Mylan Lab’s Proposed Merger with King Pharmaceutical Harvard Case Solution & Analysis

Analysis:

Quantitative analysis of KP:

Quantitative analysis of the deal is done in order to identify the value of KP through various methods. These include:

-       Discounted cash flow projections (DCF)

-       Value based on multiples of comparable transactions

-       Value based on multiples of comparable companies

Calculations performed are discussed below:

DCF:

For the purpose of value determination through DCF approach, a discount rate is determined using the WACC approach that suggests the discount rate for KP to be 6.17% using the beta calculated from stock prices. The cash flow sums up to \$8.8 billion based on cash flow projections and terminal value. Following assumptions are used for calculations:

-       Average of KP’s data available for last three years.

-       Synergies are considered to be \$100 million per year.

-       Growth rate of the pharmaceutical industry is not stable and is quite unusual. Hence, a 3% short-term growth is assumed for KP (as it is under pressure) and a 1% long-term perpetual growth rate is assumed for terminal value.

-       Market risk premium is assumed to be 5% on equity exposures, which is beyond risk-free rate.

 Simple Weighted Average Cost of Capital (WACC) Calculator Beta 0.46 % Debt 14.46% 2003 balance sheet % Equity 85.54% Corporate Tax Rate 36.40% Average of last 3 years Risk-Free Rate 4.45% 10 year Govt. rate Market Risk Premium 5.00% Assumption Interest rate 4.51% https://www.treasurydirect.gov/govt/rates/pd/avg/2004/2004_07.htm Cost of debt 2.87% Cost of Equity 6.73% WACC 6.17%

 DISCOUNTED CASH FLOW PROJECTIONS g 1.00% Perpetual (long term) growth rate - Assumption k - Discount rate 6.17% WACC Perpetuity rate (k-g) 5.17% Cash flows 0 1 2 3 4 5 2004 2005 2006 2007 2008 2009 Growth rate 3% 3% 3% 3% 3% EBITDA 599.4 617 636 655 675 695 Depreciation 15% 95 98 100 103 107 Capital Expenditures 12% 76 79 81 84 86 Operating NWC 170% 1,053 1,084 1,117 1,150 1,185 Tax rate 36% 36% 36% 36% 36% 36% Cash Flow EBIT x (1-tax rate) 393 404 417 429 442 Synergies 100 100 100 100 100 Add: Depreciation 95 98 100 103 107 Less: Change in Working Capital (775) (32) (33) (34) (35) Less: Capital Expenditure (76) (79) (81) (84) (86) Free Cash flow (264) 492 503 515 528 1,774 WACC 6.17% 6.17% 6.17% 6.17% 6.17% PV of FCFF (249) 436 421 406 391 1,405 Terminal value 10,315 PV of terminal value 7,646 Free cash flow to firm - FCFF 9,051 Less: Net debt (199) Free cash flow to Equity – FCFE 8,852

Excel file shows calculations in detail.

Multiples (comparable transactions and comparable companies):

Similarly, multiples used in recent transactions and multiples of comparable companies are also considered in determining the value of KP.   Calculations are made based on the recent data of KP and average of comparable transactions of rival firms (based on revenue and earnings that are comparable / close to that of KP). The result of calculations is as follows:

 Comparable transactions Comparable transaction as per revenue and EBITDA Kings data Roche SICOR Lek Pharmaceutical ALZA Average Value as per multiple Revenue multiple 1,521 2.132564841 7.260964912 3.103559871 14.04060667 6.634424074 10,093.61 EBITDA multiple 599 1.336343115 18.29281768 13.7 42.72664615 19.01395174 11,396.96 Net income multiple 106 N/A 25.8671875 29.96875 62.26977578 39.36857109 4,169.13 Comparable companies Comparable companies as per revenue and EBITDA Kings data Watson Endo Health Ono Pharmaceutical Perrigo Company Mylan, Inc. Average Value as per multiple Revenue multiple 1,521 2 4.7 3.1 1.3 3.5 2.92 4,442.49 EBITDA multiple 599 6.9 18.3 7 9.3 9.6 10.22 6,125.87 EBIT multiple 475 8.9 19.1 7.5 11.9 10.6 11.6 5,507.68

Observation of valuations can be enhanced in the summarized graphical view as shown below....................

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