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18 July 2014

Global
Equity Research
Major Pharmaceuticals

The appeal of consumer health


Research Analysts
European Pharma Team
44 207 888 0304
creditsuisse.pharmateam@credit-suisse.com
Vamil Divan, MD
212 538 5394
vamil.divan@credit-suisse.com
Ari Jahja
212 325 0767
ariyanto.jahja@credit-suisse.com
Matthew Keeler
212 325 9008
matthew.keeler@credit-suisse.com
Riccardo Lowi
44 20 7888 0303
riccardo.lowi@credit-suisse.com
Jacob Lundberg
212 325 6785
jacob.lundberg@credit-suisse.com
Alex Molloy
41 44 333 05 83
alex.molloy@credit-suisse.com
Charlie Mills
44 20 7888 0325
charles.mills@credit-suisse.com
Bruce Nudell
212 325 9122
bruce.nudell@credit-suisse.com
Ronak H. Shah, Pharm.D., CFA
212 325 9799
ronak.shah@credit-suisse.com
Nicolas Sochovsky
44 20 7883 8075
nicolas.sochovsky@credit-suisse.com
Jo Walton
44 20 7888 0304
jo.walton@credit-suisse.com
Matthew Weston PhD
44 20 7888 3690
matthew.weston@credit-suisse.com

COMMENT

Reckitt & Bayer leading the way


GSK and Bayer have both increased their exposure to consumer health
products via substantial deals in 2014. Long product life cycles and direct
access to consumers are clear attractions, but retail pharmacy consolidation
and the growing power of own brands are also important trends. For both
companies, increased critical mass in key geographies is a driver of synergies.
For our universe, we see historical underlying sales CAGR of only 2.2% rising to
4.8% (2014E-18E) with a recovery from manufacturing issues, product launches
and synergies from M&A more than compensating for increasing own brand
pressures, particularly in the US. For these companies, we estimate that 19% of
all investments from 2007-13 were directed to this business area (contributing
10% of 2014 EBITA). We see a current pre-tax return on aggregate 2007-13
consumer investment (including A&P) within this group of only 10% rising to
15% by 2018E, vs. a return on pharma spending (inc R&D) of 17% rising to
23% by 2018E.
Current Credit Suisse HOLT valuations highlight the continuing investor
appeal of consumer businesses. Traditional pharma companies are priced to
assume CFROI will fall from 9.5% to 8.8% over the next few years; in contrast,
consumer companies are priced for CFROI to remain at around 21.5%.
Bayer: The recent Merck OTC purchase appears to represent a high point of
valuation, but includes significant tax breaks beyond the traditional debt shield.
Good opportunity to internationalise brands from one region to another with full
global infrastructure. Immediate margin accretion expected.
GSK: Despite a strong 2014 recovery, we expect Novartis' portfolio to result in
margin dilution on consolidation into GSK. Declining margins at GSK in recent
years have reflected a period of asset disposals on a stable infrastructure, and
supply issues on key products. Obesity and smoking cessation markets have
been disappointing and GSK has been outsold by Colgate in dental.
RB: Reckitt is a best-in-class company in OTC, generating margins some 10pp
above pharma peers and an organic growth track record of at least 2x the
market, the result we believe of its relentless focus on the consumer and lean
cost management. Now one-third of group EBITA, double the 2009 level, OTC
is core to Reckitt's strategy and M&A has been value accretive.
Sanofi: Volatile top line performance driven by US Rx to OTC switches where
the group has a strong track record. Group also has strong regional brands,
although recent LatAm supply issues highlight complexity of this operation.

DISCLOSURE APPENDIX AT THE BACK OF THIS REPORT CONTAINS IMPORTANT DISCLOSURES, ANALYST
CERTIFICATIONS, AND THE STATUS OF NON-US ANALYSTS. US Disclosure: Credit Suisse does and seeks to do

business with companies covered in its research reports. As a result, investors should be aware that the Firm may have a
conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in
making their investment decision.

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18 July 2014

Key charts
Figure 1: Market share in OTC/selected consumer markets

Figure 2: CS forecasts of OTC/consumer sales 2% historic


60000

14

50000

12
10

40000

Sales $m

2013 turnover consumer healthcare $m

and 4% forecast
16

6
4

30000
20000

2
10000

0
2008

OTC

Broader consumer

Nigeria/India

2009

2010

2011

2012

2013

2014

2015

2016

2017

JNJ- consumer

Perrigo OTC/consumer

RB Healthcare

GSK consumer

Novartis- consumer

Bayer OTC/Consumer

Merck

Sanofi OTC

2018

Source: Company data, Credit Suisse research

Source: Company data, Credit Suisse estimates

Figure 3: GSK margins have declined but both GSK and

Figure 4: RB is the only company where OTC is growing

Bayer expect scale from acquisitions to drive expansion

in importance, for GSK it will depend on how long

although still shy of RB levels

Novartis remain involved


40%

% of EBITA from Consumer/OTC

Consumer Operating Margins (EBITA) %

35.0%

30.0%

25.0%

20.0%

15.0%

10.0%
2008
2009
2010
2011
GSK consumer
Bayer Healthcare EBITA margin
Bayer- stand alone Healthcare
JNJ- consumer
RB Gp Op Margin

2012

2013

35%
30%

25%
20%
15%

10%
5%
0%

2014
2015
2016
2017
2018
RB CS estimated OP Mgn
GSK -stand alone
Perrigo adj consumer op margin
RB CS estimated OP Mgn

2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018
Bayer

GSK (100%)

GSK (63%)

JNJ

Sanofi

PFE

RB

Weighted Average

Source: Company data, Credit Suisse research

Source: Company data, Credit Suisse estimates

Figure 5: HOLT suggests that the consumer returns are

Figure 6: Bayer returns depressed by cost of the Merck

high and stable but our divisional analysis with

OTC acquisition. GSK returns adjusted for JV ownership.

capitalised A&P suggests otherwise


25%

Return on Investment

20%

Consumer/OTC

15%
10%
5%
0%
2013

2018

HOLT CFROI
( Last Rep and Mkt Implied)

2014

2018

CS divsional analysis
(Pre tax Returns on 7 yr inv.)

2018 EBITA/2011-2017 invesments

45%

Pharma

40%
35%
30%

25%
20%
15%
10%
5%

0%
JNJ

BAYGn.DE
Pharma

Source: Company data, Credit Suisse HOLT, Credit Suisse research

The appeal of consumer health

GSK.L

SASY.PA

OTC/consumer

PFE
Total

RB.L

Weighted
Av

Source: Credit Suisse estimates

18 July 2014

Summary
In this report, we look at the aggregate performance of the key OTC players in our
universe in terms of sales, profitability and returns on investment.
We look at the real level of investment in these businesses for the mixed pharma/OTC
companies and review what current market prices suggest in terms of future CFROI based
on the HOLT methodology. There are more detailed comments on Bayer, GSK, Pfizer,
Sanofi and Reckitt Benckiser later in this report.
Bayer: The company has talked of increasing its consumer health exposure for some time
and, after being outbid for Schiff in 2012, recently acquired the Merck OTC unit in a $14.2b
transaction that appears to mark the high point in valuation. On our forecasts, we see it is
possible for Bayer to achieve the 1% OTC margin accretion and 2% CORE EPS accretion
in year 1 that has been predicted by the company although, theoretically, spending the
same amount on a share buyback would have been much more accretive. Bayer has very
strong global brands led by Bayer Aspirin and we expect Bayer to be able to take US
brands into other markets using this brand equity.
GSK: With a renewed focus on consumer from the Novartis transaction, we expect more
disclosure on the relative profitability of this unit. Although limited historic disclosure makes
it impossible to be definitive on like-for-like, CER growth seems to show that the overall
dental franchise has underperformed key competitor Colgate, and the wellness category
(OTC drugs) has underperformed with the anti-obesity drug (Alli) and smoking cessation
seeing lower demand compounded by recent supply issues. Lower reported margins over
time have reflected numerous disposals on a stable infrastructure. We expect the Novartis
JV to significantly improve profitability and benefit from the ongoing recovery of standalone profitability for the Novartis assets. We estimate that, with GSK disposing of its
oncology unit, the group's overall investment in consumer will rise from an effective 6% of
total investment 2007-2013 to 25% of investment over the next five years. Excluding the
impact of disposals, we estimate the underlying investment rises from 14% of combined
R&D/acq/capex to 19%.
JNJ: We project CC top-line growth for JNJ consumer of ~2.3% through 2020E driven by
c3.3% growth in OTC (the largest & fastest growing consumer segment), with the
operating margin rebounding to the mid-teens driven by the return of OTC brands to the
market following the consent decree in 2011. After acquiring Pfizers business in 2006 for
$16.6b, management has been more conservative with limited M&A. In 2Q13, JNJ
divested its North American manual toothbrush business and, in 4Q13, its North American
Women's Health business (c.$250m in 2014 sales on our estimates); and in 1Q13, JNJ
acquired Shanghai Elsker Mother & Baby, a Chinese baby care company (c.$32m in 2013
revenue on our estimates). On our forecasts, c.20% of group investment has been
directed towards consumer health, with c.12% of 2013 operating profits from this business.
Pfizer: The company became a large player in the OTC market with the 2009 acquisition
of Wyeth. Before the Wyeth deal, commitment to this area was mixed with the disposal of
its prior OTC business to JNJ in 2006. Post Wyeth, the commitment to this space has
been demonstrated by in-licencing deals such as the 2012 deal with AZN for global OTC
Nexium ($250m upfront plus royalties) with a May 2014 launch. However, with heavy
ongoing investment in pharma R&D, the consumer business is attracting less than 10% of
group investment.
Meda: OTC represented 24% of Medas group sales in 2013, and we understand around
the same level of profits. As such, Meda has one of the strongest relative exposures to
OTC. We estimate that around two-thirds of the $1.9b of acquisitions made since 2010 are
OTC focused. We estimate an underlying growth of 3-4% for these products. Key
franchises include CB-12 (bad breath), Endwarts (warts) and Naloc (nail disorders).
Merck KGaA: A focus for the last two years on pruning smaller brands and redirecting
investment particularly into EM is paying off with 6% organic growth in sales in 2013 after

The appeal of consumer health

18 July 2014

a 6% organic decline in 2012. Redirecting rather than increasing promotional spend has
boosted sales with flat costs. However, Merck needs to decide whether a division
accounting for only 5% of group Core EBITDA can ever be a real driver of growth.
RB: Reckitt is the best-in-class operator in OTC, generating margins some 10pp above
pharma peers and organic growth rates at least 2x the market rates. It brings a FMCG
(fast moving consumer good) mind-set to an industry where 9 of the top 10 players are
pharma companies whose skillset is in drug discovery and marketing to doctors/key
opinion leaders. Reckitt focuses on the consumer, stretching existing drugs/molecules into
adjacent segments, platforms or new claims. At a third of group's EBITA, Reckitt has the
highest exposure to the OTC category and management is clearly committed to increasing
this, both organically (product roll outs such as Mega Red into Europe) and externally,
spending over 5.5b on OTC assets in the last few years.
Recordati: Exposure to OTC drugs rose from 12% in 2012 to 16% in 2013, driven largely
by acquisitions. The current platform should take OTC sales to nearly 20% of group sales
by 2016E, and we expect continued M&A. We assume similar profitability to the rest of the
operations (c. 25% EBITA).
Sanofi: Consumer has been a key investment area for Sanofi, and it has a strong track
record of US Rx to OTC switches (Allegra and most recently Nasacort) and continuing
focus with the 2014 agreement to take Cialis OTC for Lilly. Sanofi's own portfolio could
yield more switches with the upcoming Pozen "safened aspirin" a possible long-term
switch candidate. The group's strong EM position plays well to OTC. However, we have
limited information on profitability but we assume returns are relatively strong.
Investment returns: We look at the overall level of investment made in this business area
by each company out of their aggregate spend in R&D, M&A, capital expenditure and
Advertising and Promotion from 2007-2013 and compare this with the aggregate EBITA
contribution over time. We look at the same profit and investment metrics for 2014E2018E.
Looking solely at the 2014E expected profit measured against the total investment in
consumer just from 2007-13, we calculate that our universe of companies is making an
average pre-tax return of 17% on their investments, a figure which we forecast to rise to
23% by 2018. In contrast, our analysis suggests that returns on past OTC consumer
investment, treating A&P in the same way as R&D for pharma, is running at 10% and
expected to rise to 15%.
This crude analysis looks at pre-tax returns on a seven-year investment period;
nonetheless, it is interesting as it contrasts with the HOLT aggregate data at a full
company level which suggests the market is pricing in sustainably higher returns on
consumer ( c 21.5%) rather than pharma investments ( c 9%).

The appeal of consumer health

18 July 2014

Market Growth 2.2% ('07-'13) expected to rise to 4.8%


The aggregate of sales from our select universe of companies shows an underlying growth
rate of 2.2% for the period 2007 to 2013 and a forecast growth rate of 4.8% going forwards,
as, by 2015, we assume full recovery from the US manufacturing supply issues suffered
recently by both JNJ and Novartis.
Companies point to increased spending on health particularly in developing markets,
government funding constraints and opportunities to switch prescription drugs to OTC
status as key drivers of sales growth. GSK illustrated many of these in its 2009 consumer
briefing where it highlighted a 2007-2009 CAGR of 7% and hopes of
sustained/accelerating growth. For GSK, this was to be based on product innovation (eg
Alli in obesity, and improved Enamel hardening toothpastes under the Sensodyne brand),
marketing excellence, and geographic expansion.
The key drivers are illustrated in Figure 7 from the GSK Consumer analyst meeting in
2009. The same drivers are reported by other players with the "pharma" companies
typically discussing science related benefits and FMCG heritage companies talking more
about market access. For all companies, geographic reach, strong brands and scale have
been the key to profitability.
Figure 7: Consumer Macro Trends GSK 2009

Source: GSK Consumer Briefing 2009

However, despite strong enthusiasm for market growth, we believe that aggregate market
growth has disappointed best expectations.
Rx to OTC switches
It is generally assumed that the switch from Rx to OTC status is a key driver of market
growth; this has happened for a number of drugs as they have approached the end of their
patent-protected prescription-only lives, when safety has been well documented.
Utilisation has increased and innovators have extended the brand value at the end of the
Rx life cycle. Continued Rx to OTC switches in existing categories are a feature of the US
market with Sanofi recently launching US OTC Nasacort into the allergy market, following
a successful US Allegra switch in 2010, and Pfizer launching OTC Nexium following on
from the earlier switch of OTC Prilosec.

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18 July 2014

Perrigo, amongst others, points to a large potential switch pipeline that might expand the
overall OTC market (see Figure 8) but, in many cases, we have seen some regulatory
reluctance to sanction Rx to OTC switches in new categories. This has come from
concerns over self-medication where this could mask diagnosis of a more serious
condition (eg UK regulators rejection of OTC Viagra) or where self-medication with less
potent products could dissuade patients who need more potent medication (the FDA
rejection of OTC statin Mevacor), and the most recent rejection of OTC Singulair for
allergy (largely on concerns that the drug would not be used solely in adults). In this regard,
it will be interesting to see the regulator's attitude to OTC Lipitor from Pfizer currently in P3
in a simulated OTC setting (n=1200 for 10mg Lipitor running Oct 2013-Dec 2014).

Figure 8: Global Rx to OTC switch opportunities, as reported by Perrigo

Source: Perrigo 2014 analyst day

Amongst the approved switches, Imitrex/Imigran was approved in the UK in 2006 as an


OTC drug for GSK but sales are low perhaps due to the cost and onerous restrictions on
purchase (2 tablets only at a time), We understand that switch work continues in the US.

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18 July 2014

Figure 9: Full list of US Rx to OTC switches 2001-2014

Drug Name
Nasacort
Oxytrol for Women
Allegra D 12 hr
Allegra 24 hr
Allegra
Prevacid 24 HR
Zegerid OTC
Alli Weight Loss Aid
Zyrtec-D - family
Lamisil Derm Gel Topical
Plan B Emergency
MiraLax
Zaditor Eye Drop
Alaway Eye Drop
Mucinex DM ER Tablet
Mucinex D ER Tablet
Prilosec OTC
Claritin Hives Relief (Tabs,Syrup)
Nicotrol TD
Mucinex ER Tablet
Claritin (Tabs, Syrup)
Claritin-D
Claritin-D 24-hour
Monistat 1 (supp)
Monistat 3 combo pk
Lotrimin Ultra Topical

Category
Allergy
Overactive bladder
Antihistamine
Antihistamine
Antihistamine
Acid reducer/PPI
Acid reducer/PPI
Weight Loss
Antihistamine/decongestant
Antifungal
Contraceptive
Laxative
Antihistamine
Antihistamine
Expectorant/Cough Suppressant
Expectorant/Decongestant
Acid reducer/PPI
Antihistamine
Smoking Cessation
Expectorant
Antihistamine
Antihistamine/Decongestant
Antihistamine/ Decongestant
Vaginal Antifungal
Vaginal Antifungal
Antifungal

Date
Oct-2013
Jan-2013
Jan-2011
Jan-2011
Jan-2011
May-2009
Dec-2009
Feb-2007
Nov-2007
Jul-2006
Aug-2006
Oct-2006
Oct-2006
Dec-2006
Apr-2004
Jun-2004
Jun-2003
Nov-2003
Mar-2002
Jul-2002
Nov-2002
Nov-2002
Nov-2002
Jun-2001
Feb-2001
Dec-2001

Bold: First product switch. Source: FDA, Credit Suisse research

Looking at the other potential categories highlighted by Perrigo in Figure 10, Oxytrol for
overactive bladder was approved in 2013 for OTC US, BI completed an OTC switch study
for Flomax in 2013 but we are unaware of any regulatory filing and Sanofi recently
completed a deal with Lilly surrounding OTC Cialis. We assume that Pfizer will pursue
OTC Viagra in the US and that Bayer will also pursue OTC Levitra.
The rise of own brands has limited branded growth
A key element limiting overall US OTC growth has been the development of the 'own
brand' business which has seen the share of own brand products rise from 33% to 35% of
the overall OTC market in the past two years. According to IRI Multi Outlet (MULO) data,
the overall US OTC market has shown only +2% CAGR over the past three years, with
5.2% CAGR growth from own brand products and 0.6% CAGR for original brands.

The appeal of consumer health

18 July 2014

Figure 10: Illustration of consumer savings and retail profits for own label/store brands

Source: Perrigo 2014 analyst day

Illustrative consumer price and retail store profitability for two key brands is shown in
Figure 10. This shows the strong incentive for US retailers to promote own brand products
where possible.
The debate for investors is whether branded companies can still expect to generate the
same return on the substantial launch costs given increasing erosion to own brands
typically some three years after launch.
Figure 11: US Approvals for new OTC products in the US 2011 to Jan 2014

Source: Perrigo 2014 analyst day

Economies of scale for the likes of own brand manufacturers such as Perrigo, that can
make product for multiple retail chains and thus share manufacturing scale efficiencies
with retailers must be significant, and Perrigo in particular also benefits from a very low
corporate tax rate given its Irish domicile. As shown in Figure 11 generic companies are
now very clearly involved in developing "own brand" OTC products.

The appeal of consumer health

18 July 2014

Ex US accounts for c. 70% of the global market


In Figure 12, we highlight the geographic breakdown of OTC drugs illustrating the
significance of the ex US markets which account for between 70% and 80% of the global
opportunity depending on the category. We estimate that emerging markets account for
some 30-40% of this global market.
Outside the US, the availability of a "pharmacy only" designation in many countries would
seem to be beneficial, allowing the regulators a " halfway house" with added safety from
pharmacists reminding customers of possible risks. However, the widespread availability
of low co pays for alternative Rx medications (and, in some countries, very cheap
prescription generics available without a formal prescription) effectively puts a lid on OTC
pricing in many markets, and limits on DTC promotion may also limit awareness of OTC
product benefits .
Figure 12: Current OTC markets for key categories and regions 2013

35

Annual sales $bn

30
25
20
15
10
5

USA

West Europe

ROW

Asia

Source: Adapted from Perrigo 2014 analyst day information. Data from Nicholas Hall 2013 OTC Year book,
Euromonitor, BCG analysis and Credit Suisse research

Most recent data on market sizes highlight over $4b of OTC market value outside
Western markets and all global players highlight the opportunities in developing markets
where increasing overall wealth typically results in a higher share of GDP being spent on
healthcare, and where OTC /self-pay has often been the first area to develop.
In the Credit Suisse annual emerging markets consumer surveys, we consistently ask
about willingness to pay for medicines, both OTC and prescription, and look at the change
in spending over time. In the 2013 survey, we noted a small absolute increase in 2013
over 2012, with spending continuing to be dominated by younger as opposed to older
cohorts of population in contrast to Western markets. We also survey attitudes to
international as opposed to local brands where we have found only a limited willingness
reported by consumers to pay a premium for international brands. Key findings on
spending are illustrated in Figure 13 to Figure 16

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18 July 2014

Figure 13: % spend on healthcare over time

Figure 14: % of income spend on healthcare 2013 by age*


12.0%

% income spent on healthcare (inc Zero)

7.0%

% disposable income on healthcare by age

% of disposable income on healthcare

8.0%
% income spent on healthcare (exc Zero)
% income spent on meds

6.0%

5.0%
4.0%
3.0%
2.0%
1.0%

10.0%

8.0%

6.0%

4.0%

2.0%

0.0%

0.0%
2010

2011

2012

Average

2013

18-29

30-45

2010

Source: Credit Suisse Emerging Markets Consumer Survey Feb 2014

2011

2012

46-55

56-65

2013

:*excluding respondents who replied 0%.


Source: Credit Suisse Emerging Markets Consumer Survey Feb 2014

Brazil

China

India

Indonesia

Russia

Saudi

S Africa

Turkey

Average montlhy spend for


regualr purchases U$ (O)

2013

2012

2012

Mexico

2012

2013

-80%

2012

20

2013

-60%

2012

40

2013

60

-40%

2012

-20%

2013

80

2013

0%

2013

100

2012

120

20%

2013

40%

2012

140

2013

60%

2012

160

2013

80%

2012

% expectations on spending for


medicines in next 12 mths (bar)

Figure 15: Average Spend per Month on Regular Purchases

Universe

Source: Credit Suisse Emerging Markets Consumer Survey Feb 2014

Brazil

China

India

Russia

Saudi

S Africa

Turkey

% access to state funded medicines (O)

2013

2012

2013

2012

2013

Mexico

2012

Indonesia

2013

0%

2012

10%

0%

2013

20%

10%

2012

30%

20%

2013

40%

30%

2013

50%

40%

2012

60%

50%

2013

70%

60%

2012

80%

70%

2013

90%

80%

2012

100%

90%

2013

100%

2012

willingness to pay a premium for Int Brand

Figure 16: Attitude to paying a premium for international brands plotted against access to state funded medicines

Universe

I wouldnt be prepared to pay extra

I would be prepared to pay 1-10% extra

I would be prepared to pay 11-20% extra

I would be prepared to pay 21-30% extra

I would be prepared to pay > 30% extra

% Access to State Funded Rx Medicines (circles -RHS)

Source: Credit Suisse Emerging Markets Consumer Survey Feb 2014

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18 July 2014

In Figure 17, we use a slide adapted from the Sanofi Latin America Briefing seminar
(November 2012) which highlights the barriers to entry based on portfolio complexity in the
OTC space. If own brand pressures in the US drive a mix shift towards the emerging
markets, companies may need to try and simplify some of this complexity to sustain
profitability. It is interesting to note the cross-over between branded Rx, OTC, and
generics in this slide, and the integrated nature of the business in many countries.

Figure 17: EM positioning of pharma, adapted from Sanofi Latin American Briefing 2012

Source: Sanofi Latin America Briefing seminar (November 2012), Credit Suisse research

The appeal of consumer health

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18 July 2014

Financial performance of Credit Suisse universe


In Figure 18, we show the aggregate consumer/OTC sales of the larger companies
covered in this report. We have made proforma adjustments to include Merck's OTC
business alongside Bayer and the Novartis OTC business alongside GSK. We used Credit
Suisse analyst forecasts for all companies apart from Perrigo where we have used
company forecasts published at the time of the Elan transaction.
Figure 18: Credit Suisse select Universe OTC/consumer sales
60000
50000

Sales $m

40000
30000
20000
10000
0
2008

2009

2010

2011

2012

2013

2014

2015

2016

2017

JNJ- consumer

Perrigo OTC/consumer

RB Healthcare

GSK consumer

Novartis- consumer

Bayer OTC/Consumer

Merck

Sanofi OTC

2018

Source: Company data, Credit Suisse estimates

From Figure 19 and Figure 20, it is clear that there has been limited change in this sector
over the past five years with JNJ retaining leadership and GSK, Bayer, Pfizer (Wyeth)
Sanofi and Reckitt Benckiser essentially unchanged.

Figure 20: OTC/Consumer Sales Proforma 2013


2013 turnover consumer healthcare $m

Figure 19: OTC Share. Euromonitor 2008 & GSK

16
14
12
10
8
6
4

2
0

OTC

Source: GSK Consumer briefing 2009

Broader consumer

Nigeria/India

Source: GSK , Sanofi, Bayer presentations, Credit Suisse research

In Figure 21, we illustrate the underlying sales growth for key companies in our universe
excluding FX and acquisitions/disposals. Sanofi' s growth in 2011 stands out and reflects

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18 July 2014

the launch of US OTC Allegra. The decline in sales for JNJ in 2010-2012 reflects the
manufacturing issues that hit both JNJ and Novartis through this period. For GSK, supply
issues for Alli and in smoking cessation have resulted in relatively poor recent sales
performance despite receiving some benefit from Novartis/JNJ manufacturing problems.
Figure 21: Underlying growth ex acq/disposals for leading consumer/OTC companies

organic % change ( exc M&A/FX)

20%

15%
10%
5%
0%
-5%
-10%
2008 2009 2010 2011
GSK consumer
Bayer OTC/Consumer
JNJ- consumer
Pfizer/Wyeth

2012

2013

2014 2015 2016 2017


RB Healthcare
Perrigo OTC/consumer
Sanofi OTC

2018

Source: Company data, Credit Suisse estimates

In Figure 22, we show the margins for key players illustrating the expected dilutive effect of
Novartis' operating margins for the GSK/Novartis JV on first consolidation in 2015, and the
immediate accretion that Bayer expects on the completion of the Merck deal. For GSK, the
gradual decline in reported margins from 2011 reflects the impact of high margin disposals
- leaving central costs with GSK and also category specific supply issues in both smoking
cessation and with Alli. JNJ margins are clearly impacted by supply issues and we
anticipate a return to previously reported margins by 2016.

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18 July 2014

Figure 22: EBITA margins for key companies and consumer divisions

Consumer Operating Margins (EBITA) %

35.0%

30.0%

25.0%

20.0%

15.0%

10.0%
2008
2009
2010
2011
GSK consumer
Bayer Healthcare EBITA margin
Bayer- stand alone Healthcare
JNJ- consumer
RB Gp Op Margin

2012

2013

2014
2015
2016
2017
2018
RB CS estimated OP Mgn
GSK -stand alone
Perrigo adj consumer op margin
RB CS estimated OP Mgn

Source: Company data, Credit Suisse estimates

In Figure 22, we look at the pre-amortisation operating margins of these businesses.


Sanofi has not published the operating margin of its consumer business which lies within
its pharma operations (2011 management comment that OTC margins were around 25%
when group margins were 33.5%), and there are clear issues of comparability of
accounting for the others with GSK, for example, carrying significant central costs some of
which would be expected to carried against the consumer business on a stand-alone basis.

The appeal of consumer health

14

18 July 2014

Company comments
Bayer: Management has flagged acquisitions in the OTC area as a key priority for some
time and, after missing out on buying Schiff to Reckitt Benckiser in 2012, investor focus on
this area increased. The OTC unit is held within a much larger consumer health division
encompassing OTC, animal health, and medical technology/diagnostics. After the Merck
transaction, OTC medicines will still only account for just over half of this division's sales.
We believe that underlying growth has averaged 5% in recent years driven by strong
growth from the key brands such as Bayer aspirin and Canesten. Management has
alluded to driving growth particularly outside the US, with savings on US promotional
spending being reinvested to great effect in the "spark" markets outside the US. With the
Merck OTC transaction, growth may be more rebalanced back towards the US.
On 6 May 2014, Merck entered into an agreement for Bayer AG to purchase the Merck
Consumer Care business for $14.2b. Consumer Care sales were c $1.860m ($1,330m
US/$530m ex US) in 2013. In addition to all Merck Consumer Care sales, Bayer will also
acquire the rights for Claritin Rx and Afrin Rx in international markets where these
products are available by prescription only (~$200m in 2013 sales). This deal explicitly
excludes all possible future Rx to OTC switches from Merck which will be sold separately
as opportunities arise. Bayer talked of an EV/EBITDA multiple of 21x 2013 implying an
EBITDA of c EUR500m based on the $14.2b acquisition.
Bayer expects revenue synergies of c $400m by 2017 (5% of combined 2015 sales) and
cost savings of $200m by 2017 (3% of combined costs). In addition, Bayer sees
substantial tax benefits with the full value of the difference between book value (we
estimate $2b) and the acquisition price ($14.2b) available to be offset against US tax over
20 years. Assuming a 30% tax rate, this brings $150-$200m of annual tax benefit to the
full group.
Overall, Bayer expects a step up of c1% in consumer care margins and 2% CORE EPS
accretion. On our numbers, the relative contribution from OTC/consumer moves up in
2015 but then starts to decline once again as pharma profitability increases quickly as
Bayer moves beyond the launch phase of Xarelto and Eylea.

The appeal of consumer health

15

18 July 2014

Figure 23: Credit Suisse model of Bayer Merck OTC Transaction


FX rate
Aleve
Canesten
Aspirin
Other Bayer
Claritin Rx
Dr Scholl US
Coppertone
Other Merck
Total OTC Sales
Costs
OTC EBIT
EBIT margin

2013
1.33
321
257
464
1509

2014
1.35
320
251
454
1445

2015
1.29
361
278
501
3170

2013
1.33

151
510
204
797
1662
-1280
382
23%

161
525
208
880
1774
-1366
408
23%

2015
combined
1.29
361
278
501
3170
161
525
208
880
6084
-4814
1270
21%

1662

1774

10882

2014
1.35

2015
1.29

Sales
synergies

Costs/
savings

2015
Merged

4
22
71
-7
64

44

71

44

10997

-342

-1452

7
6
32

2551
-2041
510
20%

2470
-1976
494
20%

4309
-3447
862
20%

150
495
200
824
1669
-1285
384
23%

161
525
212
902
6154
-4821
1378
22%

CORE EIT

7775

7775

9108

1669

Net financials

-800

-800

-1110

-1110

PTP core
Tax core
tax rate

5180
-1870
36%

5180
-1870
36%

7998
-2098
26%

7998
-2098
26%

64
-17
26%

-298
90
30%

7764
-2025

Net income underlying


No shares CORE

5018
827

5018
827

5880
827

47
827

100
827

6026
827

EPS CORE
Accretion (dilution)
Share buy back alternative
Accretion (dilution)

6.07

6.07

5880
827
7.11
7.11

7.11

0.06

0.12

7.29
2.5%
8.23
36%

Source: Company data, Credit Suisse estimates

Bayer will have 10 drugs with sales of >EUR100m per annum and the top 10 drugs will
account for 53% of total sales.

Figure 24: Product concentration top 10 account for 53% of total sales

Source: Bayer OTC acquisition presentation 2014

The appeal of consumer health

16

18 July 2014

Bayer has talked about both sales and cost synergies from the purchase of the Merck
business and has said that cost synergies should flow through the P&L and are quoted
after any reinvestment. (Bayer also talks about explicit tax shield benefits that do not show
up at the operating profit level). This contrasts with GSK only talking about "gross" cost
savings, before reinvestment

Figure 25: Bayer Merck proforma portfolio 2013

Source: Bayer Merck OTC Acquisition presentation

Figure 26: Bayer Merck proforma portfolio 2013 category exposure

1: inc sun care, 2: cold allergy, sinus, flu, 3: inc cardio, 4: foot health, women's health/other
Source: Bayer Merck OTC Acquisition presentation

We assume that increased scale will help margins and the deal is described as being
immediately accretive to divisional margins. However, we assume some further portfolio
rationalisation will be undertaken in this division along the lines of the recent disposal of
$120m of sales in interventional cardiology which we assume was low margin. A major

The appeal of consumer health

17

18 July 2014

element of margin recovery in this overall business will be set by the progress made in the
diabetes testing business where Bayer competes against Roche and JNJ. Roche
diagnostic margins range 22.4% 2011-20.8% 2013 and we assume that Bayer's diagnostic
testing margins may well be lower.

GSK:
GSK has been a top 3 players in OTC healthcare for a number of years. It has been in a
net disposal mode with annual underlying sales growth, we believe, of 5.5% being reduced
to a reported $ rate of only 2.1% by sequential disposals of both small OTC bands (high
margin) and drinks brands (low margin).
In 2009, GSK held a consumer briefing day where it discussed the acceleration of OTC
growth driven by attractive industry dynamics and a particularly strong GSK position based
on strong bands, scale in fast growing EM, an R&D intensive background which leads to
product innovation (new enamel hardening toothpaste, smoking cessation and Alli) and a
commitment to reinvest in promotion to drive the top line.
A key area for GSK which illustrates many of the attractive features has been oral care
where GSK has the Aqua fresh and Sensodyne toothpaste brands. In 2009, GSK pointed
to new enamel hardening toothpastes as one element of the expected out-performance.
From 2009 to 2013, GSK saw 7.1% CAGR in oral care, which compares with 8.0% for key
competitor Colgate. We assume that, despite strong toothpaste growth, exposure to the
lower growth denture fixative market may have depressed GSK's overall growth.
Of note has been the recent decline in reported operating margin for GSK (see Figure 22).
This has presumably reflected being in a net disposal mode having sold a number of noncore OTC brands (high margin) and soft drinks (low margin) in recent years. The most
recent performance has, however, also been impacted by supply issues with Alli the
weight loss drug that GSK has been trying to sell for some time, and weakness in the
smoking cessation area. Given the existing scale of the operation and the skew towards
OTC drugs within the consumer franchise, we continue to be surprised that GSK does not
report higher consumer margins.
We expect disclosure to increase with the start of the JV and the clear commitment by
GSK management to increase disclosure alongside the other three strategic business
areas of branded pharma, Viiv, vaccines and OTC. We assume that the move from 14 to
36 countries where GSK will claim market leadership will help margins. GSK talks about
leveraging pharmaceutical R&D and broader OTC/FMCG capabilities to drive growth.

The appeal of consumer health

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18 July 2014

Figure 27: Complementary brands in four key areas

Source: GSK Novartis transaction slides

In contrast to Bayer, GSK did not talk about specific sales synergies but only about gross
cost savings (c. 400m by year 5, which we assume will be around 200m by year 3
assuming that consumer savings are delivered in line with overall transaction savings).
However, we assume only 50% of these will be seen at the bottom line with the rest
reinvested.
The 37% interest by Novartis is an incentive for it to keep working to maximise the
synergies and to transfer any manufacturing assets etc. required within the JV.
We do not know any details of the tax structure of the deal. An explicit part of the Bayer
savings is a 20-year tax break based on the step up in value from book value to
acquisition price. We do not know if the JV structure with Novartis allows a similar tax
structure to be set up.
Figure 28: Market leading positions in a number of key OTC categories

Source: GSK Novartis transaction slides

The appeal of consumer health

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18 July 2014

Figure 29: Proforma company moves from No 1 in 14 markets to No 1 in 36 markets

Source: GSK Novartis transaction slides

Johnson & Johnson


We project CC top-line growth for JNJ consumer of ~2.3% through 2020E driven by ~3.3%
growth in OTC ~(30% of JNJ consumer sales, JNJs largest & fastest growing consumer
segment), with the operating margin rebounding to the mid-teens currently driven by the
return of OTC brands to the market following the consent decree in 2011. After acquiring
Pfizers consumer business in 2006 for $16.6b (its most recent large-scale restructuring of
the Consumer portfolio), JNJs consumer portfolio management has been more
conservative. In 4Q13, JNJ divested its North American Women's Health business
(~$250M in 2014 sales on our estimates); in 2Q13, JNJ divested its North American
manual toothbrush business; and in 1Q13, JNJ acquired Shanghai Elsker Mother & Baby,
a Chinese baby care company (~$32m in 2013 revenue on our estimates).

Pfizer
Pfizer became a large player in the OTC market with the 2009 acquisition of Wyeth.
Before the Wyeth deal, commitment to this area was mixed with the disposal in 2006 of its
prior OTC business to JNJ. Post Wyeth, the commitment to this space has been
demonstrated by in-licencing deals such as the 2012 deal with AZN for global OTC
Nexium ($250m upfront plus royalties) which was launched in May 2014. Other key
brands include; Advil in the pain category, Caltrate and Centrum in dietary supplements,
and ChapStick and Preparation H in personal care.
The data used in Figure 18 and Figure 21 are proforma Pfizer /Wyeth deal. Pfizer does not
disclose any profitability data and so it is not shown in Figure 22.

Reckitt Benckiser
RB's growth rates for healthcare have been at the top of the peer group historically with
CAGR of c.10% on an underlying basis boosted to a CAGR of 19% by acquisitions. At its
investor conference at the end of 2013, management put forward the case for healthcare
being at the heart of its strategy, given the OTC categories it was focused on are larger,
faster growing and higher margin than the rest of its businesses.

The appeal of consumer health

20

18 July 2014

Figure 30: Reckitt's health categories

Source: Reckitt Benckiser Investor Day slides

Moreover, management believes that its "consumer mind-set" gives it a competitive


advantage to peers, as it is more consumer centric, better at innovation and has deeper
relationships across different retail channels, with greater branding and marketing
expertise.
Figure 31: Reckitt's achieved fastest growth amongst the Top 10 players in OTC

Source: Nicholas Hall, Reckitt Benckiser, Reckitt Benckiser Investor Day slides

Reckitt management was also clear on its intent to consolidate what it sees as highly
fragmented market.

The appeal of consumer health

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18 July 2014

Figure 32: M&A opportunity OTC still fragmented market place

Source: : Reckitt Benckiser Investor Day slides

Reckitt does not routinely report operating margins but our analyst team understands that
they are around 29%. RB has been able to raise its healthcare margins largely due to
synergies from folding in acquisitions onto an existing infrastructure, and we assume that
Reckitt will continue to reinvest to drive sales growth in future, rather than show margin
gains.
In Figure 21, we plot the RB group operating margins for comparison. The recent decline
is due to competitive pressures in the pharma division of RB than the core OTC operations.
Recordati
Recordati is a European-based mid-sized pharma company with a relatively old Rx
product portfolio. In many European markets, the pharmacist is key to the
recommendation of OTC drugs, especially where there are limits on direct OTC
advertising, and Recordati has a strong historical relationship although its current OTC
effort is a stand-alone business.
A key feature of Recordati s 2013-2015 Business Plan presented in February 2013 was a
reiterated emphasis on the growth of the OTC business. With the share of OTC products
rising from 12% of Group sales in 2012, to 16% in 2013 and excluding further M&A we
expect this to reach c.19% by 2016E. This presents one of the highest exposures to OTC
drugs in our universe.
However, Recordati intends to drive this further with additional M&A as a way to achieve a
more balanced business diversification away from prescription drugs, affected by
government healthcare reforms and IP-driven lifecycles. In line with this target, Recordati's
M&A strategy will be focused largely on out-of-pocket products. If we exclude the
acquisition of a portfolio of US drugs from Lundbeck, which was made with the intent of
establishing a commercial infrastructure in the US, Recordati completed two acquisitions
in 2013, Casen Fleet (Spain) and Opalia (Tunisia), both with a portfolio largely represented
by out-of-pocket products. Similar OTC deals were made in the previous years in
Germany, Russia and Poland. We estimate that average profitability of Recordati's
consumer business is similar to the prescription one, although a different cost mix will be
more skewed to marketing costs rather than R&D.
Sanofi
The recent GSK and Bayer transactions are likely to have moved Sanofi from 3rd to 5th in
world rankings but still leave Sanofi with strong competitive positioning in key OTC
categories such as allergy (OTC Allegra and most recently Nasacort). The commitment to
this category is clear with the May 2014 deal with Lilly to take Cialis for erectile dysfunction

The appeal of consumer health

22

18 July 2014

over the counter. The soon-to-be-launched safened aspirin, licenced from Pozen and
currently with the FDA, is another potential longer-term switch candidate.
Sanofi may be more at risk than peers from the growing role of "own brand" OTC drugs
given the importance of switches to recent growth. We believe that US Allegra sales in
1Q2014 declined by 14% in part due to a late allergy season but also growing use of own
brand anti-allergy products. Overall US exposure is top 10 versus c. top 3 in most other
regions.
The group's strength in consumer is particularly important in EM where there is less of a
separation between pure prescription and OTC drugs. Pharmacists are an important gatekeeper to both Rx and OTC drugs and strong brand equity in the OTC space can also
benefit Rx sales, especially when patients are paying directly for drugs.
Figure 33: Sanofi focus on consumer healthcare, Mkt Position after key actions taken

Source: Sanofi China seminar 2011

The last time the company made reference to relative profitability of the various
businesses was in 3Q11 when the company commented that OTC margins were c. 25%,
against diabetes margins of 35%, underlying pharma margins excluding Plavix and Avapro
JV income of 29% and generics of 18%. This compares with an FY2011 overall
comparable margin of 33.5%. We assume that the 2011 margin may well have been
depressed by the 2011 launch costs for OTC Allegra and that profitability of this unit may
well have risen a little despite the overall group business margin falling to 27.7%. For this
analysis we have assumed that consumer margins are 5 pp below the group average in
each year.

The appeal of consumer health

23

18 July 2014

Investment returns
In Figure 34, we show both the recent CFROI of key sectors and the market implied
CFROI under the HOLT methodology. This demonstrates that, whilst investors are pricing
the pharma sector for a small fall in CFROI from a historic rate of 9.5% to 8.8%, they are
assuming that returns for consumer companies will remain stable at 21.5%.
Figure 34: HOLT CFROI by sector showing most recent CFROI and market implied future CFROI
2013 Sector Average CFROI:

2018/ 19 Sector Average Market-Im plied CFROI:

The Life Cycle Through the HOLT Lens


Innovation
Increasing
CFROI

Fading CFROI
Above Average, but Fading CFROI Levels

Mature
Average CFROI Levels & Asset Growth

Restructuring
Below Average CFROI Levels

CFROI
Food /beverage 22.6%

The Life Cycle Through the HOLT Lens


Innovation
Increasing
CFROI

Fading CFROI

Mature

Above Average, but Fading CFROI Levels

Restructuring

Average CFROI Levels & Asset Growth

Below Average CFROI Levels

CFROI
Food /beverage 22.9%

OTC / Consumer 21.5%

OTC / Consumer 21.5%

Traditional Pharma 9.5%

Chemicals 8.5%

Overall CFROI
6.9%

Traditional Pharma 8.8%

Overall CFROI
6.2%

Telco 5.6%
Chemicals 7.8%
Energy 4.6%

Utilities 3.3%

Telco 3.5%

Utilities 3%

Source: Credit Suisse HOLT, Credit Suisse estimates

Against this backdrop, in this section we look at the level of operating profits derived from
OTC/consumer for our universe of pharma/consumer companies and the level of relative
investment.
Overall, we expect the contribution to operating profits for this universe of companies to
rise from 9% in 2007 through 10% in 2014E to 13% by 2018E based on current structure.
The most exposed of these larger companies to consumer healthcare remains Reckitt,
with new product driven profit leverage in the traditional pharma business expected to
outweigh consumer growth for most of the others. For GSK, in this analysis, we have
taken the EBITA profit contribution at the 100% JV contribution level and also at the 62%
level adjusting out the initial Novartis 38% ownership. Note that we have not counted this
deal as an increase in exposure to consumer as we do not know the cost to GSK if
Novartis exercises its option to sell down over time. .

The appeal of consumer health

24

18 July 2014

Figure 35: Credit Suisse estimate of contribution to group EBITA over time (GSK at 100%
of JV and also 63% ownership )

% of EBITA from Consumer/OTC

40%
35%

30%
25%
20%
15%
10%

5%
0%
2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018
Bayer
GSK (100%)
GSK (63%)
JNJ
Sanofi
PFE
RB
Weighted Average

Source: Company data, Credit Suisse estimates

For the pharma companies, the OTC consumer businesses are slowing growing in
importance, but have not materially outgrown the core prescription pharma operations in
recent years.
Figure 36: Contribution to op profits 2007-2013

Figure 37: Contribution to op profits 2014E-2018E

100%

100%

90%

90%

80%

80%

70%

70%

60%

60%

50%

50%

40%

40%

30%

30%

20%

20%

10%

10%
0%

0%
JNJ
Pharma

BAYGn.DE
Consumer

Source: Company data

GSK.L

SASY.PA

PFE

RB.L

Other eg Md Tech/Agro/Chems

JNJ
Pharma

BAYGn.DE

GSK.L

Consumer

SASY.PA

PFE

RB.L

Other eg Md Tech/Agro/Chems

Source: Credit Suisse estimates

We have shown our calculations of the relative level of net investment by business area
for key players in Figure 38 and Figure 39. In this analysis, we have taken the reported
investment in advertising and promotion (A&P), R&D, capital expenditure and
acq/disposals into the respective business areas starting in 2007. We have taken group
reported levels of R&D, capital spending and M&A and apportioned them either as a
company has reported, or where there is not enough disclosure based on our industry
knowledge. We know that companies such as RB spend heavily on A&P where pharma
spends on R&D and so we have estimated an A&P spend for each of the companies, and

The appeal of consumer health

25

18 July 2014

for each business area where this is not disclosed. For the pharma companies, we have
set A&P in their consumer businesses at 10% of sales, to mirror the investment of RB.
The continued high level of pharma R&D increases the net pharma investment from 20072013 by $194b for this group of companies, and this continues to dwarf the OTC R&D
which we estimate at only c.$9b for this group over the same period.
Over this period, this select universe of companies acquired $64b of pharma assets and
$46b of OTC/consumer assets.
For GSK, the historic investment is skewed by around $7b of proceeds for a range of
consumer assets in the past five years, and future investment is skewed by the expected
receipt of around $13b after tax for the group's oncology assets (net $7.8b proceeds after
$5.2b of vaccine investment). In this analysis, we have not valued the asset swap of 100%
of consumer assets into the 63% JV ownership in consumer, as this doesnt represent
additional consumer investment. Including the disinvestment in consumer via various
disposals, we think the overall investment in OTC for GSK has been around 6% of total
investment (14% if we ignore the value of historic disposals), a figure we expect to rise to
25% over the next few years. If we also ignore the oncology disposal, then the investment
figure falls to 19% of expected 2014-2018 investments.
Figure 38: % of total investment 2008-2013 (inc disp.)

Figure 39: % of total investment 2014E-2018E (inc disp.)

100%

100%

90%

90%

80%

80%

70%

70%

60%

60%

50%

50%

40%

40%

30%

30%

20%

20%

10%

10%
0%

0%
JNJ
Pharma

BAYGn.DE

GSK.L

OTC/Consumer

RB.L

JNJ

Other eg Md Tech/Agro/Chems

Pharma

SASY.PA

Source: Company data, Credit Suisse research

PFE

BAYGn.DE

GSK.L

OTC/Consumer

SASY.PA

PFE

RB.L

Other eg Md Tech/Agro/Chems

Source: Company data, Credit Suisse estimates

In Figure 40 and Figure 41, we show the same investment data but this time excluding the
distorting effect of business disposals so looking purely at the positive funds invested in
R&D, capital expenditure, advertising and promotion and business acquisitions.

The appeal of consumer health

26

18 July 2014

Figure 40: % of total investment 2008-2013 (exc disp.)

Figure 41: % of total investment 2014E-2018E (exc disp.)

100%

100%

90%

90%

80%

80%

70%

70%

60%

60%

50%

50%

40%

40%

30%

30%

20%

20%

10%

10%

0%

0%

JNJ

Pharma

BAYGn.DE

GSK.L

OTC/Consumer

SASY.PA

PFE

RB.L

Other eg Md Tech/Agro/Chems

Source: Company data, Credit Suisse research

JNJ
Pharma

BAYGn.DE

GSK.L

OTC/Consumer

SASY.PA

PFE

RB.L

Other eg Md Tech/Agro/Chems

Source: Company data, Credit Suisse estimates

Having reviewed both operating profit contribution and relative levels of investment, we
can now show a crude return on investment in Figure 43 and Figure 44. Based on seven
years of historic divisional investments, we see only 10% historic pre-tax returns on the
consumer health businesses within our select group of companies rising to 15% by 2018.
The key element of the difference between this analysis and the HOLT analysis is the
advertising and promotion spend which is not capitalised by HOLT but which we have
effectively capitalised in this analysis. We have assumed 13% of consumer sales for RB
and 10% for the consumer operations of other companies as an educated guess. By
capitalising this investment, we are effectively counting the brand development spending
for consumer companies in the same way that we count R&D for traditional pharma as a
spend requiring a return. For this universe, the A&P we capitalise accounts for $25b of the
total $94b of aggregate investment from 2007-2013. Ignoring this spending would boost
our calculated historic returns by 5% from 10% to 15%.
Looking at the company data in Figure 43 of note is the very high return that RB is getting
from its pharma operation which is essentially a one-product franchise of Suboxone in the
US. For JNJ, the OTC returns are low reflecting on-going manufacturing issues and, as
we have not included restructuring charges in our investment base returns, in reality it may
be lower. For Sanofi, we do not have current data on the profit split of the businesses from
the company, and if we assume a higher consumer return which is quite possible, it would
suggest lower pharma returns. In this analysis, we have set Sanofi OTC operating margins
at c. 8%pp below group margins based on management commentary in 2011. For Bayer,
we have also made some hypothetical assumptions in our analysis as we have excluded
animal health, diagnostics and med tech from the consumer health area and, for these
businesses, we do not have a reported profit split.
In Figure 44, we set out our forecast returns. For Bayer, the returns go down as the 20112017 investment includes the full cost of the Merck OTC operation. The return for GSK
rises as we consolidate the Novartis JV from 12% to 15%, with further upside if GSK can
buy out Novartis depending on the price. Just adding 100% of the EBITA without
adjusting for the JV boosts returns from 15% to 24%. RB consumer health reaps the
reward in this analysis of continued sales growth and a further small margin gain, and we
assume that Sanofi should also see a good increase in returns on consumer investment.

The appeal of consumer health

27

18 July 2014

The return data does not match the classic HOLT analysis. Under HOLT, we see a historic
return for consumer companies of 21.5% which the market assumes will be stable. The
higher returns under HOLT reflect the fact that HOLT does not capitalise A&P spending,
which is not uniformly disclosed by companies making a consistent approach difficult.
Figure 42: Trends in CFROI according to HOLT and CS team pre-tax divisional returns

25%

Return on Investment

Pharma
20%

Consumer/OTC

15%
10%
5%
0%
2013

2018

2014

HOLT CFROI
( Last Rep and Mkt Implied)

2018

CS divsional analysis
(Pre tax Returns on 7 yr inv.)

Source: Credit Suisse HOLT, Credit Suisse estimates

HOLT suggests that traditional pharma companies have shown only a 9% return on
investment, whereas in our analysis we see a higher return on just the pure pharma
investments at 17%, weighted based on levels of investment. Over the next four years,
this analysis suggests an improvement in pharma returns to 23%..This reflects lower
patent expiry headwinds and a perception of higher R&D productivity with pharma R&D as
a percentage of sales stable at around 16.5% from 2014 for this group of companies,
down from 17.5% of sales in 2007.

Figure 44: 2018E EBITA/ Total investment 2011-2017E

(excluding disposals)

(excluding disposals)

45%

45%

40%

40%

2018 EBITA/2011-2017 invesments

2014 EBITA/2007-2013 invesments

Figure 43: 2014E EBITA/ Total investment 2007-2013

35%
30%
25%
20%

15%
10%
5%

0%
JNJ

BAYGn.DE GSK.L
SASY.PA
Pharma
OTC/consumer

PFE
Total

Source: Company data, Credit Suisse estimates

The appeal of consumer health

RB.L

Weighted
Av

35%
30%
25%
20%

15%
10%
5%
0%
JNJ

BAYGn.DE
Pharma

GSK.L

SASY.PA

OTC/consumer

PFE
Total

RB.L

Weighted
Av

Source: Company data, Credit Suisse estimates

28

18 July 2014

Figure 45: Valuation table of stocks with consumer interests covered by Credit Suisse and mentioned in this report
Consumer
Bayer
Colgate-Palmolive
GlaxoSmithKline plc
Johnson & Johnson
Meda
Merck KGaA
Novartis
Pfizer
Reckitt Benckiser
Recordati
Sanofi
Average

$
p
$
SK

SF
$
p

price
100.9
69.7
15.4
103.3
109.7
64.7
80.7
30.4
50.0
12.1
75.5

Target
Price
120
78
16
100
80
72
87
35
52
11
80

2013A
17.4
24.6
17.3
18.7
12.9
14.8
18.9
13.7
18.5
16.2
15.4
16.3

2014A
16.4
23.5
18.3
17.5
11.1
13.9
18.0
13.6
19.8
14.8
14.8
15.8

2015E
14.2
21.3
16.1
16.6
9.8
12.7
15.7
13.2
19.2
13.7
12.9
14.4

2016E
12.6
19.6
13.9
15.5
8.7
12.6
14.4
12.6
18.3
13.3
12.2
13.5

2017E
11.3
12.2
15.2
7.6
12.2
12.8
12.0
17.7
12.6
11.9
12.7

Div yield
2013E
2.1%
2.0%
5.3%
2.7%
2.4%
1.6%
3.2%
3.4%
2.8%
3.2%
3.4%
3.1%

NPV/
share

NPV/
share

Sales
growth

125.9

75.9

5.4%

1.36
1.14
1.34
1.08
1.05
1.08

15.8
86.7
122.9
69.1
88.9
27.6

11.1
93.8
72.9
63.4
82.3
28.2

1.18
1.02
1.16

12.4
92.2

11.0
80.9
-

2.4%
3.0%
6.5%
2.8%
0.9%
0.1%
1.3%
5.3%
2.6%
2.8%

EV/NPV
1.28

Source: Company data, Credit Suisse estimates

Figure 46: Consumer Deal Terms


Transaction value /

($ in millions)

Acquiror

Target

Announced

Transaction
Value

LTM Rev.

LTM EBITDA

LTM EBITDA
(synergy-adj.)

Bayer
GSK

/ Merck
/ Novartis

06/05/2014
22/04/2014

$14,158

6.4x

20.9x
asset combination

14.2x

Valeant

/ Bausch & Lomb

27/05/2013

$8,700

2.9x

13.5x

6.0x

Reckitt Benckiser

/ Schiff Nutrition

15/11/2012

1,446

5.1x

33.6x

19.4x

Reckitt Benckiser

/ SSL International

21/07/2010

4,051

3.3x

19.1x

11.1x

Sanofi

/ Chattem

21/12/2009

2,233

4.8x

13.5x

13.5x

Reckitt Benckiser

/ Adams Respiratory

10/12/2007

2,227

6.3x

29.4x

18.4x

Johnson & Johnson

/ Pfizer Consumer Health

26/06/2006

16,600

4.3x

22.7x

12.5x

Reckitt Benckiser

/ Boots Healthcare

07/10/2005

3,390

3.5x

16.9x

10.2x

Bayer

/ Roche OTC

19/07/2004

2,957

2.4x

12.5x

7.7x

GSK

/ Block Drug

09/10/2000

1,431

1.6x

14.0x

NA

Mean

3.8x

19.5x

12.4x

Median

3.5x

16.9x

11.8x

Source: Company data, Credit Suisse estimates Note Bayer synergies based on 30% margin on $400m of sales synergies +$200m cost
synergies - no tax synergies included Credit Suisse estimates

The appeal of consumer health

29

18 July 2014

Companies Mentioned (Price as of 16-Jul-2014)


AstraZeneca (AZN.L, 4371.0p)
Bayer (BAYGn.DE, 102.1)
Bristol Myers Squibb Co. (BMY.N, $48.8)
Colgate-Palmolive (CL.N, $69.45)
Eli Lilly & Co. (LLY.N, $62.81)
GlaxoSmithKline plc (GSK.L, 1543.5p)
Johnson & Johnson (JNJ.N, $102.22)
Meda (MEDAa.ST, Skr109.6)
Merck & Co., Inc. (MRK.N, $58.15)
Merck KGaA (MRCG.DE, 64.46)
Novartis (NOVN.VX, SFr81.15)
Novo Nordisk A/S (NOVOb.CO, Dkr253.4)
POZEN (POZN.OQ, $8.2)
Perrigo Company (PRGO.N, $155.35)
Pfizer (PFE.N, $30.96)
Reckitt Benckiser (RB.L, 5030.0p)
Recordati (RECI.MI, 12.23)
Roche (ROG.VX, SFr266.4)
Sanofi (SASY.PA, 76.46)
Valeant Pharmaceuticals Inc. (VRX.N, $121.71)

Disclosure Appendix
Important Global Disclosures
Jo Walton, Matthew Weston PhD, Riccardo Lowi, Alex Molloy, Charlie Mills and Nicolas Sochovsky each certify, with respect to the companies or
securities that the individual analyzes, that (1) the views expressed in this report accurately reflect his or her personal views about all of the subject
companies and securities and (2) no part of his or her compensation was, is or will be directly or indirectly related to the specific recommendations or
views expressed in this report.
The analyst(s) responsible for preparing this research report received Compensation that is based upon various factors including Credit Suisse's
total revenues, a portion of which are generated by Credit Suisse's investment banking activities

As of December 10, 2012 Analysts stock rating are defined as follows:


Outperform (O) : The stocks total return is expected to outperform the relevant benchmark*over the next 12 months.
Neutral (N) : The stocks total return is expected to be in line with the relevant benchmark* over the next 12 months.
Underperform (U) : The stocks total return is expected to underperform the relevant benchmark* over the next 12 months.
*Relevant benchmark by region: As of 10th December 2012, Japanese ratings are based on a stocks total return relative to the analyst's coverage universe which
consists of all companies covered by the analyst within the relevant sector, with Outperform s representing the most attractive, Neutrals the less attractive, and
Underperforms the least attractive investment opportunities. As of 2nd October 2012, U.S. and Canadian as well as European ra tings are based on a stocks total
return relative to the analyst's coverage universe which consists of all companies covered by the analyst within the relevant sector, with Outperforms representing the
most attractive, Neutrals the less attractive, and Underperforms the least attractive investment opportunities. Fo r Latin American and non-Japan Asia stocks, ratings
are based on a stocks total return relative to the average total return of the relevant country or regional benchmark; prior to 2nd October 2012 U.S. and Canadian
ratings were based on (1) a stocks absolute total return potential to its current share price and (2) the relative attractiveness of a stocks total return potentia l within
an analysts coverage universe. For Australian and New Zealand stocks, 12-month rolling yield is incorporated in the absolute total return calculation and a 15% and
a 7.5% threshold replace the 10-15% level in the Outperform and Underperform stock rating definitions, respectively. The 15% and 7.5% thresholds replace the +1015% and -10-15% levels in the Neutral stock rating definition, respectively. Prior to 10th December 2012, Japanese ratings were based on a stocks total return
relative to the average total return of the relevant country or regional benchmark.

Restricted (R) : In certain circumstances, Credit Suisse policy and/or applicable law and regulations preclude certain types of communications,
including an investment recommendation, during the course of Credit Suisse's engagement in an investment banking transaction and in certain other
circumstances.
Volatility Indicator [V] : A stock is defined as volatile if the stock price has moved up or down by 20% or more in a month in at least 8 of the past 24
months or the analyst expects significant volatility going forward.
Analysts sector weightings are distinct from analysts stock ratings and are based on the analysts expectations for the fundamentals and/or
valuation of the sector* relative to the groups historic fundamentals and/or valuation:
Overweight : The analysts expectation for the sectors fundamentals and/or valuation is favorable over the next 12 months.
Market Weight : The analysts expectation for the sectors fundamentals and/or valuation is neutral over the next 12 months.
Underweight : The analysts expectation for the sectors fundamentals and/or valuation is cautious over the next 12 months.
*An analysts coverage sector consists of all companies covered by the analyst within the relevant sector. An analyst may cov er multiple sectors.

The appeal of consumer health

30

18 July 2014

Credit Suisse's distribution of stock ratings (and banking clients) is:


Global Ratings Distribution

Rating

Versus universe (%)

Of which banking clients (%)

Outperform/Buy*
45%
(54% banking clients)
Neutral/Hold*
40%
(50% banking clients)
Underperform/Sell*
13%
(47% banking clients)
Restricted
3%
*For purposes of the NYSE and NASD ratings distribution disclosure requirements, our stock ratings of Outperform, Neutral, and Underperform most closely
correspond to Buy, Hold, and Sell, respectively; however, the meanings are not the same, as our stock ratings are determin ed on a relative basis. (Please refer to
definitions above.) An investor's decision to buy or sell a security should be based on investment objectives, current holdin gs, and other individual factors.

Credit Suisses policy is to update research reports as it deems appropriate, based on developments with the subject company, the sector or the
market that may have a material impact on the research views or opinions stated herein.
Credit Suisse's policy is only to publish investment research that is impartial, independent, clear, fair and not misleading. For more detail please refer
to Credit Suisse's Policies for Managing Conflicts of Interest in connection with Investment Research: http://www.csfb.com/research and
analytics/disclaimer/managing_conflicts_disclaimer.html
Credit Suisse does not provide any tax advice. Any statement herein regarding any US federal tax is not intended or written to be used, and cannot
be used, by any taxpayer for the purposes of avoiding any penalties.
See the Companies Mentioned section for full company names

The subject company (JNJ.N, PFE.N, LLY.N, BMY.N, MRK.N, GSK.L, NOVOb.CO, ROG.VX, BAYGn.DE, NOVN.VX, CL.N, VRX.N, AZN.L)
currently is, or was during the 12-month period preceding the date of distribution of this report, a client of Credit Suisse.
Credit Suisse provided investment banking services to the subject company (PFE.N, LLY.N, BMY.N, MRK.N, BAYGn.DE, NOVN.VX) within the past
12 months.
Credit Suisse provided non-investment banking services to the subject company (PFE.N, LLY.N, BMY.N, MRK.N, GSK.L, ROG.VX, BAYGn.DE,
NOVN.VX, AZN.L) within the past 12 months
Credit Suisse has managed or co-managed a public offering of securities for the subject company (PFE.N, BMY.N, BAYGn.DE, NOVN.VX) within
the past 12 months.
Credit Suisse has received investment banking related compensation from the subject company (PFE.N, LLY.N, BMY.N, MRK.N, BAYGn.DE,
NOVN.VX) within the past 12 months
Credit Suisse expects to receive or intends to seek investment banking related compensation from the subject company (JNJ.N, PFE.N, LLY.N,
BMY.N, MRK.N, MRCG.DE, GSK.L, BAYGn.DE, NOVN.VX, CL.N, MEDAa.ST, AZN.L) within the next 3 months.
Credit Suisse has received compensation for products and services other than investment banking services from the subject company (PFE.N,
LLY.N, BMY.N, MRK.N, GSK.L, ROG.VX, BAYGn.DE, NOVN.VX, AZN.L) within the past 12 months
As of the date of this report, Credit Suisse makes a market in the following subject companies (JNJ.N, PFE.N, LLY.N, BMY.N, MRK.N, CL.N,
VRX.N).
As of the end of the preceding month, Credit Suisse beneficially own 1% or more of a class of common equity securities of (BAYGn.DE, NOVN.VX).
Credit Suisse has a material conflict of interest with the subject company (MRK.N) . Credit Suisse Securities (USA) LLC is acting as financial advisor
to Merck (NYSE: MRK) on its announced proposed acquisition of Idenix Pharmaceuticals Inc. (NASDAQ: IDIX).
As of the date of this report, an analyst involved in the preparation of this report has the following material conflict of interest with the subject
company (PFE.N). As of the date of this report, an analyst involved in the preparation of this report, Vamil Divan, has following material conflicts of
interest with the subject company. The analyst or a member of the analyst's household has a long position in the common stock Pfizer (PFE.N). A
member of the analyst's household is an employee of Pfizer (PFE.N).
As of the date of this report, an analyst involved in the preparation of this report has the following material conflict of interest with the subject
company (PFE.N). As of the date of this report, an analyst involved in the preparation of this report, Ronak Shah, has the following material conflict
of interest with the subject company. The analyst has a long position in the common stock Pfizer (PFE.N).
For other important disclosures concerning companies featured in this report, including price charts, please visit the website at https://rave.creditsuisse.com/disclosures or call +1 (877) 291-2683.

Important Regional Disclosures


Singapore recipients should contact Credit Suisse AG, Singapore Branch for any matters arising from this research report.
The analyst(s) involved in the preparation of this report have not visited the material operations of the subject company (JNJ.N, PFE.N, PFE.N,
PFE.N, LLY.N, BMY.N, MRK.N, MRCG.DE, RB.L, GSK.L, NOVOb.CO, ROG.VX, SASY.PA, BAYGn.DE, NOVN.VX, CL.N, MEDAa.ST, RECI.MI,
VRX.N, AZN.L) within the past 12 months

The appeal of consumer health

31

18 July 2014

Restrictions on certain Canadian securities are indicated by the following abbreviations: NVS--Non-Voting shares; RVS--Restricted Voting Shares;
SVS--Subordinate Voting Shares.
Individuals receiving this report from a Canadian investment dealer that is not affiliated with Credit Suisse should be advised that this report may not
contain regulatory disclosures the non-affiliated Canadian investment dealer would be required to make if this were its own report.
For Credit Suisse Securities (Canada), Inc.'s policies and procedures regarding the dissemination of equity research, please visit
http://www.csfb.com/legal_terms/canada_research_policy.shtml.
The following disclosed European company/ies have estimates that comply with IFRS: (BMY.N, RB.L, SASY.PA, AZN.L).
Credit Suisse has acted as lead manager or syndicate member in a public offering of securities for the subject company (PFE.N, BMY.N, MRK.N,
GSK.L, BAYGn.DE, NOVN.VX) within the past 3 years.
As of the date of this report, Credit Suisse acts as a market maker or liquidity provider in the equities securities that are the subject of this report.
Principal is not guaranteed in the case of equities because equity prices are variable.
Commission is the commission rate or the amount agreed with a customer when setting up an account or at any time after that.
To the extent this is a report authored in whole or in part by a non-U.S. analyst and is made available in the U.S., the following are important
disclosures regarding any non-U.S. analyst contributors: The non-U.S. research analysts listed below (if any) are not registered/qualified as research
analysts with FINRA. The non-U.S. research analysts listed below may not be associated persons of CSSU and therefore may not be subject to the
NASD Rule 2711 and NYSE Rule 472 restrictions on communications with a subject company, public appearances and trading securities held by a
research analyst account.
Credit Suisse Securities (Europe) Limited .. European Pharma Team ; Jo Walton ; Matthew Weston PhD ; Riccardo Lowi ; Alex Molloy ; Charlie
Mills ; Nicolas Sochovsky

Important Credit Suisse HOLT Disclosures


With respect to the analysis in this report based on the Credit Suisse HOLT methodology, Credit Suisse certifies that (1) the views expressed in this
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The appeal of consumer health

32

18 July 2014

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Investment principal on bonds can be eroded depending on sale price or market price. In addition, there are bonds on which investment principal can
be eroded due to changes in redemption amounts. Care is required when investing in such instruments.
When you purchase non-listed Japanese fixed income securities (Japanese government bonds, Japanese municipal bonds, Japanese government guaranteed bonds, Japanese corporate bonds) from CS
as a seller, you will be requested to pay the purchase price only.

consumer in pharma 9 july.doc

The appeal of consumer health

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