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Undergraduate Student Managed Investment Fund (SMIF)

Presents:

Analysts

Jiaqi Hong

Raias Anthony Khan

Steve Sarkis

Qiudan Yu

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Table of Contents

I. Executive Summary…………………….………………………….………3

II. Industry Analysis…………………….…………………………….… 4-8

III. Company Analysis……………………..…………………………..…8-19

VI. Ratio Analysis........................……..……………………………...…20-33

V. Pro Forma Income Statement...............................................................34-41

VI. Relative Evaluation.......................……..……………………………42-43

VII. Absolute Evaluation......................……..…………………………...44-47

VIII. Recommendation .......................……..…………………………….…48

VIIII. Work Cited.…………………….………………………………….…49

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Executive Summary

The Forest Labs analyst team performed a detailed analysis of the proposed sale of Forest Labs

common stock. After extensively observing the growth and position of Forest Labs as an

emerging leader it offers a potentially high value to the SMIF undergraduate portfolio.

The analysis of Forest Labs included using techniques including ratio analysis in a custom

industry, relative and absolute valuations to make a sound and quantifiable judgment on Forest

Labs. These methods are supported by an overall analytical strategy encompassing fundamental

analysis, valuation, and risk assessment of our highly competitive industry.

.

The absolute valuation calculation shows that Forest Labs is highly undervalued however using

an decisively reduced adjustment factor and negative growths this shows the valuable position of

Forest Labs for purchase at a limit buy as the natural cyclical decline occurs as we near to

closure of Q1. The relative valuation calculation also shows that Forest Labs is fairly valued a

conclusion expounded herein.

The use of the cash flow and absolute valuation as the springboard for the recommendation was

key. This is reflective also with the risk that is involved in the overall pharmaceutical industry

due to heightened regulation climate and the risk of healthcare reform waning over the sector.

Current risk factors that are threatening Forest Labs are the FDA approval process, patent

expirations and finally the contraction on the Healthcare sector. Forest Labs currently has drugs

pending FDA approval, notably a blood-thinner and new drugs encompassing Alzheimer’s and

COPD. Analysts believe that Forest Labs can become the dominant pharmaceutical manufacturer

in its notable ethical pharmaceutical niche accounting for their fully vested business

segmentation in thereof. Forest Labs also has patents running out on several its highest grossing

drugs Namenda and Lexapro. These are Forest Labs top grossing drugs and the patent expiration

will raise questions about their value of the future pipeline after 2013, especially if generic

versions of Namenda and Lexapro are not capitalized on by Forest Labs. If the new drugs to be

launched Q2 of 2012 (Teflaro, Viibryd and Daliresp) there can be serious implications to the

overall business model. Overall with all these questions and risk factors raised the analyst team

decided to utilize the three-legged approach prescribed by SMIF in the analysis of Forest Labs

eventually leading into the strongest points (Absolute Valuation and Cash Flow Analysis which

shows us Forest Labs at the core of the business being extremely profitable in their upcoming

years post 2013 with strong cash flows, growth and increased market share.

Team recommendation: Purchase 150 shares at $30 limit buy order.

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I. Industry Analysis

Overview

Forest Labs is in the Pharmaceuticals sector of the Healthcare industry. The Healthcare industry

has been very positive even through the recession by showing positive signs of revenue growth

as well as risk betas of less than one. Standard & Poor’s lists these companies as biotechnology

companies manufacturing different types of medicine and patenting them. Many refer to stocks

in this industry as defensive because the products and services are essential. Even during

economic declines, people will still call for medical aid and medicine to overcome illness.

Having a dependable demand for goods and services makes this sector less susceptible to

business cycle fluctuations. The factors that affect the Healthcare Industry as well as

Pharmaceutical sectors include healthcare reform bills, aging population, individuals living

longer with chronic disease, technological advancement, as well as epidemics.

FRX Develops, manufactures, and sells both brand-name and generic prescription and

nonprescription drugs in the United States and Europe. The main therapeutic areas that the

company concentrates on include depression, Alzheimer's disease/neuropathic pain,

hypertension, asthma, and gastrointestinal disease.

FRX’s closest competitors are Eli Lily and Co., GlaxoSmithKline, Valeant Pharmaceuticals,

Watson Pharmaceuticals, Pfizer Inc. However, in the custom industry analysis ten companies

were used of a similar nature. These are companies that offer similar products or services relative

to the size of the company, ranging from development of products to managing company

pipeline. This includes FRX, Johnson and Johnson, Merck and Co., Abbott Laboratories, and

Bristol Myers Squibb.

Competitors’ Analysis

In the report, financial data of many peer companies in the industry were used to compare with

FRX’s numbers. Pharmaceutical companies that are conducting businesses very similar to the

nature of FRX’s business were used along with FRX to create a customized industry to get a

better sense of FRX’s performance relative to its peers and industry group. Below lists a few

brief facts about each of the companies and reasons for picking them as competitors.

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1. Eli Lily and Company (LLY)

Eli Lily is a major pharmaceutical company that also develops, produces and distributes drugs.

Some of their main drugs include Prozac and Cymbalta for depression. Eli Lily is a direct

competitor to Forest Laboratories because of their similar product sector focus. Both FRX and

LLY produce central nervous system drugs. In a broader term, LLY and FRX also have similar

market focus. LLY is fully vested in the human pharmaceuticals market. The reason behind the

juxtaposition between LLY and FRX are based on their involvement in human and ethical

pharmaceutical.

2. Pfizer Inc. (PFE)

Although Pfizer is a much more diversified and larger industry player, it has an inclusion of

similar product line and approach as FRX. PFE operates in two segments: Biopharmaceutical,

which includes Primary Care, Specialty Care, Established Products, Emerging Markets and

Oncology customer-focused units, which includes products that prevent and treat cardiovascular

and metabolic diseases, central nervous system disorders, urogenital conditionseye disease and

endocrine disorders, among others, and Diversified, which includes Animal Health products;

Consumer Healthcare products, such as pain management therapies, cough/allergy remedies,

dietary supplements, hemorrhoidal care and other personal care items; Nutrition products, such

as infant and toddler formula products, and Capsugel.

3. Valeant Pharmaceuticals International (VRX)

Valeant Pharmaceuticals International develops, manufactures and markets a broad range of

pharmaceutical products primarily in the areas of neurology, dermatology and branded generics.

Not only does. VRX have a close revenue number to FRX, they also have similar specialization

in the dermatology and neurology therapeutic classes of drugs. Market caps are also similar with

the companies.

4. Glaxo Smith Kline PLC (GSK )

Like Forest Laboratories, GlaxoSmithKline Plc is a research-based pharmaceutical and

healthcare company. It is a major global healthcare group engaged in the creation, discovery,

development, manufacture and marketing of pharmaceutical and consumer health-related

products. GSK manufactures products in the following therapeutic areas: respiratory, anti-virals,

central nervous system, cardiovascular and urogenital, metabolic, anti-bacterials, oncology and

emesis, dermatalogicals and vaccines. They also have a focus on the human pharmaceutical

initiatives.

5. Watson Pharmaceuticals, Inc. (WPI)

Watson Pharmaceuticals, Inc. (WPI) is a peer of Forest Labs because it specializes also in ethical

pharmaceuticals with the patient’s health in mind. Watson Pharmaceuticals is an integrated

global pharmaceutical company, which engages in the development, manufacturing, marketing,

sale and distribution of generic and brand pharmaceutical products. The company operates

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through three business segments. Global Generics, Global Brands and Distribution. The Global

Generics segment includes off-patent pharmaceutical products that are therapeutically equivalent

to proprietary products. This is similar to FRX which stresses the ethical treatment of patients. It

also operates under the product categories of antibiotics, anti-inflammatory, depression,

extended-release, hypertension, oral contraceptives, pain management and smoking cessation

similar to FRX.

Threats

There are numerous threats that can hurt pharmaceutical companies. They can consist of delays

in pipeline, expiration of patents, generic versions of products appearing in the marketplace, the

FDA having a strict hold on new drugs, as well as new entrants entering the industry.

1. Speculations and Delays in Pipeline

Delays in pipeline can seriously affect a firm’s ability to embark on revenue growth. The

pipeline process is as follows. A product gets submitted to the pipeline and it goes through three

different phases in the cycle. During the three phases, testing for the product goes through

numerous rigorous processes. In the end upon completion of phase three the product becomes

filed through an NDA (New Drug Application). After it is filled as an NDA it has to become

approved by the FDA (Food and Drug Administration) and later becomes available to the

market.

2. Expiration of Patents

The expiration of patents on drugs can mean a loss of sales and revenues for the firm. In FRX’s

case, Lexapro which expired in March of 2012 as well as Namenda which is set to expire on

April of 2015, will cause a loss in revenues. However, with an ample amount of cash on hand, as

well as a promising pipeline with new drugs, FRX will not likely get hit that hard from the loss

of these patents. In other cases, struggling firms who lose patents can prove to be disastrous for

their future.

3. Generic versions of products in the marketplace

As name brand products succeed in the marketplace there become generic versions of that

product selling at a cheaper price with the same active ingredient. This can cause harm to firms

with big name brand drugs in that the generic products can become much more popular mainly

because they are much cheaper than the name brand product.

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4. FDA strict hold on new drugs

After a drug has been through the pipeline and filed as an NDA, the FDA has to approve that the

drugs meet all safety guidelines before they can put it out on the market. If there are delays in

this process it can prove to be very harmful for the firm in that they have spent much money on

research and development for the product and now it is at a standstill because it did not get

approved.

5. New Entrants

The entry of new firms into the industry can cause some problems by increasing competition

among other firms especially if the specialize in the same types of drugs. New entrants can come

up with cheaper generic brands as well as better products which can hurt the growth of similar

firms.

Revenue

A custom industry of ten firms in the pharmaceuticals industry was used for comparing revenue

numbers. The companies include FRX, LLY, GSK, WPI, VRX, PFE, MRK, JNJ, ABT, and

BMY. Industry revenues grew at a steady pace for the past eight years. However, it seems to

decline a slight bit in 2012. It falls from 320,682.5 in 2011 to an estimated 314,704.9 in 2012.

This due in large part to new healthcare reforms that cut down on budget as well as the

expiration of patents for numerous firms. The industry revenues were based on the ten

companies listed earlier. The revenues for FRX have been rising for the past seven years but our

estimate has it slightly dropping in 2013. This is mainly due to the expiration of Lexapro, which

is one of FRX’s top drugs.

Trends

Pharmaceutical Trends

New changes to the FDA policy on passing drugs onto the market have been a roadblock for

pharmaceutical companies. This new policy enables a stricter and tougher testing process in

which drugs are not easily passed as they used to be. The average approval time for new drugs

can range from two or three years to one year or less. In years prior there was a simple and quick

approval process that could last just 42-days.

Another change has been with the generic pharmaceutical industry. Firms can now manufacture

generic drugs based on the original product once the patent on the original chemical entity

expires. Also the generic industry can perform this without the expensive clinical trials which

prove a drug is safe and effective that is performed by original companies. Not having to

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perform the clinical trials is key for generic producers to drastically reduce the cost of bringing a

product to market.

Mergers and Acquisition of small biotech companies by larger ones have been common during

recent years. The motive behind this is for large firms to increase market share and expand by

purchasing smaller ones. This creates more capital for the companies. The most common firms

that conduct these mergers are biotech companies, who develop products based on living cells, as

well as some firms who have developed new technology in unlocking the genetic makeup of

human beings.

II. Company Overview

Forest has well-established franchises in the therapeutic areas of the central nervous and

cardiovascular systems, the firm is always exploring new product opportunities that address a

range of health conditions. Forest Labs principal brands include Bystolic®(nebivolol), Daliresp

®

(roflumilast), Lexapro® (escitalopram oxalate), Namenda

® (memantine HCl),

Savella®(milnacipran HCl), Teflaro

® (ceftaroline fosamil) for injection, and Viibryd

®(vilazodone

HCl).

Forest identifies, develops, and delivers pharmaceutical products that make a difference in

people's lives. Forest Labs have been extremely successful in meeting its business objectives and

expanding its franchises, but also derive satisfaction in helping to bring relief to people who are

suffering. Forest Labs credit success to innovation, integrity, and commitment to developing

important products.

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Executives

Howard Solomon Chairman, Chief Executive Officer and

President

Francis I. Perier Jr. Chief Financial Officer, Executive Vice

President of Finance & Administration and

Member of Disclosure, Legal Compliance &

Risk Management Committee

Raymond Stafford Chief Executive of Forest Laboratories - Europe

Marco Taglietti M.D. Senior Vice President of Research &

Development, Member of Disclosure, Legal

Compliance & Risk Management Committee

and President of Forest Research Institute

(FRI)

Elaine Hochberg Chief Commercial Officer, Executive Vice

President of Marketing and Member of

Disclosure, Legal Compliance & Risk

Management Committee

Board of Directors

1. Howard Solomon (Director since 1964)

Mr. Solomon, 83, is Chairman, Chief Executive Officer and President of Forest. He began his

career as an attorney at leading law firms in New York and joined Forest in 1964 as a director

and secretary of the Board while serving as outside counsel for the Company. He became CEO

of Forest in 1977 and Chairman in 1998. Mr. Solomon is a Trustee of the New York Presbyterian

Hospital and previously served on the Board of Cold Spring Harbor Laboratories. He is currently

a member of the Executive Committee of the Board of Directors of the Metropolitan Opera and

Chairman of its Finance Committee. He also serves on the Board of the New York City Ballet.

Mr. Solomon graduated from the City College of New York and holds a J.D. from Yale

University.

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2. Nesli Basgoz, M.D. (Director since 2006)

Dr. Basgoz, 53, is the Associate Chief for Clinical Affairs, Division of Infectious Diseases at

Massachusetts General Hospital (MGH) and serves on the hospital’s Board of Trustees. In

addition, Dr. Basgoz is an Associate Professor of Medicine at Harvard Medical School.

Previously, she served as Clinical Director in the Infectious Diseases Division of MGH for six

years. Dr. Basgoz earned her M.D. Degree and completed her residency in internal medicine at

Northwestern University Medical School. She also completed a fellowship in the Infectious

Diseases Division at the University of California at San Francisco. She is board certified in both

infectious diseases and internal medicine.

3. Christopher J. Coughlin (Director since 2011)

Mr. Coughlin, 59, most recently served as Executive Vice President and Chief Financial Officer

of Tyco International from 2005 to 2010 and remains an advisor to Tyco. During his tenure, he

played a central role in the separation of Tyco into three independent, public companies and

provided financial leadership surrounding major transactions, including the $2 billion acquisition

of Broadview Security, among many other responsibilities and accomplishments. Prior to joining

Tyco, he worked as the Chief Operating Officer of the Interpublic Group of Companies from

June 2003 to December 2004, as Chief Financial Officer from August 2003 to June 2004 and as

a director from July 2003 to July 2004. Previously, Mr. Coughlin was Executive Vice President

and Chief Financial Officer of Pharmacia Corporation from 1998 until its acquisition by Pfizer in

2003. Prior to that, he was Executive Vice President of Nabisco Holdings and President of

Nabisco International. From 1981 to 1996 he held various positions, including Chief Financial

Officer, at Sterling Drug. Mr. Coughlin is currently serving as the lead independent director on

the board of Dun & Bradstreet, where he is a member of the Audit Committee and the

Compensation and Benefits Committee. He also serves on the board of Covidien plc, where he is

Chair of the Compliance Committee. Mr. Coughlin has a B.S. in accounting from Boston

College.

4. Dan L. Goldwasser (Director since 1977)

Mr. Goldwasser, 71, is a practicing attorney and has been a shareholder since 1992 at the law

firm Vedder Price, P.C., where he is a member of the firm’s Accounting Law Practice Group.

Mr. Goldwasser previously served as Chairman of the American Bar Association’s Business

Law Section’s Committee on Law and Accounting and as the American Bar Association’s Co-

Chairman of The National Conference of Lawyers and Certified Public Accountants. From 2003

to 2006, he also was a member of the Auditing Standards Board of the American Institute of

Certified Public Accountants. Mr. Goldwasser holds a B.A. from Harvard University and an

LL.B. from Columbia Law School.

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5. Kenneth E. Goodman (Director since 1998)

Mr. Goodman, 63, is the former President and Chief Operating Officer of Forest, a position that

he held from 1998 to 2006. For eighteen years prior thereto, Mr. Goodman served as Forest’s

Vice President, Finance and Chief Financial Officer and was named Executive Vice President,

Operations in February 1998. From 1975 to 1980, he served as a senior financial officer at

Wyeth, and before that, as a C.P.A. at Main Hurdman, which is now part of KPMG LLP. Mr.

Goodman currently serves Syracuse University as Vice Chairman of the Board of Trustees, a

member of the Executive Committee and Chairman of the Audit Committee; he previously

served as Chairman of the Budget Committee. He is also Chairman of the International Board of

Directors of the Israel Cancer Research Fund and Co-Chairman of its New York Board. Mr.

Goodman is a C.P.A. and holds a B.S. degree from The Whitman School of Management at

Syracuse University.

6. Gerald M. Lieberman (Director since 2011)

Mr. Lieberman, 64, most recently served as the President and Chief Operating Officer of

AllianceBernstein from 2004 to 2009, where he oversaw several critical functions for

AllianceBernstein, including finance, global risk management, technology, operations, human

resources, and investor and public relations. In addition, he was instrumental in developing

AllianceBernstein’s global integrated platform and enhancing its corporate governance and

financial transparency. Prior to joining AllianceBernstein in 1998, Mr. Lieberman held a number

of senior positions at Fidelity Investments from 1993 to 1998, including Chief Financial Officer

and Chief of Administration and he was a member of Fidelity’s operating committee, reporting

directly to the Chairman. Before joining Fidelity, Mr. Lieberman spent 14 years with Citicorp,

where he served as Senior Human Resources Officer and a member of the policy committee,

reporting to the Company’s Chairman and Chief Executive Officer. At Citicorp, he also held

several other senior leadership positions, including Chief Executive Officer of Citibank Mexico

and Division Head of Latin America. Mr. Lieberman is currently serving as a director at

Computershare. He is also a trustee of the University of Connecticut Foundation and was a

practicing C.P.A with Arthur Anderson. He received a B.S. from the University of Connecticut

and attended New York University’s Graduate School of Business Administration.

7. Lawrence S. Olanoff, M.D., Ph.D. (Director since 2006)

Dr. Olanoff, 59, served as Forest’s Chief Operating Officer from 2006 to 2010 and currently

serves as Senior Scientific Adviser to the Company. From July 2005 to October 2006, Dr.

Olanoff was President and Chief Executive Officer at Celsion Corporation, an oncology drug

development company. He also served as Executive Vice President and Chief Scientific Officer

of Forest from 1995 to 2005. Prior to joining Forest in 1995, Dr. Olanoff served as Senior Vice

President of Clinical Research and Development at Sandoz Pharmaceutical Corporation (now a

division of the Novartis Group) and at the Upjohn Company in a number of positions including

Corporate Vice President of Clinical Development and Medical Affairs. Over his entire career,

he was involved in 30 product approvals. In addition, he is currently an adjunct Assistant

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Professor and Special Adviser to the President for Corporate Affairs at the Medical University of

South Carolina (MUSC), as well as a Director of the MUSC Foundation for Research

Development, which is a non-profit foundation created to benefit the university. He holds a

Ph.D. in biomedical engineering and an M.D. degree from Case Western Reserve University.

8. Lester B. Salans, M.D. (Director since 1998)

Dr. Salans, 75, is a Clinical Professor and member of the Clinical Attending Staff of Internal

Medicine at the Mount Sinai Medical School. Prior thereto, Dr. Salans was a senior executive at

Sandoz Pharmaceutical Corporation (now a division of the Novartis Group). Dr. Salans is a

former Director of the National Institutes of Arthritis, Diabetes, Digestive and Kidney Diseases

of the National Institutes of Health. He served as Professor of Medicine and Director of the

Division of Endocrinology at the Dartmouth Hitchcock Medical Center, Hanover, from 1968-

1975. He also founded and is president of LBS Advisors, Inc., a consultancy serving several

pharmaceutical and biotechnology companies, academic institutions, the National Institutes of

Health and many investment firms. He serves on the board of directors of PharmaIN

Corporation, a biopharmaceutical company. Dr. Salans earned a B.A. from University of

Michigan and M.D. from University of Illinois.

9. Brenton L. Saunders (Director since 2011)

Mr. Saunders, 41, has been the Chief Executive Officer of Bausch + Lomb and a board director

since March 2010. Previously, Mr. Saunders served as a senior executive with Schering-Plough

from 2003 to 2010, most recently as President of Global Consumer Health Care. He also served

as Head of Integration for both Schering-Plough’s merger with Merck & Co. and for its $16

billion acquisition of Organon BioSciences. Before joining Schering-Plough, Mr. Saunders was a

Partner and Head of the Compliance Business Advisory Group at PricewaterhouseCoopers LLP

from 2000 to 2003. Prior to that, he was Chief Risk Officer at Coventry Health Care between

1998 and 1999 and a co-founder of the Health Care Compliance Association in 1995. Mr.

Saunders began his career as Chief Compliance Officer for the Thomas Jefferson University

Health System. In addition to the Bausch + Lomb board, he serves on the boards of ElectroCore

LLC and the Overlook Hospital Foundation. He is also the former Chairman of the New York

chapter of the American Heart Association. Mr. Saunders was also recently named to the Federal

Reserve Bank of New York’s Upstate New York Regional Advisory Board. He received a B.A.

from the University of Pittsburgh, an M.B.A. from Temple University School of Business, and a

J.D. from Temple University School of Law.

10. Peter J. Zimetbaum, M.D. (Director since 2009)

Dr. Zimetbaum, 47, has served as Director of Clinical Cardiology at Beth Israel Deaconess

Medical Center in Boston (BIDMC) since 2005 and served as Director of Clinical

Electrophysiology at BIDMC from 2001 to 2005. Additionally, since 2006, Dr. Zimetbaum has

been an Associate Professor of Medicine at the Harvard Medical School (HMS), and he currently

serves on the HMS Standing Committee on Conflicts of Interest. Dr. Zimetbaum received his

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M.D. degree from the Albert Einstein College of Medicine in 1990 and is board certified in both

cardiovascular medicine and cardiovascular electrophysiology.

Cyclicality of Market and Forest Labs

Everything old is new again. It seems like Forest Labs (NYSE:FOREST LABS) is perpetually

beset by worries about its future: Will the company be able to navigate the next patent cliff and

will the company continue to find attractive licensing deals to keep its growth engine running?

Even though the company has pretty much always been able to find favorable answers to the

questions, Wall Street never seems willing to give Forest all that much benefit of the doubt.

Forest Labs released early prescription data and trends for their new drug Daliresp. As of the

week ended March 30, there have been over 135,000 prescriptions written. Overall total

prescription volume in the March quarter increased almost 40% over the December quarter after

having doubled in the fiscal third quarter over the second. New prescription share of the total

market was 1.49% for the week ending March 30 versus 1% for the last week of December,

while TRx share was 1.15% versus 0.75% for the same period. Over 18,000 physicians have

already tried Daliresp, including 39% of all specialists, which is a very positive signal, and over

50% [ph] of physicians have used Daliresp more than once.

Since launch, primary care physicians and other healthcare providers have written approximately

75% of scripts; specialists, around 25%, which is in line with expectations. Forest Labs sales

force has reached 85% of Forest Labs client target audience. Physicians’ interest in Daliresp is

very high, with awareness of products well above 90%. Feedback from pulmonologists and PCPs

is positive, as seen by the fact that most prescribers have written more than once.

Over 30 million patients are taking antidepressants in the U.S. Patients need a first-line

antidepressant that offers efficacy that can help them recover as well as an acceptable side-effect

profile. Furthermore, roughly 50% of patients need an alternative antidepressant, primarily due

to lack of efficacy of the previous agent or secondarily, due to side effects. In either situation,

Viibryd can be that option. Its mechanism of action is different from other antidepressants.

Viibryd's the first and only approved SSRI and 5HT1A receptor partial agonist.

As of the week ended March 30, there have been over 415,000 prescriptions written by

approximately 43,000 prescribers, including almost 44% of high-prescribing psychiatrists.

Approximately 70% of prescribers are repeat prescribers. Since launch, about 43% of scripts

have been written by psychiatrists and approximately 57% by primary care physicians and other

healthcare providers. We're very pleased with the response to this product by not only specialists,

but also primary care physicians.

Bystolic's study has sustained growth so far and is a good example of how we build products

over time to their full potential. Sales in the quarter for Bystolic were $96.9 million, representing

growth of 32.6% year-over-year. At 4 years post-launch, Bystolic's NRx volume has surpassed

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many anti-hypertensive agents while looking at launch-align new Rx volumes. Moreover, total

prescription launch aligned volume is in line with Benicar, a first-line ARB. Bystolic achieved a

4% share among specialists several months ago, and weekly national share among all prescribers

is now consistently above 4%.

Interestingly, younger patients comprise a higher percentage of Bystolic’s patient base than they

do for other beta blockers and other antihypertensive agents in general. 56% of Bystolic's

patients are younger than 65 compared to 46% for other beta blockers and 52% for the general

antihypertensive market.

In quarter 4, days of therapy increased 20% over quarter 3 to reach approximately 120,000 days

of therapy in the quarter. Teflaro has a strong user base, with over 3,000 hospitals purchasing,

which is almost 50% of the entire hospital universe. The number of new and repeat accounts is

also climbing and significantly exceeds CUBICIN's launch-aligned user base count. Quarter-

over-quarter, we've seen an increase of 13% in total accounts purchasing Teflaro, and 83% of

hospitals have purchased Teflaro multiple times.

Formulary acceptance continues to advance with the majority now of target hospitals, 56%,

granting Teflaro unrestricted access. Overall, we had 80 formulary wins since December, and 17

have been in the top 250 hospitals, where days of therapy growth continues to outpace growth in

the overall market. In addition, over time, the gap in days of therapy between unrestricted access

versus non-formulary access continues to widen.

Share of the ABSSI market in January was 1.26% versus 0.89% in December, a 0.37-point

increase in one month. Forest Labs CAP market share jumped to 0.42% in January, versus 0.25%

in December and more remarkably, from 0.1% at the beginning of the respiratory season.

Namenda is and remains an important product for Forest. Sales for Namenda were $393.1

million in the quarter with growth of 19.5% year-on-year, which contains consistent, single-digit

real growth 8 years post-launch. We expect Namenda to continue to be a growth product for

Forest as we continue to support it. Furthermore, the launch of an XR product that has a higher

dose, a once-a-day formulation and also has been studied in combination with all

acetylcholinesterase inhibitor should propel future growth for this important product.

Savella sales in the current quarter were $25.3 million, growth of 6.5% year-on-year compared to

sales of $23.7 million last year. Overall, the fibromyalgia market has grown more modestly than

anticipated and has proven itself to be a more specialty-driven market than a broad-based

primary care category. Savella's share among specialists is comparable to that of Cymbalta and

Lyrica.

Lexapro's patent exclusivity ended this past March. Substitution rates for Lexapro quickly grew

to greater than 80% in just 6 weeks. Consequently, wholesalers rapidly drew down their

inventories. Sales of Lexapro were $355.8 million versus $594.8 million the same quarter a year

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ago. Only 2 generic products, Mylan's and Teva's, will be in the market until mid-September

2012, when the 180-day Hatch Waxman exclusivity period ends.

Overall, fourth quarter fiscal 2012 was a good quarter for Forest Labs promoted products. Sales

of Forest Labs newest products were up: Daliresp increased 56%; Viibryd, 32%; Teflaro, 22%

over the previous quarter. Forest Labs more established products, Bystolic and Namenda,

continue to enjoy real unit growth several years post-launch. As we prepare for another round of

important launches, Forest Labs is very encouraged by these results.

Forest Laboratories Outlook

The ever-present concern about Forest Labs is whether the company can continue to recharge its

product portfolio with lucrative new drugs. Forest does no in-house new drug research, instead it

focuses all of its future toward acquiring, developing and exploiting other companies'

compounds. It has been a very successful model throughout Forest's history. Overall through this

Forest is a competitive leader in its niche of dealing with pharmaceuticals in this way and does

just as Merck (NYSE:MRK), Pfizer (NYSE:PFE) and Novartis (NYSE:NVS) in converting

revenue to free cash flow.

The geography of big-cap pharmaceutical companies has changed a lot over recent years due to

regulation, more frequent patent cliffs, reform and the maturation of the Alheimer’s

pharmaceutical market. Companies like Pfizer, Merck, and Glaxo (NYSE:GSK) have reduced

their headcount in R&D and are currently aggressively seeking wider use of licensing

agreements and acquisitions. This is similar to Forest’s approach. AstraZeneca (NYSE:AZN)

and Lilly (NYSE:LLY) is currently dealing with pipeline failures and patent cliffs more than

ever. There is a stronger interest due to the success of Forest that the exploitation of in-licensing

and acquisition.

In other words, Forest Labs has more and more competition when it comes to striking profitable

bargains for small companies' pipeline candidates in their quest for attaining compound rights.

In respect to Forest Labs’s pipeline, the company has Teflaro for infections, two COPD drugs

and a promising candidate in late-stage testing for irritable bowel syndrome and chronic

constipation. Beyond that they are doing what they do best and are utilizing additional

compounds. In this case it is being tested for depression; these are compounds which would be

natural extensions of Forest's long-held franchise in psychiatric medication.

P a g e | 16

1. Patent Expiration

Forest Laboratories faces expiration of two of its blockbuster drugs in 2012. As you can see from

current drugs portfolio below, Namenda and Lexapro which represent 85% of their current

revenue of that fiscal year are going to experience patent expiration. And this patent cliff has

become the major concern for the investors. This report also aims to explore whether the Forest

Labs’ newly launched drugs and drugs in the pipeline would have the potential to cover the

revenue loss due to the patent expiration of Namenda and Lexapro.

Patent of drugs in the United States expires every fifteen years. As soon as the patent expires,

generic versions of the drug are allowed to enter the market, bringing the once brand name drug

dramatic competition. However, it does not mean that the revenue that the drug was gaining

would vanish right after the patent expires. Firstly, it takes time for the generic version of the

drugs to come into the market. Secondly, the drug’s brand equity and customer loyalty over the

last fifteen years should still help to keep parts of its revenue. And it is likely the same for Forest

Lab’s two drugs: Namenda and Lexapro.

Current Drugs for fiscal year ended March 2011.

P a g e | 17

2. Prospects of New Launches

As investors, we are all concerned about whether Forest Lab’s Newly Launched drugs would be

successful enough to cover the revenue loss due to patent expiration. Below we examined the

performance of four of its recently launched drugs and one old drug in the second quarter of fical

year 2012.

According to Forbes new release, Bystolic, Forest Labs’ beta-blocker for the treatment of

hypertension, posted revenues of 82.3 million, up 29.2% for the second quarter of fiscal year

2012. Savella, which is approved for the management of fibromyalgia, posted revenues of $25.5

million, up 19.1% from the year-ago period.

Forest Labs’ new product, Teflaro, posted revenues of 5.3 million, up from $2.7 million in the

first quarter of fiscal 2012. The FDA granted approval to Teflaro for the treatment of patients

suffering from acute bacterial skin and skin structure infection and community acquired bacterial

pneumonia in October 2010. Forest Labs launched the product in March. The company is

targeting 2,200 key hospitals and hospital systems. The Center for Medicaid and Medicare

Services (CMS) has added Teflaro to the Specifications Manual for National Hospital Inpatient

Quality Measures as a recommended initial antibiotic (applicable to hospital discharges on or

after January 1, 2012). This should increase the use of Teflaro as a first-line agent, particularly in

community-acquired bacterial pneumonia.

Two other products, Daliresp and Viibryd, were launched in August. While Daliresp, which is

approved for the treatment of chronic obstructive pulmonary disease (COPD), recorded revenues

of 1.2 million, Viibryd (vilazodone HCl), approved for the treatment of major depressive

disorder (MDD) recorded revenues of $5.3 million.

Q2 FY 2012 Performance of the New Launches

P a g e | 18

3. Broad Pipeline

From the pipeline taken from Forest Labs’ official website, it is quite observant that Forest Labs

has a variety of drugs in its pipeline. Two of its drugs have filed for NDA. Five of its drugs are in

their phase three of development. In comparison, as shown in the table below, Valent

Pharmaceutical only has one drug filed for NDA. One drug in its third phase of development and

the rest of the drugs in its pipeline are still in the preliminary development phase.

Pipeline from Forest Labs

P a g e | 19

Pipeline from Valent Phamaceutical International. Inc

Main Points

Forest Labs faces a sharp fall-off in sales and cash flow in just a couple of years due to the

development of new product revenue streams.

Overall Forest Labs needs to continue to develop its pipeline to maintain competitive leadership

and market share in its industry. With the expiration of patents of flagship brands (Lexapro and

Namenda) Forest Labs is at risk of not executing sales at the same caliber as its push in these

launches. Forest Labs is in a unique stage of development and with the post-submission stage

completed for their new emerging brands it can prove to be a leader in the pharmaceutical

industry.

P a g e | 20

IV. Ratio Analysis

Profitability Ratios

Notes: Forest Labs fiscal year is in March, while its competitors’ are all in December. We want

the calendar time periods to overlap as much as possible, so we line up FOREST LABS March

2012 number with its competitors’ December 2011 numbers through all the ratio analysis part.

Sales

From the chart, you can see that Pfizer and GlaxoSmithKline get the highest revenue and are far

above its peers. Lily is hovering around the industry average. Forest Lab’s revenue size is closer

to Watson, especially in year 2011, when Forest Labs was 4565.7 million and Watson was

4584.4 million. Valeant has the lowest revenue among all the competitors through 2002 to 2011.

When we look at the sales growth rate chart below, we can see that Forest labs’ growth rate is

neither under- nor out-performing its competitors.

P a g e | 21

Net Income

Because net income shows a company’s total profits, it is an important measure in analysis.

Forest Labs’ net income is almost at the bottom due to the size of the company being

comparatively small. We can see on the chart that the blue line of Forest Labs only surpassed

Valeant and Watson. But the average annual growth rate from 2006-2011 is the second highest

among those comparable. In March 2012, Forest Labs’ Net Income was 979.1 million; compared

with Pfizer’s 8697.0 million there’s a huge gap in between. But actually the net income of

FOREST LABS is gradually increasing.

P a g e | 22

Cash Flow Operations

The cash flow from operations number for Forest Labs( March 2011) is almost four times the

number of Valeant ( December 2010). Their cash flow from operation is comparatively flat

among its competitors. And FOREST LABS stays above 1000 million since 2007 (March 2008).

Due to the March 2012 cash flow from operations is not avaialble ,we only calcuated the the

average annual growth rate from 2006 to 2010. As we can see their average annual growth rate

of 6.65% is the second highest, and the average industry growth rate is -1.28%.

P a g e | 23

Net Profit Margin

Net Profit Margin is the ratio of net profits to revenues for a company that shows how much of

each dollar earned by the company is translated into profits. From the chart we can see that

Forest labs’ net Margin is comparatively healthy than the industry average. That means Forest

Labs’ ability of translated revenues into profits is more efficient than its competitors. Also,

compared with WPI, VRX and LLY’s net profit margins are more volatile than FOREST

LABS’s. Starting in 2009, the custom industry’s average net margin is gradually decreasing, but

it picks up in 2010. FOREST LABS shows an upward trend from 2009 to 2010, and then goes

down in 2011.

P a g e | 24

Gross Margin

Forest Labs is comparatively stable among its competitors; the highest ratio was 79.229% in

March 2003, and the lowest ratio was 77.832% in March 2010. It floated within a pretty narrow

range. Also, on the chart, Forest Labs surpassed the custom industry average from 2004 to 2010,

and surpassed GlaxoSmithKline a little bit in 2010.

P a g e | 25

ROE and DuPont Analysis

Return on Equity represents how much profit a company generates with money its shareholders

have invested. On the chart, Forest labs’ ratio is higher than Pfizer since 2003. Also, Forest Labs

comparatively stays on a stable level. By using the DuPont analysis to break down the

composition of ROE into three parts, we can see that financial leverage and asset turnover did

not change that much, it is the floating net profit margin cause the change in ROE ratio.

P a g e | 26

ROA

ROA is measured as income dollars generated per dollar of assets and shows how profitable a

company is relative to its assets. ROA represents how efficient management is at using its assets

to generate earnings. Overall, Forest Labs was on the top, except in the years 2006, 2009 and

2010. Also, we can see that FOREST LABS is higher than its competitors and industry averages

throughout the years 2002 to 2011. But the decrease of the ROA ratio starting in 2007 is due to

the gradual increase of the average assets, and that means Forest Labs’ ability to use assets to

generate earning decreased.

P a g e | 27

Liquidity Ratios

Quick Ratio 1

The quick ratio measures a company’s ability to meet its short-term obligations with its most

liquid assets, excluding inventory. The Forest Labs’ line is far above its competitors and

industry average. In year 2010 the quick ratio of FOREST LABS reached the peak of 5.13, while

custom industry average was only 2.04, so there is a 3.94 gap in between. In 2006, the cause of

Forest Labs’Quick ratio’s upward trend and industry average’s downward trends is because

FOREST LABS decreased its inventory from 610.2 in year 2003 to 451.4 million in year 2010,

but other competitor’s inventory all increased during this period.

P a g e | 28

Current Ratio

The current ratio gives an idea of the company’s ability to pay back its short-term liabilities with

short-term assets. The pattern of Current ratio is similar to the Quick Ratio. In March 2011

Forest Labs reached it’s peak of 5.61, while industry average was still at a low level.

Current Ratio

FRX

LLY

GSK

WPI

VRX

PFE

Industry Avg

P a g e | 29

Efficiency Ratio

Asset Turnover

Asset turnover measures the amount of sales generated for every dollar’s worth of assets. Forest

Labs’ asset turnover ratio is hovering around the top 2 in the past 8 years. And during 2006 to

2008, its ratio was even better than GlaxoSmithKline’s. Forest Labs’ ratio is far above Valeant’s,

which is the most similar company to Forest Labs. But since 2006 FOREST LABS’s asset

turnover has been trending downward to 0.641 from 0.940, and became the third highest among

those competitors. It is the growth of average asset outpacing the growth of sales that caused this

downward trend.

P a g e | 30

Inventory Turnover

Inventory Turnover shows how many times a company’s inventory is sold and replaced over a

period of time. At the beginning, Forest’s ratio started out near the lowest among this peer group

, but its COGS (excluding depreciation and amortization) increased from 458.4 million in 2002

(March 2003) to 891.0 million in 2010 (March 2011), which is almost double the number of

COGS; meanwhile the Average Inventory number is hovering around $450 million. It caused the

Forest Labs’ inventory turnover ratio to spike to 2.01 in year 2009. And it has stayed among the

top 3 since the year 2007.

P a g e | 31

Receivables Turnover

Receivable turnover ratio measures the number of times, on average, accounts receivables are

collected during the period. Forest Labs receivables turnover declined from 13.75 in March 2003

to 8.10 for their March 2006 year, and it has remained between 8 and 8.5, and above this peer

group, since then.

P a g e | 32

Asset Turnover

Asset turnover measures the amount of sales generated for every dollar’s worth of assets. Forest

Labs’ asset turnover ratio is hovering around the top 2 in the past 8 years. And during 2006 to

2008, its ratio was even better than GlaxoSmithKline’s. FOREST LABS’s ratio is far above

Valeant’s, which is the most similar company to FOREST LABS. But since 2006 FOREST

LABS’s asset turnover has been trending downward to 0.641 from 0.940, and became the third

highest among those competitors. It is the growth of average asset outpacing the growth of sales

that caused this downward trend.

P a g e | 33

Solvency

Financial Leverage Ratio

Financial leverage is calculated as total assets divided by total shareholder’s equity. It is a

measure of total borrowing and use of leverage in their capital structure. Forest Labs do not have

debt, so they have the lowest financial leverage which makes it less exposed to failure risk.

P a g e | 34

IV. Pro Forma Income Statement

One of the most important stepping stones to analyze while valuing a company is the income

statement. The components contribute to each other and allow you to make future estimates and

construct earnings per share estimate. The Pro Forma Income Statement includes industry

revenues, yearly share, total revenue, depreciation, amortization, cost of goods sold, operating

expenses, average diluted shares, and earnings per share. The values are represented in

thousands.

Industry Revenues

Projection: 314.704

Based on FactSet estimates, there could be a prediction on industry revenues. This was done by

constructing a graph with FRX’s top competitors (LLY, GSK, WPI, VRX, and PFE) as well as

comparing it to our ten custom firms (including MRK,JNJ,ABT, and BMY). Actual revenue

numbers were used for each company from 2002-2012, and forecasted the revenue values for

2013.

Revenues

0.0

10,000.0

20,000.0

30,000.0

40,000.0

50,000.0

60,000.0

70,000.0

80,000.0

LLY

WPI

FRX

GSK

PFE

VRX

Industry Avg

P a g e | 35

Yearly Share

Projection: 1.305%

Yearly share has been around the 1.3 to 1.4 range fluctuating up and down for the past seven

years relative to our custom industry. It had been growing steadily from 2006-2010 then took a

slight dive in 2011 to 1.381 and rebounded in 2012 to 1.424. There will be a decrease to 1.305 in

the yearly share for 2013 as by calculating the eleven and ten year averages. This decline is

mainly due to delay in the pipeline for the new drug linaclotide, which is used for the treatment

of irritable bowel syndrome as well as the expiration of one of their heavy hitter patents,

Lexapro, which is a treatment for depression. There are also generic brands of Lexapro that have

been produced by Teva (TEVA) as well as Mylan (MYL) marketing an authorized generic

version of the product.

FRX Yearly Share

P a g e | 36

Total Revenue

Projection: 4,106.90

The estimate for total revenue was calculated by taking the yearly share estimate for 2013, and

multiplying it by the industry revenue for the same year, then multiplying that by a thousand. A

decrease in total revenue from 2012 from 4,565.7 million to 4,106.90 for 2013 is projected due to

the loss of patent for Lexapro.

Revenue Comparison

The pie chart below compares FRX’s revenue size with regards to that of other similar

companies in the industry. The 2011 sales revenue for LLY, GSK, WPI, VRX, and PFE was

used as well as the March 2012 fiscal year for FRX as our input data to create the chart below.

Sales Revenue

Dec 2011

FRX 4,565.7 LLY 24,286.5 GSK 44,091.2 WPI 4,584.4 VRX 2,463.5 PFE 67,425.0

P a g e | 37

Depreciation

Projection: 43.97

The five year average was used for depreciation arriving at 43.97 million for the 2013 estimate.

It has remained in the 40.0 to 50.0 (thousands) range for the past six years.

Depreciation

Amortization

Projection: 70.74

Amortization rises from 65.4 million in 2012 to the highest it has been at 70.74 for 2013 as it is

estimated on the company’s 10K for 2013.

Cost of Goods Sold

Projection: 987.63

Cost of Goods Sold excluding Depreciation and Amortization was taken as a percentage of

revenue by using COGS excluding D&A and dividing it by total revenue. For the 2013 estimate,

the average over the ten years as well as the year to date for 2011 was taken. The estimate for

COGS excluding D&A in 2013 came by taking total revenue and multiplying it by the COGS

P a g e | 38

percentage of revenue estimate which was $872.91 (thousands). Depreciation was averaged for

the past 5 years and Amortization was taken as an estimate from the 10K. Adding these three

arrived at the total COGS estimate for 2013. It has been growing since 2006 but is due for an

expected decrease since revenues have declined.

Operating Expenses

Projection: 2217.26

This was recorded by taking SGA Operating Expenses and then splitting it into R&D and other

SGA. For 2013 the estimate for R&D was found in the 10K, $850.00 (thousands) also

calculating the 2013 Other SGA expense estimate by finding other SGA as a percentage of

revenue (33.29%), which was the average of the past eleven years, then multiplying it by

revenue. Then adding R&D and SGA to get the total operating expense. This has been going

steady around the 30.0 to 40.0% range since 2002.

Operating Expenses as % of Revenue

P a g e | 39

Provision for Legal Judgment/Other Extraordinary Expense

Projection: 0

FRX shows no signs of any of these expenses.

Interest Income: 23.8

The interest income forecast for 2013 comes from the calculation of the projected interest yield

of 8% for 2012 multiplied by adding cash and s/t investments as well as total investments and

advances for 2012. It is expected to stay around the 20.0 to 30.0 (thousands) range as it has for

the past couple of years.

Interest Income

Interest Expense

Projection: 0

FRX has no debt and shows no signs of it.

P a g e | 40

Contract Revenue and Other Income

Projection: 191.3

This was done by taking an average over the past seven years to come up with an estimate for

2013. It has stayed put in the high 100.0 (thousands) for the past two years.

Contract Revenue and Other Income

P a g e | 41

Average Weighted Diluted Shares

Projection: 268000

This is a slight drop from the year before. The expiration of the patent for Lexapro remains a

contributor to this. The number was obtained from the 10K report.

Earnings Per Share

Projection: 3.068

EPS has been growing for FRX during the past two years. But as the patent for Lexapro expires

the EPS will drop a slight bit. However, FRX has added two other new products, Viibryd and

Daliresp, to keep themselves from falling out of the market.

EPS

P a g e | 42

V. Relative Valuation

The following charts indicate the trailing P/E for Forest Lab’s Comparables pharmaceutical

stocks Eli Lilly (LLY), Watson Pharmaceuticals (WPI), Johnson & Johnson (JNJ),

GlaxoSmithKline (GSK), Pfizer (PFE), Merck & Co., Inc (MRK), Abbott Laboratories (ABT),

Valeant Pharmaceuticals (VRX), and Bristol Myers Squibb Co. (BMY). Due to the fiscal year of

Forest Labs being different from the other comparables, we use the subbed methodology to get

their P/E from the Factset. This way, we can line up Forest Labs numbers with other

comparables in the Decembers through 2002-2011.

Company Trailing P/Es

As we can see from this chart, Merck P/E of 128.71 for 2010 and Valeant P/E of 89.79 for 2011

are so significantly high among their historical P/E ratio, and we think they will pollute our later

calculation of mean and median, and future price estimate. So, in this case we decided to exclude

Merck P/E, and for Valeant P/E we leave it there, but we decided to raise our adjustment factor

later a little bit.

The historical relative proportion between Forest Labs and the benchmark P/E ratios will be used

in forecasting the future relationship between Forest Labs and its competitors. As shown in the

table below, we divided Forest Labs P/E by the P/E of comparables, P/E of custom industry’s

average, as well as the S&P500 healthcare sector. We did this for each year and calculated both

the average and median to form our adjustment factors.

P a g e | 43

P/E Ratio Relationships

In 2011, the relationships were all below 1, and the last two years P/E relationships are

significantly different from the mean and the median’s column. In this case our group decided to

use the adjustment factors, that we felt were most accurate and resembled the most recent trends.

Also, the lower adjustment factor we use the more conservative price estimate we can get.

Since we want to estimate March 2013 for Forest Labs, we use three-fourths of 2012 forward

P/E and one-fourth of 2013 forward P/E ratio to get the 2013 weighted average number. Also, in

order to figure out the left hand side forward P/E for 2013, we use the price from 4/27/2012

divided by the Non-GAAP expected 2013 EPS for FOREST LABS’s comparables. By using the

formula and the expected EPS of Forest Labs for 2013, which we got from our assignment 3, we

can see the green part is our estimate for the Forest Labs future Price and Current Price. And the

average price estimates are hovering around 36 dollars. Compared with the price 34.92 last

Friday April 27, Forest Labs is fair valued.

P a g e | 44

VI. Absolute Valuation

Since Forest Laboratories has no debt or dividends, the Free Cash Flow to Firm model is

applied for our absolute evaluation. The Free Cash Flow to Firm refers to cash flow available to

all providers of capital (equity & debt) after operating expenses are deducted and investments in

fixed (Capex) and/or working capital are made.

Cost of Capital

We used two different methods to calculate possible cost of capital: the CAPM and Bond

yield + Equity premium method.

CAPM (Capital Asset Pricing Model)

The cost of capital (k) calculated by CAPM, equals beta of FOREST LABS multiplied by

the market risk premium plus a risk free rate of return. The market risk premium equals the

expected market return minus the risk free rate. The calculation is shown in the table below.

10 Yr 30 Yr

Treasury Strip 2.186% 3.38%

Risk Premium (MR-RF) 8.58% 7.39%

Expected Market Return (MR) 10.77%

Beta 0.785

P a g e | 45

Calculation RF+Beta(MR-RF)=K

K1 K2

Results 0.089 0.092

In the tables below, we show groups of treasury rates and betas we have looked at and

our rationale behind choosing the ones to be put into the CAPM calculation.

Treasury Rates (as of 4/18)

10 Year 30 Year

T-bond 1.98% 3.13%

Strip 2.186% 3.38%

Beta 5yr (3/30/2007-3/30/2012) Beta 10yr(3/29/2002-3/30/2012)

Raw Adj Raw Adj

0.678 0.785 0.623 0.749

The risk free rates used here are the STRIP numbers for both 10 Year and 30 Year rate.

The market expected return used here is the US market return ratio as of 4/17/2012 from

Bloomberg. The 5- year adjusted beta is used because we want to be conservative in our

evaluation by inserting the highest beta.

Bond Yield + Equity Premium Method

The method that is demonstrated in the Utendahl analysis is utilized to get to our third

possible cost of capital here. We firstly selected Valeant Pharmaceutical, which is a company

very similar to Forest Laboratories as our comparable. We then found that its most recently

issued 10-year bond has a yield to maturity of 7.335% as of 4/26/2012. Then an equity premium

is applied to this yield to get to our third cost capital as it was the case in the Utendahl example.

The equity premium refers to the return difference between equity and bond. The equity

premium applied in Utendahl case was 3%, which is ten years ago. We believe that a 10%

increase in that number is reasonable with regards to the current economic condition. This will

lead our equity premium to be 3.5%. Therefore, through the Bond yield + Equity premium

method, our K3 amounts to roughly 11% (7.335%+3.5%=10.84%).

Cost of Capital (k) Used

P a g e | 46

We felt that k1 and k2 from the CAPM calculation failed to capture the additional risk

corporate bond brings over. Additionally, we also want to keep taking a conservative position by

taking the highest k to prevent from inflating our price estimates. Therefore, the k3 cost of

capital of 10.64% is used throughout the absolute valuation.

Near Term Growth Rate for FCF

Next, we looked at the historical free cash flows of FOREST LABS over the last ten

years as shown above. We calculated the geometric average growth rate of the FCF over three

periods. From the results, we concluded that FOREST LABS’s free cash flow has experienced

significant growth from 2002 to 2008. And the growth trends continued from 2008 onwards

excerpt a slight drop in 2009 and 2010. However, the growth rate over the last four years has

been a lot more moderate. Therefore, we decided to take 2.65% as our near-term growth rate for

free cash flow.

Near-Term and Long-Term Growth Rate Matrix

In order to be more conservative and comprehensive in our evaluation, we choose to do

two streams of scenario analysis. We created a matrix shown as below using near-term growth

rate (g1) ranging from -3% to 9% and long-term growth rate (g2) ranging from -3% to 5% to

estimate the current intrinsic value of Forest Laboratories by following the steps below.

1. Estimate the future free cash flow for Forest Laboratories from 2012 to 2018 using g1.

2. Discount all the 2012 to 2018 FCF estimates using k3 and sum them up to get total PV

for 2012 to 2018.

3. Use the FCF for 2018 calculated from step 1 and multiply by g2 to get to estimate FCF

for 2019

4. Calculate Estimate of intrinsic value of FCF for 2018 onwards in with the formula below:

P a g e | 47

Est (IV 2018) = FCF 2019/ (k3-g2)

5. Discount the result from step 2 to 2012 to get the PV for 2018 onwards.

6. Add up the PV for 2012 to 2018 and PV for 2018 onwards to get the total PV.

7. Divide the PV with the Weighted Average Diluted Shares of 268 Million for Forest

Laboratories to get to the estimate of intrinsic value for FOREST LABS now.

Growth Rate from 2018 Onwards (g2)

Near-Term Growth Rate (g1) -3% -2% -1% 1% 2% 3% 4% 5%

-3% 33.22 34.52 36.04 39.99 42.63 45.92 50.15 55.79

-2% 34.76 36.15 37.76 41.96 44.76 48.26 52.76 58.77

-1% 36.37 37.84 39.56 44.02 47.00 50.72 55.50 61.88

1% 39.80 41.46 43.39 48.43 51.78 55.98 61.37 68.56

2% 41.62 43.39 45.44 50.78 54.34 58.79 64.51 72.14

2.65% 42.85 44.68 46.82 52.37 56.06 60.69 66.63 74.56

3% 43.53 45.40 47.58 53.24 57.01 61.73 67.80 75.89

4% 45.52 47.50 49.81 55.81 59.81 64.81 71.24 79.81

5% 47.59 49.69 52.13 58.49 62.72 68.02 74.83 83.91

6% 49.75 51.97 54.56 61.29 65.77 71.38 78.58 88.19

7% 52.01 54.35 57.09 64.21 68.95 74.88 82.51 92.67

8% 54.35 56.83 59.73 67.25 72.27 78.54 86.60 97.36

9% 56.80 59.42 62.48 70.43 75.73 82.36 90.88 102.24

The chart above is telling us that with the worst case scenario, a negative three percent

near-term and long-term growth rate will only lead Forest Laboratories to be fairly valued (The

price as of 4/30/2012 is $34.83). If Forest Laboratories continues its recent five year growth rate

of 2.65% in the near-term, even a negative three percent long-term growth rate will lead Forest

Laboratories to be undervalued. However, looking from another perspective, the result might

also be signifying that the market is currently expecting Forest Labs to have negative growth rate

for a long time. However, according to our company and industry research, we believe even if it

is the case, the market should be having overly low expectation for Forest Labs providing that it

has great cash position and broad pipeline.

P a g e | 48

Along with results from company and industry analysis conducted above, we conclude

that Forest Laboratories is likely to be undervalued.

VII. Recommendation

Overall by using a three-legged approach in our valuation of Forest Labs including ratio analysis

in a custom and relative industry, cash flow analysis and absolute/relative valuation we conclude

forest is undervalued even within a scenario analysis framework at a 3 percent growth rate. After

extensively observing the growth and position of Forest Labs, the Forest Laboratories analyst

team considers Forest Labs as an emerging leader in the near future bringing great potential

value to the SMIF.

Our absolute valuation calculation shows that Forest Labs is highly undervalued however using

the highest cost of capital and negative growths this shows the valuable position of Forest Labs

for purchase. Our relative valuation calculation shows that Forest Labs is fairly valued.

Recommendation: Purchase 150 share at $30 limit buy order

P a g e | 49

References

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<http://www.reuters.com/article/2012/03/28/us-forestlaboratories-idUSBRE82R0KE20120328>.

"Forest Labs, & Pierre Fabre Medicament reports positive phase III results of levomilnacipran in

MDD patients."Www.pharmabiz.com. 30 Apr. 2012.

<http://pharmabiz.com/NewsDetails.aspx?aid=68743&sid=2>.

"Forest Labs Q4 profit falls."Market Watch. 17 Apr. 2012.

<http://www.marketwatch.com/story/forest-labs-q4-profit-falls-2012-04-17>.

"Company Profile for Forest Laboratories Inc (FRX)." Bloomberg. 30 Apr. 2012.

<http://www.bloomberg.com/quote/FRX:US/profile>.

"Ironwood Pharmaceuticals Provides First Quarter 2012 Investor Update." Bloomberg. 1 May

2012. Business Wire. <http://www.bloomberg.com/apps/news?pid=conewsstory>.

"Overview for Forest Laboratories Inc (FRX)."Bloomberg. 24 Apr. 2012.

<http://www.bloomberg.com/quote/FRX%3AUS>.

"Development Pipeline." Development Pipeline. Web. 08 May 2012.

<http://www.valeant.com/products/pipeline.aspx>.

"FOREST LABS INC (NYSE: FRX) | Buy/Hold/Sell Analysis." FRX. Web. 08 May 2012.

<http://finapps.forbes.com/finapps/BuyHoldSellAnalysis.do?tkr=FRX>.

P a g e | 50

"Forest Laboratories Management Discusses Q1 2012 Results - Earnings Call Transcript -

Seeking Alpha." Forest Laboratories Management Discusses Q1 2012 Results - Earnings Call

Transcript - Seeking Alpha. Web. 08 May 2012. <http://seekingalpha.com/article/280330-forest-

laboratories-management-discusses-q1-2012-results-earnings-call-transcript>.