Financial Management Strategy Watson Pharmaceutical - Essay Example

TABLE OF CONTENTS Page No. Part Strategic intents………………………………………………………….. 2 1. Determining the generic or strategic level of industry…………….. 2 1.2. Develop results you want to accomplish……………………………….. 3 Part 2 Develop strategic alternatives thru tactical relationships:………………… 3 2.1. Select a strategy; review it against intent and mission…………………… 4 Part 3. Choose strategy evaluation method…………………………………………….. 4 3.1.ECONOMIC VALUE ADD……………………………………………………….. 4 3.2. Cost benefit analysis…………………………………………………………… 5. 3.2.1. Benefit / cost ratio………………………………………………………………….. 5 Part 4 Review and revise (if necessary) the mission statement………………………. 6 Part 5. Assess strategic fit………………………………………………………………. 7 Conclusion………………………………………………………………………………… 7 Annex……………………………………………………………………………………. 9 References………………………………………………………………………………… 12 1. Financial Management Strategy Watson Pharmaceutical : Part 1. Strategic intents Watson Pharmaceuticals is a global pharmaceutical company whose mission is to improve the quality of life for patients around the world through the development and distribution of trusted generics and advanced, specialty branded pharmaceuticals”(About.us) Watson Pharmaceuticals has been founded in 1984. It maintains its headquarters in Corona, California, U.S.A; it has 18 plants, distribution centers, and marketing/sales facilities worldwide. At present Watson Pharmaceuticals employs 5,789 employees worldwide, and have recorded revenue of $2.498B as of 2007; operating income of $255.660M, and a net income of $141M. In total assets, Watson has $3.472B and a total equity of $1,849B. Watson is the fifth largest pharmaceutical company in the United States On June 28, 2004, Watson Pharmaceuticals refocuses its strategy of product development, sales and marketing to three areas of operation, i.e. Nephrology, urology and generics. The company took a new strategy of marketing their products thru differentiation. (Company corporate information)) 1.1Determine the generic or business level strategy (low cost v. differentiation Differentiation strategy Watson finds competition in the primary care product too challenging and has decided to differentiate their product approach through a specialty market. The Strategy of Watson is to develop a product that is unique, hard to copy, and to create a market segment for their products. The underlying strategy of Watson is to develop a “niche” thru a specialty and difficult to manufacture products”. The company has been successful in creating a specialty market of generic brand and will focus on development of brand products in Urology and Nephrology The concept of differentiation is far more important in our economy today because of too much competition, and being unique is the key to successful marketing This set of action will focus on customers with unique needs on Nephrology, Neurology and generics. Low cost strategy Watson believes that low cost drugs are being served by too many competitors and competing in this market will crowd them out. 1.2. Develop results you want to accomplish a. Watson will be able to streamline its operational structure and gain cost effectiveness. b. An annual savings of $80 million to $90 million will be realized by terminating sales contract in the primary care area. c. Increase sales by 15% by combining product development, strategic alliances, collaborations, synergistic acquisitions of products and business Part 2 Develop strategic alternatives thru tactical relationships: Watson will be engaged in the exclusive exploration of physician’s offices, independent pharmaceuticals and chains of distributors with the acquisition of Andrx. Acquisition of Andrx cost the company an amount of $1.9 billion, and with this, sales is expected to grow by 15%. Andrx is considered a big name in “formulating and commercializing difficult-to-replicate controlled-release pharmaceutical products and selective immediate-release products’. (Business Wire 2006) This strategy allowed Watson to sustain the distribution of its differentiated products to expand its distribution channels and continue to provide future growth opportunities. This move is expected to create more revenue to the company and ultimately deliver more value to the company and to the shareholder. 2.1. Select a strategy; review it against intent and mission I choose the strategy of acquisition and merger of Andrx Corp. because it has similar intent and mission of developing “bioequivalent versions of difficult to formulate, controlled-release tablets and capsules.” (Business Week) Watson Pharmaceutical’s new strategy will focus on the same difficult to manufacture drugs. Thomas P. Rice, Andrxs Chief Executive Officer, believes the merger is a good opportunity for both companies. He was quoted saying: "This transaction provides excellent value to our shareholders while also opening new business avenues for Andrx in terms of geography, product offerings, and technologies. The combined assets, product portfolio, and capabilities of the two companies position us strongly for the highly competitive pharmaceutical market. Andrxs manufacturing, R&D, controlled-release technology, distribution network, and employees, in combination with Watsons excellent team and capabilities, create a significant vertically integrated company in the specialty pharmaceutical industry," Part 3. Choose strategy evaluation method 3.1.Economic Value Add The Economic Value Add (EVA) is defined as “the calculation of what profits remain after the costs of a companys capital - both debt and equity - are deducted from operating profit.” EVA is a method of calculating the true value of shares due to shareholders that takes into consideration the cost of capital (Ben McClure) There are four steps in the calculation of EVA: 1. Calculate Net Operating Profit After Tax (NOPAT) 2. Calculate Total Invested Capital (TC) 3. Determine a Cost of Capital (WACC) 4. Calculate EVA = NOPAT – WACC% * (TC) The WACC is defined as “an overall required return as a whole to determine the economic feasibility of an expansionary opportunities and mergers. (Investopedia) For example, the EVA of Watson for 2009 is NOPAT 2009 TOTAL INVESTED CAPITAL (in mil.) WACC EVA $63.0 $3.850B 11.43% $63.0- 11.43% = $72.00 NOPAT – WACC - $63-$72 -$9.0 This means Watson has invested $3.850B, and has earned $63.0 for 2009, the economic value for investors is negative $9.0, or it is the loss that remained after cost of capital is deducted. 3.2. Cost benefit analysis Cost benefit is “a technique designed to determine the feasibility of a project or plan by quantifying its costs and benefits. A cost benefit analysis will be done to find out how well, or how poorly, the planned strategies of Watson Pharmaceuticals will turn out. (Investorwords) It is an analysis of the positive factor (cash flows) and the subtraction of negative ones (cost) to determine a net result. The difference between the two indicates whether the planned action is advisable. Data used in the analysis comes from the 2003 to 2007 financial statement of the Watson Pharmaceuticals... Financial highlights of Watson Pharmaceuticals is attached as an annex tables 3. .2. 1. Benefit / cost ratio Watson Pharmaceuticals invested its capital (debt and equity to the project which is $3.850.B, and pays a stream of cash flows for 5 years from 2003 to 2007. Assume also that the WACC is 11.5%, using the present value calculator (Moneychimp) present value of this investment is $2,234,016,583, which is less than the capital invested. Capital cost $3.850 B Present value of cash flows $2.234 --------- NPV (1.616) The rule for NPV is accept project if NPV is >0. The result is negative. Computation shows a negative net present value, which means that strategy is not theoretically feasible on a short term basis. This shows the investment did not provide expected ROI on a short run period. Present value of benefits divided by present value of costs. Present value of benefits PV of cash flows 2.234 PV of costs 3.850 Benefit ratio 0.058 The computation shows that the benefit ratio is less than the WACC of 11.40% that only means planned action (strategy) is not advisable. Part 4 Review and revise (if necessary) the mission statement To reinstate the mission statement, ”to improve the quality of life for patients around the world through the development and distribution of trusted generics and advanced, specialty branded pharmaceuticals. This mission is being carried through by its partner, Andrx Pharmaceuticals that is an expert company in distribution thru independent channels. Product development remains in the domain of Watsons Pharmaceuticals. A revision of the mission statement is needed to include mission statement of Andrx. The revised mission statement should state the change of strategy that should specify the concentration of differentiated hard to manufacture products to respond for the needs of special clients. Part 5. Assess strategic fit. The acquisition cost of Anryx in 2006 cost Watson $1.2 billion. Watson expects that with this strategy, revenue is expected to increase. From the table of revenues, growth increase is still low in spite of acquisition of Anryx. Year Revenue % INCREASE VALUE 2006 $603 M - 2007 $645.2 0.07 42.0 2008 $640.7 - - 2009 $662.0 .034 22.0 Future value of $1.2 billion (cost of acquisition) at 12% rate of interest, disc. factor of 7.469 should give a value of $ 8.962 B It means that if this amount is invested today at 12%, it will give investor revenue of $7.7 in 25 years. Present value of $1.2 billion at 12% rate, disc. factor 0.059 for 25 years gives a value of $70,800.000.NPV is negative as investment returns is less than amount invested. This means that there is something wrong with the implementation of the strategy and theoretically not feasible. Conclusion Based on the computations of EVA and Costs and Benefits, the present strategy of Watson is not providing sufficient returns to the company. The figures show a symptom problem that lies in the marketing approach of the company. Reuters Analysts recommendation is “to HOLD” transaction of Watson Pharmaceuticals. This only shows internal problems of the company that calls for an immediate action. Annex 1 Interim Income Statement Top of Form View: AnnualInterim Bottom of Form In Millions of U.S. Dollars (except for per share items) 2009 2009-09-30 Period Length 3 Months 2009 2009-06-30 Period Length 3 Months 2009 2009-03-31 2009-06-30 Period Length 3 Months 2008 2008-12-31 Period Length 3 Months 2008 2008-09-30 Period Length 3 Months Revenue 662.1 677.8 667.4 645.2 640.7 Other Revenue, Total -- -- -- -- -- Total Revenue 662.1 677.8 667.4 645.2 640.7 Cost of Revenue, Total 353.7 385.0 381.4 376.2 386.7 Gross Profit 308.4 292.8 286.0 269.1 254.0 Selling/General/Admin. Expenses, Total 120.1 128.2 134.1 111.2 101.3 Research & Development 51.9 42.3 40.8 47.6 45.3 Depreciation/Amortization 22.2 22.1 21.8 20.1 20.2 Interest Expense, Net - Operating -- -- -- -- -- Interest/Investment Income - Operating -- -- -- -- -- Interest Expense(Income) - Net Operating -- -- -- -- -- Unusual Expense (Income) 5.5 8.7 7.8 0.0 0.3 Other Operating Expenses, Total -- -- -- -- -- Total Operating Expense 553.4 586.3 585.9 555.1 553.7 Operating Income 108.7 91.5 81.5 90.1 86.9 Interest Expense, Net Non-Operating (9.0) (4.6) (4.7) (7.5) (7.0) Interest/Invest Income - Non-Operating 1.0 3.7 3.2 4.0 14.1 Interest Income(Exp), Net Non-Operating -- -- -- -- -- Gain (Loss) on Sale of Assets -- -- -- -- -- Other, Net 1.6 0.0 0.0 (0.0) (0.0) Net Income Before Taxes 102.3 90.6 80.0 86.6 94.0 Provision for Income Taxes 39.3 37.6 30.9 30.2 23.0 Net Income After Taxes 63.0 53.0 49.1 56.4 71.1 Minority Interest -- -- -- -- -- Equity In Affiliates -- -- -- -- -- U.S. GAAP Adjustment -- -- -- -- -- Net Income Before Extra. Items 63.0 53.0 49.1 56.4 71.1 Accounting Change -- -- -- -- -- Discontinued Operations -- -- -- -- -- Extraordinary Item -- -- -- -- -- Tax on Extraordinary Items -- -- -- -- -- Net Income 63.0 53.0 49.1 56.4 71.1 Preferred Dividends -- -- -- -- -- General Partners Distributions -- -- -- -- -- Miscellaneous Earnings Adjustment -- -- -- -- -- Pro Forma Adjustment -- -- -- -- -- Interest Adjustment - Primary EPS -- -- -- -- -- Income Available to Com Excl ExtraOrd 63.0 53.0 49.1 56.4 71.1 Income Available to Com Incl ExtraOrd 63.0 53.0 49.1 56.4 71.1 Basic Weighted Average Shares 103.40 103.40 103.10 103.04 102.89 Basic EPS Excluding Extraordinary Items 0.609 0.513 0.476 0.547 0.691 Basic EPS Including Extraordinary Items 0.609 0.513 0.476 0.547 0.691 Dilution Adjustment 1.5 1.9 2.0 2.0 2.0 Diluted Weighted Average Shares 117.10 118.80 118.20 117.86 118.00 Diluted EPS Excluding ExtraOrd Items 0.551 0.462 0.432 0.496 0.619 Diluted EPS Including ExtraOrd Items 0.551 0.462 0.432 0.496 0.619 DPS - Common Stock Primary Issue -- 0.000 0.000 0.000 0.000 Gross Dividends - Common Stock -- 0.0 0.0 0.0 0.0 Total Special Items 8.3 20.6 26.6 0.0 0.3 Normalized Income Before Taxes 110.6 111.2 106.6 86.6 94.3 Effect of Special Items on Income Taxes 3.2 8.5 10.3 0.0 0.1 Inc Tax Ex Impact of Sp Items 42.5 46.1 41.2 30.2 23.0 Normalized Income After Taxes 68.1 65.1 65.4 56.4 71.3 Normalized Inc. Avail to Com. 68.1 65.1 65.4 56.4 71.3 Basic Normalized EPS 0.659 0.629 0.635 0.547 0.693 Diluted Normalized EPS 0.594 0.564 0.570 0.496 Source: Reuters.com http://www.reuters.com/finance/stocks/incomeStatement?symbol=WPI.N REFERENCES About Watson “Vision, Mission, Values.” About us. Watson Pharmaceuticals. 06 Nov. 2009 Ben McClurre. “Cost Benefit Analysis”. Investopedia. 05 Nov. 2009 Read More