current line-up?

Pipeline - Good, but no major products

With core products fading now and facing generics in a few years, the company

is hosting an R&D Day on 7 January. We believe that Forest's pipeline has hits

and misses, but will not bridge the gap caused by the patent cliff. We provide

three proprietary physician surveys on Daxas and linaclotide, which lead us to

forecast modest sales for Daxas and moderate sales for linaclotide. We also

highlight the one question to ask on the R&D Day.

Field of Dreams approach not our style

We like the movie Field of Dreams, but we do not use it as a blueprint to model

companies. We believe that some Street models have placeholders for phantom

products that have yet to be acquired and SG&A and R&D expenses declining

during the patent expiry years - something management has stated will not

happen. With a potential activist hovering and plenty of potential deals in the

space, some may want to stick around. However, we would lighten positions into

the strength and initiate coverage with a SELL rating and a US$28 target price,

based on our discounted cashflow (DCF) model.

Financials

Year to 31 Mar 08A 09A 10CL 11CL 12CL

EPS ($) 3.06 2.96 3.46 3.89 4.39

CL/consensus EPS (%) - - 100 103 108

EPS (% YoY) NM (3) 17 12 13

PE (x) 10.5 10.8 9.3 8.3 7.3

Source: Calyon Securities (USA); FactSet for consensus data. CL = estimate

Forest Labs$32.11 - SELL

David [email protected]

(1 212) 261 7268

Kim [email protected]

(1 212) 261 7148

Milind [email protected]

(1 212) 408 5828

4 January 2010

USAPharmaceuticalsReuters FRX

Bloomberg FRX

Priced on 31/12/2009

S&P500 1,115

12M hi/lo $32.76/$18.37

12M price target $28.00

±% potential -13%

Target set on 04/01/2010

Shares in issue (m) 302

Free float (est) (m) 299

Market cap (m) $9,697

3M avg daily vol 2,294,165

Q1 Q1 Q2 Q312

16

20

24

28

32

36

2010

1 Year Price History for FRX

Created by BlueMatrix

2 [email protected] 04 January 2010

Forest Labs - SELL

Swot analysis Strengths Weaknesses

Solid position in central nervous system disorders (CNS) with leading products in Alzheimer’s Disease and anti-depressants.

A large mid- and late-stage pipeline of products with multiple potential catalysts ahead in 2010. We do not see any significant approvability risk to several of the leading pipeline programs.

A large and capable sales force.

No debt and large cashflow.

The company has patent expiries in the next several years on products that represent >80% of current sales.

The company does not have deep experience in corporate acquisitions, which raises integration risk for any potential deals.

The company has had a number of major R&D setbacks, which raises the issue of target identification.

Core product trends have recently weakened.

Opportunities Threats (risks)

Build out the company’s research capability and move beyond in-licensing.

Several late stage R&D programs could help establish the company in new therapeutic areas, such as gastrointestinal and respiratory; this could open up additional in-license opportunities.

The company is building a pipeline of 2010-14 launches; any setbacks to the pipeline could be material.

The number of products being developed in areas in which Forest is actively researching and new products could impact the market for Forest products.

Valuation history

PE bands PB bands Comment

min6.2x

31.5x

avg56.9x53.4x

max276.7x

2

6

20

65

210

Dec99 Dec01 Dec03 Dec05 Dec07 Dec09 Dec11 Dec13

log

So urce: IB ES

min1.56x

2.58x

avg3.61x

16.69x

max29.77x

4

14

53

200

720

Dec99 Dec01 Dec03 Dec05 Dec07 Dec09 Dec11 Dec13

log

Source: IB ES

Forest trades at 8.6x CY10CL PE, while its peer group trades at a median 9.7x and mean 10.0x, implying an approximate 10-15% discount for Forest. While the shares appear to be trading at a historical low PE, we believe that given its upcoming patent expiries, a PE methodology is not the most appropriate way to value the shares.

Bands (from the top): max, +1sd, avg, -1std, min.

Forest Lab - US$32.11 - SELL The business Competition & market franchise

Forest Laboratories and its subsidiaries develop, manufacture and sell both branded and generic forms of ethical drug products. The company’s current revenue drivers are Lexapro for depression, Namenda for Alzheimer’s Disease, Bystolic for hypertension, and Savella for fibromyalgia. The company’s business model has primarily focused on developing products in collaboration with licensing partners.

The pharmaceutical industry is highly competitive as to the sale of products, research for new or improved products and the development and application of competitive drug formulation and delivery technologies. There are numerous companies in the USA and abroad engaged in the manufacture and sale of both proprietary and generic drugs of the kind which Forest Laboratories sells. The company also facescompetition for the acquisition or licensing of new product opportunities from other companies. Among Forest’s competitors are Pfizer, Lilly, Merck, GlaxoSmithKline, AstraZeneca, Bristol Myers, King and Cephalon.

[email protected] January 2010

Section 1: Cheap, but for big reasons Forest Labs - SELL

Cheap, but for big reasons Forest today looks very different from just a few years ago when it had the world by the tail, having successfully launched the blockbuster Celexa and then as a follow-on, its son-of-Celexa Lexapro. But, in many ways, it is the same: the same strategy of in-licensing products from overseas companies and the same investor enthusiasm for yet-to-be-approved pipeline products.

In two ways, though, it is very different. The stock is much lower than it was five years ago, and the company is much closer to the time period in which two major products lose patent expiry. We believe Forest has done an admirable job in building a pipeline to help offset the impact of these expiries, but we do not believe Forest will be able to bridge the gap of lost revenues with what is in the pipeline now.

The phrase ‘a bridge too far’ comes from a book and movie of the same title, both about the failed attempt by the Allied forces in World War II to drop 35,000 troops behind enemy lines, capture key bridges and hold the positions for ground forces to come later. The exact derivation of the phrase is believed to have come from British Lt. General Frederick Browning, deputy commander of the First Allied Airborne Army, who thought the operation was too challenging to succeed, telling Field Marshal Bernard Montgomery before the operation, ‘I think we may be going a bridge too far.’

While we do not believe Forest is overreaching - in fact, it appears to be doing many things right - we believe the Street might be giving too much credit for the pipeline and for flexibility in spending that simply is unlikely to be there when some are predicting it.

Forest is a specialty pharmaceutical company that specializes in in-licensing drugs from overseas mid-sized drug companies and selling them in the USA. Oftentimes, these are opportunities that are too small or late-in-class drugs that large-cap drug companies pass on but Forest sees the clinical opportunity that others do not see.

To us, the Forest story is simple. The company has matured, on the level part of its S-curve and has a largely non-scalable business model facing patent expiries. The massive success of Lexapro and Namenda and their pending patent expiries create a revenue and earnings gap in the next few years that is, in our opinion, too large to fill with the good pipeline it has given its cost structure.

Forest is very different from just a few years ago,

but its strategy is the same

We do not believe Forest will be able to bridge the

gap of lost revenues

Forest is doing many things right, but the Street might be too

optimistic



Figure 1

Forest Labs sales and growth trends

17.9 16.211.5

7.3 6.19.2

(4.8)

(18.0)

2.33.9

(35.2)

(6.2)

1,500

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Source: Company, Calyon Securities (USA)

Forest began to run out of steam in 2004 when the pipeline accumulated a number of setbacks that occurred just as the leverage from a string of hits, such as Celexa, Lexapro and Namenda, started to diminish. During the same time, the president & COO and CFO left the company and the new president & COO, former head of R&D for Forest, took the helm.

As can be seen in Figure 2, Forest shares generally outperformed not when it had many pipeline opportunities, but when it had proven growth drivers in Celexa, Lexapro and Namenda. The figure also shows Forest’s mixed history of pipeline success. In other words, investors were rewarded after approvals without the approvability risk of the pipeline.

Figure 2

Forest - Share performance

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1/1/98 9/1/99 5/1/01 1/1/03 9/1/04 5/1/06 1/1/08 9/1/09

Celexa approved and launched

Namenda launched

Lexapro launched

Acamprosate failsLercanidipine gets "approvable letter"

Memantine (Namenda) for

neuropathic pain fails

FDA requests new trials for Lercanidipine

Dexloxiglumide program is discontinued

Neramexane fails Phase

Lexapro fails to win Panic Disorder and Social Anxiety

Disorder sNDAs

Milnacipran fails a

Phase III trial

Desmoteplase fails PhII/III

Desmoteplase PhII/III halted

Aclidinium Phase III is mixed, in Street's view

Oglemilast fails PhIIb in COPD

Source: Calyon Securities (USA), FactSet, company

Forest began to run out of steam in 2004

Shares outperformed when it had proven

growth drivers in Celexa, Lexapro and Namenda

(US$)

The challenge for Forest is what happens in 2013

and beyond



How big is Forest’s patent expiry problem? In simple terms, it is big:

Lexapro, which represents 59% of our FY10 current product sales estimate, faces patent expiry in 2012.

Namenda, which represents 28% of our FY10 current product sales estimate, faces patent expiry in April 2015.

Savella, launched earlier this year, represents approximately 1% of our FY10 current product sales estimate, has exclusivity for four more years and uses patents that expire in 2021, but we are uncertain to the timing of composition of matter patent term expiration.

Figure 3

Forest 2010CL sales by product – Patent expirations

Other

Savella (2014/2021)

Bystolic (2020)

Lexapro (3/2012)

Namenda(2015)

Source: Calyon Securities (USA)

In addition, Forest also receives co-promotion contract payments related to Benicar which expire in 2014. The active co-promotion portion of the deal expired in 1Q09, so now the deal enters a period in which Forest will receive declining royalties, without marketing the product, through March 2014, when it will end. This is yet another headwind, as in 2009, Forest had none of the sales force expense, but had the royalty. Now in each year until the complete expiry in 2014, the royalty will decline.

Strategy We believe what is hurting Forest is something that it cannot do much about, if it continues to focus on in-licensing late stage molecules. This area has become very crowded with large-cap pharmaceutical companies, and mid-cap pharmaceutical companies elbowing each other for the privilege to overpay for a product in development. In turn, both are having to look earlier in the development drugs, and as this happens, the risk profiles increase and the costs go up.

We believe this is a typical non-scalable business model facing the problem of success with some large products that are beginning to fade. Strategically, we believe the company is faced with two essential options: Continue this strategy but with a greater number of products in-licensed or develop a deeper original research capability, a la Merck or Pfizer. Both have issues:

Increasing the number of in-licensing. As we indicated earlier, the problem is that it is a strain on resources, and increasing the number of in-licensed programs which, on average where the supply has dropped

A typical non-scalable business model with

products beginning to fade

We believe Forest’s patent expiry problem

is big

In-licensing late stage molecules has become

crowded

Not a patent expiry, but Forest will receive declining Benicar

royalties through Mar 14



and demand has increased, is likely to result in either lower quality deals or less attractive terms.

Deeper research capability. Forest has attempted this strategy with the establishment of Forest Research Group a few years ago, but this is something that is very difficult to do on general physician target programs when the competition is Pfizer or Merck. In addition, one needs a research culture and not a sales culture, something we believe is admirably being tried at Forest and has taken root in some small way, but has not permeated the company.

Cheap on some metrics An earnings yield of 10% and an ROE of 17% appear attractive, especially in light of US$10.16 in cash per share, but these should be balanced with the pending patent expiries.

Forest’s 10.3% earnings yield is high among specialty pharma peers, although low versus large-cap pharma peers.

Forest spends in line with other leading companies in terms of R&D, at nearly 21% of sales.

Forest has among the highest return on sales at nearly 19%, which is even more impressive to us given the high R&D spending.

Its Ev/Ebitda is among the lowest among specialty pharma peers, at 4.9x.

Figure 4

Comp table Price as of

12/31/09 09CL PE Earnings

yield (%)Ev/

EbitdaROS (%)

R&D as % of sales

ROIC (%)

ROE (%)

Cash/share

Forest Labs (FRX) 32.11 9.6 10.4 5.1 18.6 20.7 11.8 17.2 10.16

Cephalon (CEPH) 62.42 10.4 9.6 5.8 13.0 19.3 10.9 15.1 21.23

Endo (ENDP) 20.52 7.6 13.2 4.3 13.9 11.6 15.9 16.6 5.41

King (KG) 12.27 11.4 8.8 5.7 (28.0) 6.2 7.3 (18.6) 2.10

Medicis (MRX) 27.05 17.1 5.8 6.9 5.4 19.5 5.8 4.5 8.35

Warner Chilcott (WCRX)

28.47 15.9 6.3 10.8 41.1 6.3 7.9 24.3 3.00

Pfizer (PFE) 18.19 9.0 11.2 5.1 17.8 16.0 11.3 12.1 6.50

Merck (MRK) 36.54 11.2 8.9 10.2 34.5 22.5 12.3 37.9 10.55

Note: PE and Ebitda based on forward year consensus estimates except for Forest Labs. ROS, ROIC, ROE, R&D as % of sales based on LTM. Priced as of 31 December 2009. Source: Calyon Securities (USA), Capital IQ

We believe that the combination of the earnings yield and ROE, plus the flurry of pipeline information and low multiple, is driving investor attention to Forest shares. Many probably view the pipeline as a free option at these levels.

Forest has an attractive earnings yield, ROE and cash per share of US$10

Forest spends in line with other leading companies

in terms of R&D


Section 2: Core trends are mostly poor Forest Labs - SELL

Core trends are mostly poor Unfortunately, many of Forest’s core product trends are also weakening into the patent expiry, making the goal of fitting products into the patent expiration bucket more difficult.

Lexapro represents approximately 59% of our FY10 product sales estimate. Trends are poor and recently appear to be weakening further.

Figure 5

Lexapro new prescription volume and market share

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Forest Labs NRx market share (RHS)

(Rx's) (%)

Source: Calyon Securities (USA), IMS Health

Figure 6

Lexapro weekly prescription growth (YoY rolling 8-week average)

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(%)


Namenda, which represents approximately 28% of our FY10 product sales estimate, is also experiencing a rapid and unexplained slowdown. Having spent most of the year in the 12-16% prescription growth range, the product has recently dropped below the 10% YoY growth level - or nearly a 40% drop in growth since mid-2009.

Many product trends look poor

Lexapro represents approximately 59% of

product sales

Namenda growth peaked in mid-09 and now seems

to have fallen out of bed

Weekly prescriptions show a recent

acceleration of the decline


Section 2: Core trends are mostly poor Forest Labs - SELL

Figure 7

Namenda weekly new prescription growth (YoY rolling 8-week average)

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Multiple product marketing – Is the sales force capable? We are concerned that the accelerated decline in Lexapro and the slowdown in Namenda came just a couple short months after Forest launched Savella, its new treatment for fibromyalgia. Is Forest’s sales force capable of marketing multiple products to multiple physician groups without losing traction? Are the products so promotion-sensitive that they rely on constant sales promotion?

While this concern is important for the near term as Forest continues to market Savella and its two flagship products are losing ground, we are more concerned what this means for the future pipeline that is full of products that will need to be detailed to physician groups and that Forest representatives have not detailed to before. If Forest’s sales force is too thin or not capable to manage Savella and maintenance details on Lexapro and Namenda, marketing an irritable bowel syndrome (IBS) drug to gastroenterologists (GIs) and internists, a hospital antibiotic to infection specialists and chronic obstructive pulmonary disorder (COPD) therapies to pulmonologists and family practitioners might be beyond the company’s current capabilities. Such a scenario seems understandable and coincides with the company’s comments not to expect massive sales force reductions when Lexapro goes off patent. It will be important to determine whether this is a capacity or capability issue.

Is Forest’s sales force capable of marketing

multiple products?

When they launched Savella, they started

losing ground on core products

Namenda recently dropped below the 10%

YoY growth level


Section 3: Pipeline - Good, but no major products Forest Labs - SELL

Pipeline - Good, but no major products One area where we differ the most from the Street regarding Forest is the pipeline assessment, which we think is promising, but more modest in comparison to Street expectations.

Specifically, we believe linaclotide, Daxas, aclidinium and ceftaroline will each have peak sales of US$100-400m, while the Street have ranges of US$1-2bn for some of these products. In addition, while financial details have not been disclosed, many are assuming the products have similar profitability of the existing marketed products. While we have no reason to believe that these products will have dramatically different profitability, we note that 1) they could, and 2) several of these are going to specialist markets that Forest has little to no experience selling into.

Nonetheless, we believe Forest rightfully deserves kudos for attempting to build a credible pipeline. We believe the pipeline is very good for an in-licensed pipeline, but point to the problem of the crowded in-licensed market - the most innovative drugs are competitive markets and without a research culture, innovation is difficult to buy.

We note that most of the terms for the deals in the pipeline have not been disclosed, so we and the Street are assuming the deals are similar to what we have seen before, which may not be the case given these are later stage compounds.

Figure 8

Pipeline overview - Lots of shots on goal

Product Phase Est launch

Est Peak sales

(US$m)

Comment

Linaclotide - CC/IBS-C III 400 Amitiza, a US$250m product, seems to have a better effect, although additional IBS-C data in mid-10 may alter this view

Daxas - COPD adjunctive therapy

Filed 2010 300 May 2010 action date; Street high US$1.5bn sales estimate might be off by US$1-1.25bn; GI side effects, no effect on

exacerbations in severe patients; a-fib seen in treatment arm a wildcard

Aclidinium - COPD III 2013 100 - 250 Filing in late-11/early-12; looking at combinations as well; PIII COPD data 1Q10

Ceftaroline - CAP and SSTI Pre-filing 2011 250 To be filed by year-end 09Cariprazine - Schizophrenia, bipolar mania and other CNS indications

IIb 2013 Fixed dose data due 4Q09; 2010 PIII begins for Schizophrenia/Bipolar mania; Still in Phase II for MDD

Adjunctive/Bipolar Depression Levomilnacipran III 2011 Summer 09 start of PIIIF2695 – nSSRI III Dec 08 in-licensed from Pierre FabreDutogliptin - DPP4 for Type II diabetes

III 2015 1 Phase III start Phase III began in mid-09; 1st PIII data in 2Q10

Radiprodil (RGH-896) - Pain II 2015 Phase II data 1H10Oglemilast - COPD II Failed Failed in COPD; Data 1Q10 from partner Glenmark in asthmaBystolic – CHF Market 2010 CHF indication; March 2010 action dateSource: Calyon Securities (USA), company

Forest rightfully deserves kudos for building a credible pipeline . . .

Unlike the Street, we don’t believe Forest has any US$1bn products in

the pipeline

. . . but it’s just not enough



Linaclotide - Good, not great Linaclotide is a product for chronic constipation and irritable bowel syndrome with constipation (IBS-C).

Nutshell: Based on our assessment of the clinical data and interviews with physicians, we believe that linaclotide, if approved, will not be the US$2bn drug some have suggested.

We believe that linaclotide might offer a benefit versus Sucampo’s Amitiza, a US$250m product, but the clinical data so far does not point to a clear benefit. It appears this is another product in a market that needs additional products given patients’ non-response to many treatments.

In clinical data announced in early November 2009, linaclotide was shown to be effective in two separate Phase III trials, showing that it improved the signs and symptoms of chronic constipation (CC).

In Trial 01, the overall responder rate was 16% in the 133 mcg dose, 21.3% in the 266 mcg group. A 12-week CSBM overall responder was defined as a patient who had three or more complete spontaneous bowel movements (CSBMs) per week and an increase of at least one CSBM per week over baseline for at least nine of the 12 weeks of the treatment period. During the baseline period, 72% of patients had no CSBMs.

A total of 16.0% (p=0.0012) of patients receiving 133 mcg and 21.8% (p<0.0001) of patients receiving 266 mcg of linaclotide experienced ≥3 weekly CSBMs in at least nine out of 12 weeks as compared to 6.0% of patients receiving placebo. In addition 31.0% (p<0.0001) of patients receiving 133 mcg and 40.1% (p<0.0001) of patients receiving 266 mcg of linaclotide achieved an increase of ≥1 from baseline in weekly CSBMs in at least nine out of 12 weeks as compared to 13.0% of patients receiving placebo.

Linaclotide-treated patients demonstrated a significant increase in average weekly CSBMs from baseline (0.6 for placebo; 2.0 for 133 mcg, p<0.0001; 2.7 for 266 mcg, p<0.0001) and a significant increase in average weekly spontaneous bowel movements (SBMs) from baseline (1.1 for placebo; 3.4 for 133 mcg, p<0.0001; 3.7 for 266 mcg, p<0.0001).

In the second trial (Trial 303) released in November 2009, there was no clear dose response, with the 12-week CSBM overall responder rate of 21.2% in the 133 mcg linaclotide and 19.4% in the 266 mcg linaclotide group.

A total of 21.7% (p<0.0001) of patients receiving 133 mcg and 19.4% (p<0.0001) of patients receiving 266 mcg of linaclotide experienced ≥3 weekly CSBMs in at least nine out of 12 weeks as compared to 3.8% of patients receiving placebo. In addition 39.2% (p<0.0001) of patients receiving 133 mcg and 37.0% (p<0.0001) of patients receiving 266 mcg of linaclotide achieved an increase of ≥1 from baseline in weekly CSBMs in at least nine out of 12 weeks as compared to 11.0% of patients receiving placebo.

Linaclotide-treated patients demonstrated a significant increase in average weekly CSBMs from baseline (0.5 for placebo; 1.9 for 133 mcg, p<0.0001; 2.0 for 266 mcg, p<0.0001) and a significant increase in average weekly

Linaclotide is unlikely the US$2bn drug some have

suggested

Linaclotide was shown to be effective in two Phase

III trials for CC

In one trial, the overall responder rate was

21.3% in the high dose group

In the second trial, there was no dose response, but a 19.4% responder

rate



SBMs from baseline (1.1 for placebo; 3.0 for 133 mcg, p<0.0001; 3.0 for 266 mcg, p<0.0001).

Across both trials, the most common adverse events in linaclotide-treated patients were diarrhea, flatulence and abdominal pain. Overall rates of discontinuation due to adverse events were 7.4% for linaclotide and 4.2% for placebo.

While not directly comparable as they were not head-to-head trials and had different study designs, we consider Amitiza as a good proxy for linaclotide. Amitiza showed in a similar patient population an approximate increase of four SBMs from baseline versus the 2-2.7 CSBMs shown with linaclotide. We also note that the SBM measure of Amitiza’s trial differs slightly from the CSBMs of the linaclotide trials.

As a result, we believe that from a commercial basis, with no previous experience selling into GI, Forest will have its work cut out for itself in marketing linaclotide as anything better than good additional therapy and not a groundbreaking new addition to the current standard of care.

Linaclotide survey results. We conducted a survey of 25 physicians (16 gastroenterologist and nine internal medicine physicians). Provided with the data from the Phase III chronic constipation data released in November 2009 and recalling other additional information they had previously gathered from linaclotide, physicians were on average impressed with the data on the drug thus far.

In evaluating the responses of the sample, all but one physician believed that the Phase III IBS-C data coming in mid-2010 would be successful.

Figure 9 illustrates how irritable bowel syndrome-constipation (IBS-C) is often a more complicated condition to treat than is CC. Because of this, we believe the data that is expected in mid-2010 is key to the commercial success of linaclotide.

Figure 9

When you consider chronic constipation versus irritable bowel syndrome-constipation, is one more challenging to treat than the other? If so, which one?

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CC

IBS-C

Same

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Overall rates of discontinuation due to

adverse events were 7.4%

We conducted a survey of 25 physicians

IBS-C is often a more complicated condition to

treat than is CC



In our survey, we wanted to explore the current prescribing patterns of physicians to assess where linaclotide would fit into treatment regimens, if eventually approved by the FDA. With Amitiza being the only prescription drug on the market approved for both CC and IBS-C given the removal of Zelnorm from the market in 2007, much of our survey sought to explore how physicians viewed linaclotide given Amitiza’s availability on the market today and how they remember using Zelnorm.

As Figures 10-11 illustrate, Amitiza is used more often in CC than in IBS-C. We also note that because IBS-C has a pain component to the disease, other prescription drugs such as anti-spasmodics and selective serotonin reuptake inhibitor (SSRIs) are given in combination with treatments that help with constipation.

Figure 10 Figure 11

What treatments or drugs tend to work for your patients in the treatment of CC?

What treatments or drugs tend to work for your patients in the treatment of IBS-C?

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0 10 20 30 40 50 60

Anti-spasmodics

Senna

Colace

Laxatives

Fiber

Miralax

Amitiza

(%)


Figure 12

Do you prescribe Amitiza?

79

21

0 10 20 30 40 50 60 70 80 90

Yes

No

(%)


79% of our sample prescribes Amitiza in their practice, but based on their responses on how they view the drug, it seems as if there are needs that perhaps another market entrant could provide. Overall, physicians felt Amitiza was good or mostly effective, but nearly all noted that it worked well in only a segment of their patients - certainly not the majority. Physicians noted that

Much of our survey sought to explore how

physicians viewed linaclotide and Amitiza

79% of our sample prescribes Amitiza

Amitiza is widely prescribed



nausea and vomiting are often cited by patients as side effects and in rare cases there have been complaints of chest pain. Physicians were positive on Amitiza’s easy, oral dosing and the fact that it provided them with a prescription option to address the condition.

Among our physician sample, Amitiza is prescribed in 20% of IBS-C patients. In determining what it would take for linaclotide to be more successful drug than Amitiza, physicians asked for a drug with the following attributes:

Once daily dosing

Fewer side effects/better safety data - primarily less nausea, but also less bloating, less dyspnea and chest pain

Higher response/success rate than Amitiza

We asked physicians if they believed linaclotide had the potential to have more commercial success than Amitiza. Of the 16 physicians who answered this question, 69% believed that linaclotide had this potential primarily because of the more favourable side effect profile they had seen thus far in the trials.

Figure 13

Based on the data you have seen thus far regarding Linaclotide and your experience with Amitiza, do you think it has the potential to be more successful than Amitiza?

69

6

25

0 10 20 30 40 50 60 70 80

Yes

Too early to tell

Maybe

(%)


69% said that linaclotide had the potential to

outsell Amitiza based on side effect profile

Amitiza is prescribed in 20% of IBS-C patients

Most doctors believe linaclotide will top

Amitiza



Figure 14

Before it was taken off the market, did you prescribe Zelnorm?

76

24

0 10 20 30 40 50 60 70 80

Yes

No

(%)


76% of our sample was Zelnorm prescribers before it was taken off the market. Because we are trying to evaluate where on the spectrum linaclotide might fall relative to Amitiza and Zelnorm, we wanted to learn more about how physicians used Zelnorm.

On average, physicians prescribed Zelnorm in 43% of their IBS-C patients. This compares to the 20% of IBS-C patients that physicians said they currently prescribe Amitiza.

To be more successful than Zelnorm, physicians believed that linaclotide would have to be more efficacious and, most importantly, safer than Zelnorm (ie, no cardiac effects).

As far as whether linaclotide has the potential to be more successful than Zelnorm, 72% of physicians said the potential existed. However, we note that 11% of physicians said it did not have the potential. When we posed the same question to physicians with respect to Amitiza, every physician believed that linaclotide would be as good as Amitiza.

Our experience is that physicians often are optimistic about drugs that they have yet to use.

Every doctor believed linaclotide will be at least

as good as Amitiza

76% of our respondents prescribed Zelnorm

We wonder if linaclotide is more like Zelnorm or

Amitiza



Figure 15

Based on the data you have seen thus far regarding Linaclotide, do you think it has the potential to be more successful than Zelnorm?

72

11

6

11

0 10 20 30 40 50 60 70 80

Yes

Maybe

Unclear at this time

No

(%)


While we see that linaclotide has an opportunity to help fill an unmet need as Zelnorm was pulled off the market years ago, we wanted to understand why it was that Amitiza has not been more successful given that it has no competitors on the market. We believe that understanding Amitiza’s position will help us understand the environment that Forest would likely be entering if linaclotide is successfully approved and launched. We asked physicians why given Amitiza’s lack of competition it has not been able to reach the success that Zelnorm had. The key issues cited were:

Weary/afraid of a Zelnorm situation (ie, another recall of a product)

Not as effective with gas and bloating or overall symptoms

Nausea and vomiting limit the use

Cost/insurance coverage

Less marketing

While we will have to wait and see on how the side effect profile will pan out for linaclotide, it seems clear that Amitiza’s incidence of nausea and vomiting and lack of broad-based efficacy on gas and bloating hold back some of its potential success. However, we note that the fact that physicians are afraid of a Zelnorm situation occurring again or that cost/insurance issues are a deterrent to prescribing will unlikely or should not necessarily change with linaclotide. There is no reason to believe that Forest would price linaclotide lower than Amitiza and we quite frankly see the fear of a Zelnorm situation occurring again as unfair to Amitiza as it is not a systemic drug - whereas Zelnorm was. Linaclotide, like Amitiza, is non-systemic, so it will be interesting to see whether physicians’ fears will dissipate by the time linaclotide comes to market in the 2011-12 timeframe.

Finally, we asked our physician sample in what percentage of CC/IBS patients they believed they would use linaclotide, if approved. On average, the answer was 36%. With a responder rate of approximately 20% in studies, this could point to approximately 7% of IBS patients being on linaclotide longer term,

Linaclotide has an opportunity to help fill an

unmet need

Forest might price linaclotide at a premium

Doctors said they would use linaclotide in 36% of

CC/IBS patients

72% of respondents believe linaclotide will be

more successful than Zelnorm



although it is not clear from the responses if the physicians were adjusting their answer for the likely responder rates.

Daxas: Filed - COPD Nutshell: We believe Daxas’ side effects and lack of effect on exacerbations will limit its use. Approvability as the first oral PDE4 drug for COPD is not assured, but if approved, we believe that it is not a major advance. Some on the Street see Daxas as a US$1.5bn-plus drug, but the company sees it as a US$400-500m product. We believe the Street’s high estimate is off the mark, and the company’s estimate is much more likely to be closer to reality. In our proprietary survey of 30 pulmonologists and 25 internists, the respondents expected to use the drug in 18-21% of patients on drug therapy.

Daxas is a once a day oral tablet PDE4 inhibitor and would be the first oral PDE4 approved for COPD if it receives regulatory approval. In trials, Daxas showed a reduction in moderate to severe exacerbations by 17% per patient per year (rate of 1.14 events per year with roflumilast versus 1.37 per year with placebo, p<0.001).

Historically, PDE4 inhibitors, despite broad anti-inflammatory properties, have been limited by side effects, suggesting oral therapy would not be effective.

In two previously published studies, Daxas was shown to improve lung function, but did not improve the number of exacerbations, although a subsequent non-predefined subgroup analysis showed that it did reduce the exacerbation rate for the most severe patients. In another study, Calverley et al. showed roflumilast had a positive effect on lung function and exacerbations on severe patients.

Based on the most recently published studies, roflumilast did not look that impressive to us. In the Calverley study, the data from two studies appeared more favourable to us than in the Fabbri studies, both published in the Lancet in August 2009.

Calverley presented two studies (M2-124 and M2-125) and showed that on a pooled basis of the two studies, Daxas statistically reduced moderate or severe exacerbations when moderate and severe exacerbations were a combined measure. However, this appears to be due solely to the reduction of moderate exacerbations as the Daxas failed to show a statistically significant when looking at severe exacerbations alone. In addition, the results in moderate exacerbations and perhaps the overall combined results seem to be partially driven by results that were much more significant in the m2-125 study.

In a separate article in the August 2009 Lancet, Fabbri et al showed that while Daxas had an effect on FEV1, the primary outcome, it had no statistical effect on reduction of number of exacerbations per patient. We believe that this is a critical secondary endpoint for physicians to decide to use the drug as adjunctive therapy. In addition, given the drug was more beneficial on the secondary outcomes in the tiotropium plus roflumilast trial than in the salmeterol plus roflumilast trial, its use might be further restricted.

We believe the GI side effects of Daxas might be its Achilles’ heel. The number of patients with adverse events that were judged by the investigator to be related to treatment was 18% with salmeterol and roflumilast, 3% with

Daxas is a once a day oral tablet PDE4 inhibitor and

would be the first approved for COPD

Daxas was shown to improve lung function,

but did not improve the number of exacerbations

August 2009 Lancet: Daxas had an effect on

FEV1, but had no effect on exacerbations

We believe the GI side effects of Daxas might be

its Achilles’ heel

Some on the Street see Daxas as a US$1.5bn-plus

drug - we think much, much smaller



salmeterol and placebo, 12% with tiotropium and roflumilast, and 2% with tiotropium and placebo. Approximately 8-9% of patients showed weight loss or diarrhea, and approximately 4-5% had nausea.

Black Swan: In the Calverley studies, atrial fibrillation was an infrequent complication reported by 17 (1%) patients in the roflumilast groups and seven (<1%) of those in the placebo groups. Numerically higher and something that could be problematic in a large patient population. Physicians asked about this were not concerned at the rate seen in the studies so far.

COPD is a big problem, but if approved, we do not think this will materialize as a major product - adjunct therapy for a small slice (10-15%) of patients, especially if the 18% adverse event rate continues.

Daxas survey results. We conducted a survey of 30 pulmonologists and 25 internal medicine physicians to obtain their views on Daxas. As way of background, we first sought to understand what percent of patients currently on Spiriva or Serevent were not well controlled. Not surprisingly, pulmonologists’ patients, on average, were less controlled likely due to the fact that pulmonologists see more serious patients.

Figure 16

What percent of your patients on Spiriva or Serevent are not well controlled?

(%) Pulmonologists Internal medicineMean 23 18Median 25 15Mode 30 10Source: Calyon Securities (USA)

Given that the data on exacerbations for Daxas is mixed when examining the improvement of lung function versus reduction of exacerbations, we asked physicians what metric they believed was more important of the two. Between both groups, reduction in exacerbations was seen as much more important than improvement in lung function when it came to judging efficacy of a drug.

Figure 17 Figure 18

Pulmonologists Internal Medicine

69

17

14

0 20 40 60 80

Exacerbations

Lung function

Equallyimportant

(%)

64

36

0 20 40 60 80

Exacerbations

Lung function

(%)


Reducing exacerbations was seen as much more

important than FEV

Atrial fibrillation was an infrequent complication

reported by 17 (1%) patients

Two surveys on Daxas - 30 pulmonologists and 25

internal medicine physicians



Regarding what physicians consider a meaningful improvement in exacerbations and lung function, the average responses are summarized in Figure 19.

Figure 19

What do you consider a meaningful improvement in . . .

Pulmonologists (%) Internal Medicine (%)Exacerbations (reduction) 33 48Lung function (improvement) 17 15Source: Calyon Securities (USA)

Early in our survey, we provided physicians with efficacy data regarding Daxas and asked based on the data, what percent of their patients they would prescribe Daxas as an adjunctive therapy.

Figure 20

What percent of your COPD patients would Daxas be used for adjunctive therapy?

Pulmonologists (%) Internal Medicine (%) 31 22 Source: Calyon Securities (USA)

Following this question, we presented physicians with details regarding the adverse event profile, specifically pertaining to the diarrhea and/or weight loss and the nausea. Given this information, we asked physicians if they would change how they prescribe this medication. Interestingly, the answers between the two physician groups was divergent, with pulmonologists seeing the adverse event profile as being significant enough to change their views on how they would prescribe the drug whereas the majority of internal medicine physicians saw the data as not significant enough to change their current view.

Figure 21 Figure 22


52

48

46 48 50 52 54

Yes

No

(%)

33

67

0 10 20 30 40 50 60 70

Yes

No

(%)


We also introduced the “Black Swan” issue, where 1% of Daxas patients reported atrial fibrillation. We indicated to the physicians that this complication had not been determined to be treatment related but wanted to learn whether this information was of any significance to the physicians.

Before knowing the side effects, doctors expected to use Daxas in 22-31%

of patients

Pulmonologists saw the adverse event profile as being significant enough

to change their outlook



Figure 23 Figure 24


74

4

22

0 20 40 60 80

Not significant

Not sure

Significant

(%)

48

52

44 46 48 50 52 54

Not significant

Significant

(%)


Once again, the divergence between the two physician groups was interesting as pulmonologists saw the atrial fibrillation complication as insignificant, while internal medicine physicians saw it as more concerning.

Finally, we asked physicians to consider all of the information provided and again to tell us what percentage of patients they would prescribe Daxas.

Figure 25

What percentage of your patients would you put on this drug?

(%) Pulmonologists Internal Medicine% on Daxas (before reviewing AEs) 31 22% on Daxas (after reviewing AEs) 18 21Difference (13) (1)Source: Calyon Securities (USA)

Regarding what more information physicians would on Daxas, the responses were typical for a relatively unknown drug that physicians have not yet had experience. Some of the most popular answers were:

Cost/formulary coverage

Long-term safety

Long-term efficacy

Drug-drug interactions

Quality of life scores

Aclidinium: Phase III - COPD Nutshell: We do not believe aclidinium will be much of a player in the treatment of COPD as it appears less efficacious and without the body of knowledge and use as Spiriva. In other words, there seems to be no reason a physician would use aclidinium given the availability of Spiriva.

In two studies first released in September 2008, Forest and its partner Almirall showed that aclidinium had a benefit on FEV1. In both studies, aclidinium therapy demonstrated a significant difference versus placebo in trough FEV1 at 12 weeks (p-value <0.001) and 28 weeks (p-value <0.001). The effect of aclidinium compared to placebo in trough FEV1 was maintained over one year (p-value <0.001). The improvement in the trough FEV1, at

We do not believe aclidinium will be much of a player in the treatment

of COPD

Internists saw the atrial fibrillation complication

as significant; pulmonologists didn’t

Doctors say they would put about 20% of patients

on the drug



week 12 and 28, of aclidinium arms compared to placebo was in the range of 60 to 70 mL in both trials. The change from baseline in peak FEV1 observed after dosing aclidinium compared to placebo at 12 and 28 weeks was between 153 and 177 mL (p-value <0.0001), with a median time to peak of two hours.

The magnitude of the bronchodilatory effect of aclidinium was lower than seen in previous studies.

The product failed to show a clinically relevant improvement in health-related quality of life compared with placebo in one of the two studies.

The product failed to show a difference versus placebo in delaying time to the first moderate to severe exacerbation in patients with COPD in ACCLAIM/COPD I, but did in ACCLAIM/COPD II. In the pooled analysis of both studies, the effect was also not statistically significant, although the sponsors claim it showed a trend toward significance.

Aclidinium showed a modest side effect profile, however, conflicting results in two COPD studies as well as missed endpoints make us sceptical. With what appears to be lower than Spiriva effect in exacerbations, we are sceptical on the commercial potential.

Aclidinium is scheduled to be filed in late 2011 or early 2012 according to Almirall, the company that licensed the product to Forest.

Oglemilast - PDE4 inhibitor failed in COPD; Let’s try asthma While there are many drugs that fail in one indication only to be successful in others, expectations are fairly low for Glenmark’s Oglemilast. The drug failed in COPD study in August 2009. At the time of that failure, Glenmark’s CEO indicated that while disappointing, investors were missing the potential for the drug in asthma and that data should be ready in December 2009 or January 2010. While Forest management has provided a broader timeline for the asthma data as being available in 1Q10, we suppose there is the possibility that the asthma data could be shared at the R&D Day.

The current asthma study details are as follows:

Eligibility criteria: Adult patients with a physician-documented diagnosis of chronic, stable, persistent, mild to moderate asthma (clinical symptoms and documented reversibility of airway obstruction, with an FEV1 of 60% to 85% of the predicted value).

The following criteria must be met at the randomisation visit:

At least 80% compliance during the single-blind placebo run-in period

FEV1 between 60% and 85% of the predicted value

Without asthma exacerbation during the run-in period

Reversibility: Patients are required to demonstrate a ≥ 12% increase in FEV1 (with an absolute improvement in FEV1 of at least 200mL) ≥ 10 minutes and up to 15 minutes after inhalation of 400 μg salbutamol via a spacer; any symptom score being ≥ 1 for at least 4 out of the last 7 days of the run-in; and use of salbutamol for symptom relief on > 2 occasions on at least 4 out of the last 7 days of the run-in. This drug is too early stage and not enough data exists for us to have a view of the clinical profile of the drug.

In one study, aclidinium failed to show a

difference versus placebo in delaying exacerbations

Oglemilast failed in a previous study for COPD

earlier in 2009

The data might be ready for the R&D Day in

January 2010 or shortly after


Section 4: Field of Dreams approach not our style Forest Labs - SELL

Field of Dreams approach not our style We think there is a fundamental flaw in the way the Street is modelling Forest over the long term and believe it is taking a page from the movie Field of Dreams – a ‘build it and they will come’ approach to modelling. That is, many seem to be looking at Forest’s pipeline, putting the products in the model, and then discounting the sales by some probability - say 20-50%, assuming this takes into account the time value of money and risk.

We have three major concerns regarding Street expectations for Forest:

1) Field of Dreams approach - Overly optimistic assumptions for sales of products over the long term not even being developed yet, products not in the pipeline but ‘to be identified later’

2) Assumption of large declines in R&D and SG&A expenses in patent expiration years (2013 and beyond), not taking into account product launches into markets that Forest has not launched into before and the non-variability of certain expenses (think Schering-Plough (SGP) with Claritin expiration)

3) The use of discount rates and not true probabilities

We underscore that we believe this is a Street issue, not a Forest issue. From what we can tell, the company does not endorse placeholders for phantom products or rapid drops in SG&A when Lexapro goes off patent, and in fact cautions against those that do. We address each one in turn:

Placeholders and phantom products The Street appears to be making some big assumptions about Forest’s pipeline. It assumes Lexapro and Namenda go off patent as expected, but that Forest absorbs this without hiccups to timing or spending with the launch of new products. Furthermore, the Street expects that spending moderates as a result of the patent expiries. What is surprising to us is that several models include major placeholders for products not even in the pipeline - products to be acquired. So without knowing the terms or knowing the spending requirements, the Street seems to be assuming that Forest will not only in-license additional products, but they will also be successfully developed, approved and have significant contributions.

We think it is unrealistic to have US$500m of sales projected to start the year after Lexapro goes generic, growing to US$1.6bn of new product sales for products to be launched between now and. We also disagree with any models that include US$600m in sales for “unidentified products” in 2016 - or products not in the pipeline that is just assumed to be purchased, launched and successful.

We disagree with Street models that assume Daxus can be a US$1.5bn drug or have US$3.0bn of new product revenue between now and 2015. Closing the gap with large sales numbers, accompanied by SG&A declining two percentage points in the terminal year, and R&D as a % of revenue dropping seem too optimistic to us.

We disagree with any Street models that have US$1.5bn of new product revenue between now and 2015, without any roadmap of how these revenues tie to product sales.

We think putting in phantom-acquired revenue is at the least an aspirational approach to modelling. Our model includes an incremental US$750m of

The Street is currently making some big

assumptions about Forest’s pipeline

We think putting in phantom-acquired

revenue is aspirational

Many on the Street put sales into the model for products that have not

even been in-licensed yet

We disagree with any models that include

US$600m in sales for “unidentified products” in 2016, products Forest has

yet to in-license

And think Daxas sales of US$1.5bn and US$3bn new product revenue

during the gap years is unrealistic



pipeline sales, but no phantom revenue from products not identified yet. Our pipeline revenues start in 2011 ramping up to US$750m by 2015. While we are more conservative than the Street, we believe this is more reflective of risk for each product.

For Forest to be able to buy US$600m or US$1bn of new products sales that is growing rapidly, we estimate that it would cost the company at least US$3-4bn, or all its cash - and this assumes no failures.

Unrealistic SG&A and R&D assumptions drive DCFs

‘. . . it’s important to keep in mind that as Lexapro and Namenda mature, don’t forget we’ve recently launched Bystolic last year, Savella this year, hopefully we will be in a position to launch Daxas when it gets approved, hopefully next year. And we’ve also filed - and we also plan to have filed by the end of this year, right around the end of this year, for Ceftaroline. So you’ve got four products in three years that are, either approved or in front of the FDA. So, expectations around SG&A, I would think that, we’d be doing a great job if we can keep it to inflationary increases.’

- Francis Perier, 20 October 09, Forest Labs quarterly conference call to investors

In addition to spikes in phantom product sales, some Street models assume substantial SG&A and R&D savings that we believe are unrealistic and also artificially boost DCF valuations. We estimate that the cost structure will not be nearly as flexible as people think - cutting salespeople while launching products is not a great strategy to assure a strong launch. However, much of the Street has built SG&A and R&D levels that look very flexible.

For example, we disagree with any Street models that call for R&D declining about 30% in the year Lexapro goes generic and SG&A declining by 50%, we think there should be no reason for R&D declining from one year to the next so dramatically and such SG&A adjustments would seem severe given the company’s plan to launch pipeline products. In addition, Forest’s sales force is geographically focused, so simply cutting a large part of the sales force would be disruptive.

In addition, we also disagree with any Street forecast that assumes gross profit margins spike from the current 78% level to about 80% by 2016. While this sounds minor, Forest has not had 80% gross margins in the past 10 years, and with no dramatic change to the business model, we are not certain this is reasonable. In addition, given the patent expiries, we would expect gross margin to decline, as the mix of partnered products increases.

Our model assumes that SG&A does not decline or drop off with the patent expirations of Lexapro in 2012 and Namenda in 2015 because of the need to keep the sales force to market Savella, Bystolic and other potential products that the company expects to get approved (Daxas in the spring, linaclotide couple years down the road, etc). In our conversations with management, it was our sense that our views on SG&A were in line with its current long-term plans.

We think the most important question to ask at the R&D Day on 7 January is ‘Does management expect to be able to dramatically cut SG&A and R&D during the patent expiry years, or will product launches during the period

But some Street models show substantial SG&A and R&D savings when

Lexapro goes generic

We disagree with any Street forecast for R&D

and SG&A to decline dramatically

We disagree with any Street forecast for gross

margins to spike

The one question to ask at the R&D Day

Mgt says investors should not expect major drops in SG&A and R&D expenses

in patent expiry years



necessitate keeping spending near current levels?’ We believe Forest management will clearly answer that dramatic cuts are not in the cards.

50% is not 3% Based solely on probabilities and not our assessment of individual pipeline opportunities, we believe Forest has a 90% chance of having one of its major pipeline programs face a significant delay or rejection. If we assume a 50% probability for either approval on time versus a delay or rejection on each drug in the pipeline, the probability of all being approved and launched on time is only approximately 3%, or a 97% likelihood of some sort of problem. If we assume that there is an 80% chance of approval on time, then the probability of all occurring only rises to about one-third. That is, if you bet against the pipeline happening on time, then you have, we estimate, about a two-thirds chance of being right. While we have attempted to identify areas of potential issues in the pipeline section, given Forest’s dependence on the overall pipeline happening at the right time, we are more cautious than peers.

This probability exercise is important because it highlights to investors that most Street models appear to be assuming a best-case scenario for Forest’s pipeline, and incremental setbacks would be subtracted from their base-case valuation expectations.

Estimates and valuation As we assess our estimates, there are several key assumptions and variables that could impact earnings, including new in-licensing opportunities with nearer-term launches as well as pipeline setbacks that could remove a product altogether from the model.

Figure 26

Fiscal year estimates

(US$m) 10CL 11CL 12CL 13CLRevenue 4,075.5 4,373.1 4,641.8 3,009.4EPS 3.46 3.89 4.39 1.00FCF 1,104.4 1,230.6 1,386.2 351.6FCF/share 3.64 4.06 4.56 1.15Source: Calyon Securities (USA)

Figure 27

Calyon versus consensus EPS

(US$) 10CL 11CL 12CL

Calyon EPS 3.46 3.89 4.39Consensus 3.46 3.78 4.06

Source: Calyon Securities (USA), FactSet

To us, most Street models are assuming a best-case

scenario for Forest’s pipeline

We estimate the probability of the pipeline

being approved and launched on time is only

approximately 3%

We are above consensus in the near term



Figure 28

Forest Labs income statement

(US$m) 2008 2009 10CL 11CL 12CL 13CL 14CL 15CL 16CLRevenue 3,836.3 3,922.8 4,075.5 4,373.1 4,641.8 3,009.4 3,286.4 3,129.1 2,565.8 Growth (%) 11.5 2.3 3.9 7.3 6.1 (35.2) 9.2 (4.8) (18.0)Cogs 800.1 816.7 879.3 924.4 974.8 662.1 723.0 688.4 564.5 Gross profit 3,036.2 3,106.1 3,196.3 3,448.7 3,667.0 2,347.3 2,563.4 2,440.7 2,001.3 Margin (%) 79.1 79.2 78.4 78.9 79.0 78.0 78.0 78.0 78.0 SG&A 1,154.8 1,303.3 1,260.4 1,321.7 1,346.1 1,354.2 1,281.7 1,282.9 1,257.3 % of sales 30.1 33.2 30.9 30.2 29.0 45.0 39.0 41.0 49.0 R&D 671.0 661.3 586.1 612.2 603.4 601.9 591.6 600.0 600.0 % of sales 17.5 16.9 14.4 14.0 13.0 20.0 18.0 19.2 23.4 Operating income 1,210.4 1,141.5 1,349.8 1,514.8 1,717.5 391.2 690.1 557.8 144.1 % of sales 31.6 29.1 33.1 34.6 37.0 13.0 21.0 17.8 5.6 Pre-tax income 1,210.4 1,141.5 1,349.8 1,514.8 1,717.5 391.2 690.1 557.8 144.1 Tax provision 242.5 240.2 299.3 335.9 380.8 86.7 153.0 123.7 31.9 % tax rate 20.0 21.0 22.2 22.2 22.2 22.2 22.2 22.2 22.2 Net income 967.9 901.3 1,050.5 1,178.9 1,336.7 304.5 537.1 434.1 112.1 Diluted EPS (US$) 3.06 2.96 3.46 3.89 4.39 1.00 1.75 1.41 0.36 Growth (%) 5.8 (3.3) 17.0 12.3 13.0 (77.3) 75.8 (19.4) (74.3)Shares out (diluted) (m) 316.1 304.4 303.3 303.3 304.3 305.3 306.3 307.3 308.3 Source: Calyon Securities (USA)

Our DCF results in a value of US$28.08 per share, which is 13% below the current share price. Our key assumptions are a 9.8% WACC, which is a FactSet-derived estimate, and an 8.3x terminal value, which results in a present value of the cashflows of approximately US$4.3bn and a terminal value of approximately US$1.3bn.

We use a terminal multiple of 8.3x, which is higher than our forecast of Forest’s TEV/LTM Ebitda of 7.6x, but in line with the mean TEV/LTM Ebitda of peer companies.

We have used discounted cashflow for our primary valuation approach as we believe that with Forest facing significant patent expiries over the next several years and having a strong balance sheet, other approaches, such as PE or PE/growth, are not appropriate.

Our DCF model results in a value of US$28.08 per

share

The terminal value is one-third that of the NPV of

forecast cashflows



Figure 29

DCF model

(US$m) 2008 2009 10CL 11CL 12CL 13CL 14CL 15CL 16CLNet sales 3,836.3 3,922.8 4,075.5 4,373.1 4,641.8 3,009.4 3,286.4 3,129.1 2,565.8 Growth rate (%) 11.5 2.3 3.9 7.3 6.1 (35.2) 9.2 (4.8) (18.0)Ebit 1,210.4 1,141.5 1,349.8 1,514.8 1,717.5 391.2 690.1 557.8 144.1 Margin (%) 31.6 29.1 33.1 34.6 37.0 13.0 0.0 0.0 0.0 Pre-tax income 1,210.4 1,141.5 1,349.8 1,514.8 1,717.5 391.2 690.1 557.8 144.1 Tax (242.5) (240.2) (299.3) (335.9) (380.8) (86.7) (153.0) (123.7) (31.9)Tax rate (%) 20.0 21.0 22.2 22.2 22.2 22.2 22.2 22.2 22.2 Ebiat 967.9 901.3 1,050.5 1,178.9 1,336.7 304.5 537.1 434.1 112.1 Plus: Depreciation and amortization

86.7 96.5 96.5 96.5 96.5 96.5 96.5 96.5 96.5

Less: Capital expenditures (34.9) (40.6) (42.6) (44.8) (47.0) (49.3) (51.8) (54.4) (57.1)Less: Change in net working capital 0 0 0 0 0 0 0 0 0Unlevered free cash flow 1,019.7 957.2 1,104.4 1,230.6 1,386.2 351.6 581.8 476.2 151.5 Cumulative unlevered FCF 5,282.3 Terminal value 1,996.9 PV of free cashflow 4,323.4 PV of terminal value 1,342.1 Implied enterprise value 5,665.6 Implied equity value sensitivity table Plus: Cash & equivalents 2,854.1 Ebitda multiple terminal value Less: Total debt (9/30/09) 0.0 6.0x 8.3x 10.0x Implied value of equity 8,519.7 8.0% 27.58 28.89 29.86 Diluted shares outstanding (m) 303.4 9.8% 26.86 28.08 28.99 Implied value per share (US$) 28.08 10.0% 26.78 27.99 28.89 Source: Calyon Securities (USA)

We do not believe that an earnings multiple for Forest is illustrative, given the patent expiries the company faces. However for those looking to use earnings multiples as a valuation tool for Forest, the shares currently trade at an 8.6x 10CL PE, while the peer group (Cephalon, Endo Pharmaceuticals, King Pharmaceuticals, Merck, Medicis Pharmaceutical, Pfizer, Warner Chilcott) trades at a median 9.7x and mean 10.0x, implying an approximate 10% discount for Forest. We chose these peers as we believe they represent other pharmaceutical companies with varying degrees of patent expiry issues in the coming years. We believe this discount is appropriate given the size of the patent expiry sales relative to the company’s size.

Our analysis results in a per share value of US$28. All else being equal, the shares would look more attractive at a 20% discount to this value, or about US$23 per share. We would become more constructive on Forest shares if any of the products were to show stronger-than-expected launches. We believe in the meantime, many Street estimates need to come down for products such as Daxas and adjust for the SG&A spending trending flat during the patent expiry years, not declining rapidly as many are now modelling.

However, Icahn Associates, a well-known activist fund, which showed up as a one-million share new holder as of the 30 September 2009 filing date requirement, could be potentially positioning for an activist role at Forest. We can envision the shares trading above our DCF-based valuation based on the potential for an activist to unlock value at Forest, but as we discuss later, we do not see many paths other than a sale or merger with a research-based drug company and substantial cost cuts to unlock value.

Shorter-term investors may wait until the next filing requirement to see whether Icahn Associates has purchased additional shares; we would use that opportunity to further lighten up positions into the strength.

Forest trades at a discount to peers on an earnings multiple basis

Icahn Associates recently showed up as a one-

million share new holder

WA

CC

We believe many Street estimates need to come

down for products such as Daxas



Cash spent on buybacks Forest has approximately US$10 per share in net cash, no debt and estimated cash flow of approximately US$3bn over the next three years.

We estimate the company has spent approximately US$4bn over the past five years buying back stock in successive programs, the last of which has approximately only five million shares remaining. In total, the company has purchased nearly 90 million shares, reducing its share count by 19% since 2004.

While we understand the company’s desire to return cash to shareholders in some form, we do not believe this has been a financially sound approach. Had the company done nothing with the cash and just allowed it to accumulate, we estimate that this would have translated to approximately US$14-$15 per share in cash in addition to its already approximate US$10 per share in cash. In other words, had the company not spent the money on share repurchases at average prices we estimate are about 35% higher than today, shareholders would have approximately US$25 per share in cash.

By spending much of its cash and having only approximately 43% domiciled in the US, it has limited its acquisition flexibility.

Figure 30

History of share buybacks

20

10

25 25

10

0

5

10

15

20

25

30

Jul 04 Dec 04 May 05 May 06 May 07

(m)

Source: Calyon Securities (USA), company

Obviously now water under the bridge, we nevertheless underscore this point as Forest looks forward to the next few years with a rising cash mound and decent cashflow, driven by Lexapro, and the question of what to do with the cash is likely to arise again in the coming months.

We would like to see the company lever up the balance sheet and find a company with a research capability and/or commercial opportunity pipeline.

What could an activist do? According to filings as of 30 September 2009, Icahn Associates has purchased a million shares of Forest, or less than 1%. Is the share purchase the start of something or simply a trade into an R&D meeting?

About US$4bn spent over the past five years buying

back at average prices well above US$40/share

Company has actively bought shares

What will Forest do with the cash coming in?



We do not have that answer. However, given our concerns that Forest’s business strategy is a bit outdated for a company of its size and is not very scalable, we believe a discussion exploring potential ways of improving Forest is warranted. From our review, we are not sure it can do a lot:

Not too many drug companies want to take on patent exposure risk

The majority of Forest’s cash is located outside the US

The sales force is needed to sell the recent launch of Savella and maintain some share of voice on Lexapro.

That said, founder/CEO Howard Solomon, who has done a solid job in building the company, could potentially be in a tough spot, as an activist could call for a separation of the company from the older legacy products, a reduction in R&D and SG&A and more partnering on marketed products. Additionally, some might argue that the company’s stated aversion to corporate mergers and large-scale acquisitions, which has helped the company in the past from the distraction of deal integration, might be needed now in order to give the company an innovative engine for growth. An activist might argue that the aversion to M&A is short-sighted in nature and more a reflection of not having the management bench depth to build longer-term value through deal integration.

With a geographically focused sales force versus a therapeutically focused one, we are not certain there is much that can be done to cut the sales force, as the products in the pipeline - COPD, irritable bowel syndrome, complicated skin infections - sound like niche therapies, but they are not. Family practitioners (FPs) and general practitioners (GPs) prescribe more GI products than GIs do. FPs and GPs prescribe more COPD and asthma drugs than respiratory specialists.

Some might argue that with no experience selling these classes of products into these physician groups, perhaps Forest is better off simply halving or more the sales force and partnering the detailing of the products. Obviously all these types of deals are things that can better be seen from the inside than the outside, which speaks to the goal of many activists – ‘let’s get under the hood and see where we can help.’

Additionally, some might argue that with companies such as Sepracor and MGI Pharma being sold at large premiums to Japanese companies, putting Forest up for sale where there could be cost synergies and a strategic buyer might make sense.

We believe this is the largest risk to our SELL rating – deals in the space have been plenty, and overseas firms have been seeking good sales forces. Forest could be an attractive candidate.

Given Icahn Associates’ successes in healthcare including major wins at Mylan and Imclone and more recently activist wins for board seats at Biogen and Amylin, we think Forest might be right up its alley. In addition, as a Delaware corporation in which we are not aware of any poison pill defences, Forest might be even more attractive to an activist. However, a key component is missing - shareholder dissatisfaction with management.

There is not much that can be done to cut the

sales force

Forest has avoided mergers and large-scale

acquisitions - maybe it shouldn’t

We think Forest might be right up its alley



Figure 31

Comp table Avg Median Forest

Labs Eli

LillyGlaxoSmithKline Pfizer Merck Bristol-

Myers Squibb

Allergan Cephalon

Gross margin 76.5 77.0 76.1 78.5 75.1 79.2 77.1 70.2 79.3 76.8 Ebitda margin 26.2 29.2 29.3 0.2 35.6 31.7 38.8 29.0 25.3 19.3 Ebit margin 20.0 23.1 26.7 (5.3) 30.6 21.1 32.0 25.1 19.3 10.6 Operating profit margin 25.7 25.7 20.7 27.1 31.7 34.4 27.0 24.4 21.9 18.2 Net margin 14.9 16.0 21.1 (10.2) 18.9 16.6 32.7 15.3 13.1 11.3 Free cashflow margin 11.5 9.9 28.3 21.1 10.0 16.6 8.4 1.5 9.8 (3.9)Asset turnover 0.7 0.7 0.8 0.7 0.7 0.4 0.5 0.8 0.7 0.6 Pretax margin 18.6 21.8 26.7 (6.4) 27.1 20.1 30.9 23.6 17.9 9.2 Pretax return on assets 12.2 14.0 20.3 (4.7) 20.2 8.7 16.2 19.1 11.8 5.7 Net return on assets 9.4 10.5 16.1 (7.4) 14.1 7.2 17.2 12.4 8.7 7.0 Net return on equity 20.7 17.7 19.6 (20.5) 52.5 13.1 42.3 27.7 14.9 15.9 Sales growth +2.0 +2.1 +4.7 +3.7 +4.2 (6.5) (2.9) +0.6 (2.3) +14.5

Note: Data based on quarter ended 30 Sep 09. Source: Calyon Securities (USA), FactSet

As Forest stands today, we believe its shares are worth approximately US$28/share, including contribution from a number of pipeline products, but not all. We believe our estimates are on the more conservative side versus Street estimates and that the Street needs to catch up to us in terms of SG&A spending during the patent expiry years. We believe that an activist might be able to generate additional value, although, how is not exactly clear at this point given the company’s current in-licensing model and GP/FP-focused pipeline. Some shareholders may be willing to wait to see if there is any next move by a potential activist, especially those with a positive bias to the upcoming R&D news flow. This is an upside risk to our call.

Summary In summary, we think Forest is doing an admirable job in trying to get as many shots on goal as possible for low approvability risk products. It has done a good job in that category. We cannot fault the company for Street estimates of peak sales that appear unrealistic to us. The company does not encourage the high estimates and seems to want to keep expectations modest.

We do believe that the time has come for Forest to take the specialty pharmaceutical model from “buy and develop” to “research and develop,” and do that through an acquisition, not through trying to build it internally.

We believe that Forest could benefit from more aggressive moves in returning significant amounts of cash to shareholders (although US$2bn of the US$3.5bn in cash is domiciled overseas and cannot come into the US without significant tax penalties) or to look to find a company with a research culture and a pipeline of programs suited to the US market.

We believe Forest’s capital structure is far too conservative. The company should look to raise debt in these low rate environments, to move into other therapeutic categories and to add-in companies that have research and development capabilities, as stringing together a group of US$200-500m products is not a good way to build a major pharmaceutical company, in our view.

Many have decided to park money in the low-multiple Forest shares. A good earnings yield, the sheer number of shots on goal and solid balance sheet in a market that could see significant volatility makes Forest a seemingly

We think Forest is doing an admirable job of

building the pipeline . . .

. . . but we don’t believe the pipeline can bridge

the gap

We believe there is 13% downside risk versus

potential activist activity upside



attractive place to do it. However, barring everything going well with the pipeline, an activist getting involved or changes in core product trends, we believe investors should sell the shares.

We have highlighted where we believe investors might be wrong in thinking the shares are cheap: Street models appear to be basing their DCFs on unrealistic assumptions. The models seem to assume costs decline with the patent cliff and we do not believe they will. We believe most of the pipeline products are not game-changers for Forest or for the markets in which they compete. Further, we believe there is approvability risk.

The next potential catalyst is the R&D Day on 7 January. While many investors own the shares into the event, we do not believe there will be groundbreaking updates from the meeting. We do believe it will be an opportunity for management to present the number of programs that are before them and how the opportunities line up to potentially fill in the sales and profitability gap that lays ahead in 2012 and again in 2015. We believe it will be a positive meeting from a “story” standpoint, but not one in which new positive data, groundbreaking strategy or restructuring/business combination will be revealed.

Our caution of owning the shares into the meeting is that the base trends are weak and the R&D Day might wake up the Street to the fact that assumptions for rapidly declining R&D and SG&A spending is probably unrealistic. We believe the company will explicitly state that it is unrealistic to expect a company with a bulging pipeline and multiple launches on tap to cut spending in those years.

Investment risks Our SELL rating is based on valuation and not on any known or suspected upcoming negative catalyst. However, there are several risks to our rating, many of which we have touched on earlier. We highlight what we consider to be the biggest risks:

Deal activity in the space - Many companies in the sector have sold in the past several years at large premiums to buyers who were looking for strong sales forces in the USA, something Forest certainly has. While we believe the change of control provision in its product agreements makes a purchase unlikely unless the buyer negotiated individually with each partner, it certainly is a possibility.

Having an activist fund take a position in the company without having made its intentions, if any, known, creates the possibility of an activist becoming involved and uncertainty of a sale or fundamental change such as large cuts to spending boosting the share price.

Forest is an in-licensing based company and it could in-license additional attractive compounds which could be accretive to earnings.

Our model does not anticipate the company to have sufficient programs emerge from its pipeline to offset declines from the loss of patent protection on two key products. Our model does not include several programs that Forest is working on, and if successful, these would be significantly additive to our base case.

We think Street DCFs are based on unrealistic

assumptions

Our caution is that base trends are weak;

R&D/SG&A assumptions look wrong

There are several risks to our SELL rating


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Figure 32

Forest Labs quarterly model (US$m) FY04 FY05 FY06 FY07 FY08 FY09 1QA 2QA 3QCL 4QCL FY10 1QCL 2QCL 3QCL 4QCL FY11 FY12 FY13

Lexapro 1,089.0 1,605.3 1,873.3 2,106.0 2,292.0 2,301.0 565.5 566.0 567.9 554.0 2,253.4 559.8 560.3 562.2 548.4 2,230.9 2,208.6 220.9Namenda 0.0 332.7 508.0 660.3 829.7 949.3 259.3 275.3 262.5 273.1 1,070.2 285.2 302.8 288.8 300.4 1,177.2 1,236.1 1,297.9Bystolic 0.0 0.0 0.0 0.0 0.0 69.2 37.7 40.7 46.8 53.8 179.0 61.9 71.2 81.9 94.1 309.1 340.0 374.0Savella 0.0 0.0 0.0 0.0 0.0 0.0 9.6 10.2 15.0 15.0 49.8 20.0 25.0 27.0 30.0 102.0 122.4 146.9Ceftaroline 10.0 20.0 30.0 100.0 150.0Daxas 10.0 10.0 10.0 10.0 40.0 100.0 200.0Linaclotide 20.0 100.0Aclidinuim 25.0 50.0Oglemilast 0.0 0.0Dutogliptin 0.0 0.0Cariprazine 0.0 0.0Other product revenue 1,561.5 1,114.4 412.6 417.1 380.1 316.6 76.1 70.5 70.0 70.0 286.7 65.0 65.0 65.0 60.0 255.0 267.8 254.4Net product sales 2,650.4 3,052.4 2,793.9 3,183.3 3,501.8 3,636.1 948.2 962.7 962.2 965.9 3,839.1 1,002.0 1,034.4 1,044.9 1,062.9 4,144.1 4,419.8 2,794.0Contract revenue 0.0 61.4 118.2 176.9 216.5 209.0 47.7 50.6 56.2 59.2 213.6 51.1 54.2 60.2 63.4 228.9 222.1 215.4Interest income 0.0 0.0 0.0 65.5 108.7 74.4 12.2 9.4 9.4 9.4 40.4 9.4 9.4 9.4 9.4 37.6 37.6 37.6Other income 29.8 45.9 50.3 16.0 9.3 3.3 0.0 1.2 1.2 1.2 3.7 1.2 1.2 1.2 1.2 4.9 4.9 4.9Total revenue 2,680.3 3,159.6 2,962.4 3,441.8 3,836.3 3,922.8 1,008.2 1,023.9 1,018.4 1,025.0 4,075.5 1,053.1 1,088.6 1,105.1 1,126.3 4,373.1 4,641.8 3,009.4Revenue 2,680.3 3,159.6 2,962.4 3,441.8 3,836.3 3,922.8 1,008.2 1,023.9 1,018.4 1,025.0 4,075.5 1,053.1 1,088.6 1,105.1 1,126.3 4,373.1 4,641.8 3,009.4 Growth (%) 17.9% -6.2% 16.2% 11.5% 2.3% 4.3% 3.2% 2.1% 6.2% 3.9% 4.5% 6.3% 8.5% 9.9% 7.3% 6.1% -35.2%Cogs 608.5 687.5 651.0 745.6 800.1 816.7 216.7 221.2 220.0 221.4 879.3 227.2 228.6 232.1 236.5 924.4 974.8 662.1

Gross profit 2,071.8 2,472.1 2,311.4 2,696.2 3,036.2 3,106.1 791.4 802.8 798.5 803.6 3,196.3 825.9 860.0 873.0 889.8 3,448.7 3,667.0 2,347.3 Margin (%) 77.3% 78.2% 78.0% 78.3% 79.1% 79.2% 78.5% 78.4% 78.4% 78.4% 78.4% 78.4% 79.0% 79.0% 79.0% 78.9% 79.0% 78.0%

SG&A 888.5 993.7 1,031.5 1,046.3 1,154.8 1,303.3 311.8 304.9 320.8 322.9 1,260.4 325.7 326.6 331.5 337.9 1,321.7 1,346.1 1,354.2 % of sales 33.2% 31.5% 34.8% 30.4% 30.1% 33.2% 30.9% 29.8% 31.5% 31.5% 30.9% 30.9% 30.0% 30.0% 30.0% 30.2% 29.0% 45.0%R&D 246.5 293.7 410.4 465.0 671.0 661.3 147.1 163.1 137.5 138.4 586.1 147.4 152.4 154.7 157.7 612.2 603.4 601.9 % of sales 9.2% 9.3% 13.9% 13.5% 17.5% 16.9% 14.6% 15.9% 13.5% 13.5% 14.4% 14.0% 14.0% 14.0% 14.0% 14.0% 13.0% 20.0%

Operating income 936.8 1,184.8 869.5 1,184.8 1,210.4 1,141.5 332.5 334.8 340.2 342.4 1,349.8 352.8 381.0 386.8 394.2 1,514.8 1,717.5 391.2 % of sales 35.0% 37.5% 29.4% 34.4% 31.6% 29.1% 33.0% 32.7% 33.4% 33.4% 33.1% 33.5% 35.0% 35.0% 35.0% 34.6% 37.0% 13.0%

Pre-tax income 936.8 1,184.8 869.5 1,184.8 1,210.4 1,141.5 332.5 334.8 340.2 342.4 1,349.8 352.8 381.0 386.8 394.2 1,514.8 1,717.5 391.2Tax provision 200.9 346.0 161.0 254.7 242.5 240.2 69.6 75.6 76.8 77.3 299.3 78.2 84.5 85.8 87.4 335.9 380.8 86.7 % tax rate 21.4% 29.2% 18.5% 21.5% 20.0% 21.0% 20.9% 22.6% 22.6% 22.6% 22.2% 22.2% 22.2% 22.2% 22.2% 22.2% 22.2% 22.2%

Net income 735.9 838.8 708.5 930.1 967.9 901.3 262.9 259.2 263.4 265.1 1,050.5 274.6 296.5 301.0 306.8 1,178.9 1,336.7 304.5

Diluted EPS $1.95 $2.25 $2.08 $2.89 $3.06 $2.96 $0.87 $0.85 $0.87 $0.87 $3.46 $0.91 $0.98 $0.99 $1.01 $3.89 $4.39 $1.00 Growth (%) 15.4% -7.6% 38.9% 5.8% -3.3% 9.8% 6.4% 39.5% 17.2% 17.0% 4.5% 14.5% 14.3% 15.7% 12.3% 13.0% -77.3%Shares out (diluted) (m) 376.8 372.1 340.3 321.9 316.1 304.4 303.4 303.5 303.3 303.1 303.3 303.2 303.2 303.3 303.3 303.3 304.3 305.3

Note: FY10-13 figures are Calyon estimates. Source: Company, Calyon Securities (USA)


Appendix Forest Labs - SELL

Appendix 1: Risks & drivers

Investment by numbers We are forecasting Forest sales to grow in the low- to mid-single digits through the patentexpiry of Lexapro in 2013.

While some spending in SG&A may shift from Lexapro to newer products Savella, Bystolicand potentially Daxas and Ceftaroline, our operating spending assumptions as a percentageof sales remain fairly flat. As such, we project Forest to have steady incremental growth in operating income, free cashflow, Ebitda and EPS over the next three years.

We estimate the most dramatic shift in Forest’s model will come in 2013 and beyond, whenLexapro goes generic. While not highlighted in the charts to the left, we project that as a result of generic competition, total revenue will fall 35% in 2013 from 2012 and without theflexibility to cut spending due to the need to support new product launches coming over thenext couple years, operating income and EPS will fall approximately 77%, while free cashflow per share will fall 75% relative to 2012.

Risks to our view We believe the biggest risks to our recommendation are:

Deal activity in the space - Many companies in the sector have sold in the past several years at large

premiums to buyers who were looking for strong sales forces in the USA, something Forest certainly

has. While we believe the change of control provision in its product agreements makes a purchase

unlikely unless the buyer negotiated individually with each partner, it certainly is a possibility.

Having an activist fund take a position in the company without having made its intentions, if any,

known, creates the possibility of an activist becoming involved and uncertainty of a sale or

fundamental change such as large cuts to spending boosting the share price.

Forest is an in-licensing based company and it could in-license additional attractive compounds

which could be accretive to earnings.

Our model does not anticipate the company to have sufficient programs emerge from its pipeline to

offset declines from the loss of patent protection on two key products. Our model does not include

several programs that Forest is working on and, if successful, could be significantly additive to our

base case.

Sales (US$m)

0

1,000

2,000

3,000

4,000

5,000

FY08 FY09 FY10CL FY11CL FY12CL

Op profit (US$m)

0

500

1,000

1,500

2,000


Op profit margin (%)

0.0

10.0

20.0

30.0

40.0


EPS (US$)

0.00

1.00

2.00

3.00

4.00

5.00


Free cashflow (US$m)

0

400

800

1,200

1,600


Ebitda (US$m)

0

500

1,000

1,500

2,000



IMPORTANT DISCLOSURES

Analyst certificationI, David Maris, hereby certify that the views expressed in this research report accurately reflect my ownpersonal views about the securities and/or the issuers and that no part of my compensation was, is, or will bedirectly or indirectly related to the specific recommendation or views contained in this research report. Inaddition, the analysts included herein attest that they were not in possession of any material, non-publicinformation regarding the subject company at the time of publication of the report.

Q1 Q2 Q3 Q1 Q2 Q3 Q1 Q2 Q310

20

30

40

50

60

2007 2008 2009 2010

Rating and Price Target History for: Forest Laboratories Inc. (FRX) as of 01-01-2010

Created by BlueMatrix

Valuation methodology

As we assess our estimates, there are several key assumptions and variables that could impact earnings, including newin-licensing opportunities with nearer-term launches as well as pipeline setbacks that could remove a product altogether fromthe model. Our DCF results in a value of US$28.08 per share, which is 13% below the current share price. Our keyassumptions are a 9.8% WACC, which is a FactSet-derived estimate, and an 8.3x terminal value, which results in a presentvalue of the cashflows of approximately US$4.3bn and a terminal value of approximately US$1.3bn. We use a terminalmultiple of 8.3x, which is higher than our forecast of Forest's TEV/LTM Ebitda of 7.6x, but in line with the mean TEV/LTMEbitda of peer companies.We have used discounted cashflow for our primary valuation approach as we believe that withForest facing significant patent expiries over the next several years and having a strong balance sheet, other approaches,such as PE or PE/growth, are not appropriate.

Risk to target

Our SELL rating is based on valuation and not on any known or suspected upcoming negative catalyst. However, there areseveral risks to our rating. The biggest risks: Deal activity in the space - Many companies in the sector have sold in the pastseveral years at large premiums to buyers who were looking for strong sales forces in the USA, something Forest certainlyhas. While we believe the change of control provision in its product agreements makes a purchase unlikely unless the buyernegotiated individually with each partner, it certainly is a possibility. Having an activist fund take a position in the companywithout having made its intentions, if any, known, creates the possibility of an activist becoming involved and uncertainty of asale or fundamental change such as large cuts to spending boosting the share price. Forest is an in-licensing based companyand it could in-license additional attractive compounds which could be accretive to earnings. Our model does not anticipate thecompany to have sufficient programs emerge from its pipeline to offset declines from the loss of patent protection on two keyproducts. Our model does not include several programs that Forest is working on, and if successful, these would besignificantly additive to our base case.

EVA is a registered trademark of Stern, Stewart & Co. "CL" in charts and tables stands for Calyon Securities(USA) Inc. estimates unless otherwise noted in the Source. Calyon Securities (USA) Inc. does and seeks to dobusiness with companies in its research reports. As a result, investors should be aware that the firm may havea conflict of interest that could affect the objectivity of this report. Investors should consider this report as onlya single factor in making their investment decision.RATING RECOMMENDATIONS: Buy = Expected tooutperform the local market by >10%; Outperform (O-PF) = Expected to outperform the local market by0-10%; Underperform (U-PF) = Expected to underperform the local market by 0-10%; Sell = Expected tounderperform the local market by >10%. Performance is defined as 12-month total return (includingdividends). Overall rating distribution for Calyon Securities (USA) Inc. Equity Universe: Buy / Outperform -82%, Underperform / Sell - 18%, Restricted - 0%. Data as of 31 December 2009. INVESTMENT BANKINGCLIENTS as a % of rating category: Buy / Outperform - 16%, Underperform / Sell - 16%, Restricted - 0%.Data for 12-month period ending 31 December 2009. Prior to 25 November 2008, Calyon Securities (USA) Inc.

Forest Labs - SELL


used an absolute system (based on anticipated returns over a 12-month period): Buy: above 20%; Add:10%-20%; Neutral: +/-10%; Reduce: negative 10-20%; Sell, below 20% (including dividends). FOR AHISTORY of the recommendations and price targets for companies mentioned in this report, please write to:Calyon Securities (USA) Inc., Compliance Department, 1301 Avenue of the Americas, 15th Floor, New York,New York 10019-6022. CALYON SECURITIES (USA) INC. POLICY: Calyon Securities (USA) Inc.'s policy is toonly publish research that is impartial, independent, clear, fair, and not misleading. Analysts may not receivecompensation from the companies they cover. Neither analysts nor members of their households may have afinancial interest in, or be an officer, director or advisory board member of companies covered by the analyst.ADDITIONAL INFORMATION on the securities mentioned herein is available upon request. DISCLAIMER: Theinformation and statistical data herein have been obtained from sources we believe to be reliable but in no wayare warranted by us as to accuracy or completeness. We do not undertake to advise you as to any change inour views. This is not a solicitation or any offer to buy or sell. We, our affiliates, and any officer director orstockholder, or any member of their families may have a position in, and may from time to time purchase orsell any of the above mentioned or related securities. This material has been prepared for and by CalyonSecurities (USA) Inc. This publication is for institutional client distribution only. This report or portions thereofcannot be copied or reproduced without the prior written consent of Calyon Securities (USA) Inc. In the UK,this document is directed only at Investment Professionals who are Market Counterparties or IntermediateCustomers (as defined by the FSA). This document is not for distribution to, nor should be relied upon by,Private Customers (as defined by the FSA). This publication/communication is distributed for and on behalf ofCalyon Securities (USA) Inc. in Australia by CLSA Limited; in Hong Kong by CLSA Research Ltd.; in India byCLSA India Ltd.; in Indonesia by PT CLSA Indonesia; in Japan by Calyon Securities Japan, a member of theJSDA licensed to use the "CLSA" logo in Japan; in Korea by CLSA Securities Korea Ltd.; in Malaysia by CLSASecurities Malaysia Sdn Bhd; in the Philippines by CLSA Philippines Inc.; in Thailand by CLSA Securities(Thailand) Limited; and in Taiwan by CLSA Limited, Taipei Branch. Singapore: This publication/communicationis distributed for and on behalf of Calyon Securities (USA) Inc. in Singapore through CLSA Singapore Pte Ltdsolely to persons who qualify as Institutional, Accredited and Expert Investors only, as defined in s.4A(1) ofthe Securities and Futures Act. Pursuant to Paragraphs 33, 34, 35 and 36 of the Financial Advisers(Amendment) Regulations 2005 with regards to an Accredited Investor, Expert Investor or Overseas Investor,sections 25, 27 and 36 of the Financial Adviser Act shall not apply to CLSA Singapore Pte Ltd. Please contactCLSA Singapore Pte Ltd in connection with queries on the report. MICA (P) 001/01/2009 File Ref. No.: 931318.This publication/communication is also subject to and incorporates the terms and conditions of use set out onthe www.clsa.com website. Neither the publication/ communication nor any portion hereof may be reprinted,sold or redistributed without the written consent of CLSA Limited and Calyon Securities (U.S.A.) Inc.© 2010Calyon Securities (USA) Inc. All rights reserved.

Forest Labs - SELL

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Forest Labs - The Wall Street Journalonline.wsj.com/public/resources/documents/MarisAnalyst1027.pdf · 4.01.2010 · which Forest Laboratories sells. The company also faces competition