Ramon V.

del Rosario College of Business

(RVRCOB)
Financial Management FNC 535M
Taft Campus LS 218

“American Home Product Corporation”

Case Analysis and Corporate Strategy

Individual Report of
Jerelynn B. Hipolito
Group 6
BSA

Dean Atty. Joe-Santos Balagtas Bisquera

MBA Professor

Hipolito, Jerelynn B. American Home Product Corporation 12 November 2015

 Executive Summary

American Home Products (AHP) is one of the largest pharmaceutical

companies in the United State. It has more than 1500 marketed brands in
four business lines which are prescription drugs, packaged drugs, food
products, housewares and household products. However, the main
profitable product of the company is prescription drugs. AHP has a tight
financial control and maintains a conservative capital structure policy. It has
no debt and excess liquidity. It aims to make money for stockholders and to
maximize profit by minimizing cost. Due to the tight financial control, the
company can reduce the short-term debt and risk orientation hence lowers
the investment relative to R&D. In addition, the company is risk-averse as it
always avoids taking risk in developing and introducing new products in the
volatile drug industry, which can save the cost of R&D. Most of AHP’s new
products are acquired after the development other firms, imitated of new
products introduced by competitors or extended of existing products in the
company.
American Home Products Corporation (AHP) was founded in 1926
and has a history of continuous acquisitions of smaller companies that
made proprietary medicines. In 1931, AHP purchased John Wyeth &
Brother, Inc. from Harvard University. Another important acquisition was
that of Canada’s Ayerst Laboratories in 1943. Ayerst was a large
pharmaceutical company that had introduced Premarin, the world’s first
conjugated estrogen product, and now the most widely prescribed product
in the United States (ahp.com). In March of 1982, Sherwood Medical was
acquired, enabling AHP to capture a share of the developing medical
devices market. In 1984, Whitehall, an original member of AHP, started to
market ibuprofen in the United States that was sold under the trademark
Advil.
Lawyer John Stafford became CEO in 1986 and soon after he
supervised the acquisition of Bristol-Meyer’s animal health division and
assimilated the new business into Fort Dodge, now Fort Dodge Animal
Health. In 1989, AHP bought A.H. Robins along with its popular consumer
products, including Chap Stick, Dimetapp, and Robitussin. AHP and
American Cyanamid merged in 1994 in a deal valued at $9.6 billion. AHP
introduced many new products in 1996, including Redux and Pondimin
(Phen-Phen), two weight-reduction drugs. These drugs were later pulled
from the market because of links to serious health problems and lawsuits
soon followed. When 1998 mega-merger plans with SmithKline Beecham

Hipolito, Jerelynn B. American Home Product Corporation 12 November 2015

and Monsanto collapsed, AHP settled for the acquisition of New Jersey
based Solgar Vitamin and Herb Company for $425 million. It’s clear to see
that AHP’s history is comprised of acquisitions in the desire to be the
ultimate leader of the pharmaceutical industry.

Problem
Institutional

How much business risk does American Home Product Face? How
much financial risk would AHP face at each of the proposed levels of debt?

Operational

How much potential value, if any can AHP create for its shareholders
at each of the proposed level of debt?

Corporate Objectives

The Chief Executive Officer of the company, Mr. Laporte was

approaching retirement, and analysts speculated on the possibly of a more
aggressive capital structure. To minimize the combination of business risk
and financial risk.

Areas for Consideration

Environmental Opportunities and Threats

Micro Economic Indicator

Political

AHP should look into the political indicators such as establishing

international links and reaching out to international markets and dealers in
the event that AHP will create a more aggressive capital structure policy.

Economic

The economy was prosperous until the early 1970s, then faltered
under new foreign competition and high oil prices. By 1980 and the seizure

Hipolito, Jerelynn B. American Home Product Corporation 12 November 2015

of the American Embassy in Iran, there was a growing sense of national
malaise.

Demographic

Fort Dodge is another distributor and member of the AHP family. They
are a leading manufacturer and distributor of prescription and over-the-
counter animal health care products for the livestock, companion animal,
and swine and poultry industries in North America and international
markets (ahp.com). The partnership of Fort Dodge with AHP creates a
more diverse company and, therefore, a broader product range.

Socio-Cultural

American Home Products Corporation has a relatively large team of

managers. AHP employs more than 52,000 citizens, a substantial decrease
from 1994’s statistic of 74,000. AHP’s principal corporate officers consist of
twenty-two vice-principals, one treasurer, and one secretary. AHP’s
management team also consists of 12 subsidiary officers from AHP’s
principal divisions.

Market Profile and Outlook

American Home Products has a suprisingly vast array of products.

From women’s health care products to agricultural goods to animal health
care products, AHP covers a variety of pharmaceutical needs. From
potential for great growth to ample benefits to high pay, the pharmaceutical
industry is an industry with a promising standpoint. Because people will
always need medicine for some sort of ailment, the pharmaceutical industry
will always be in business. Pharmaceuticals will be the world’s answer to
life-threatening diseases such as cancer, AIDS, and heart disease. As long
as baby’s are being born and grandparents are aging, there will be a need
for pharmaceuticals.

Competition

In 1983, AHP spent $425 million to buy the Sherwood Medical Group.
A manufacturer of medical supplies, Sherwood placed AHP in a competitive
position to capture the lion's share of the growing medical-device market.
Under Stafford's guidance in the late 1980s and early 1990s, American

Hipolito, Jerelynn B. American Home Product Corporation 12 November 2015

Home Products worked to transform itself into a health care company
through acquisitions and divestments.

Technology

AHP research, products, and educational initiatives benefit millions of

women, most widely prescribed medication in the United State. By 1979
prescription drugs accounted for 39 percent of total sales and 55 percent of
net income. As the company expanded its high-technology line, it divested
itself of its cosmetics and toilet preparations.

Resources

Corporate Franchise

According to the law dictionary, corporate franchise is the right to

exist and do business as a corporation. AHP is a corporation that has been
in the industry for several years already and can be inferred that they are
given the right by the government to do business.

Shareholders & Key Officers

William Laporte, 17 years as the CEO of AHP.

Product

AHP’s products heavily marketed brands in four lines of business:

prescription drugs, package drugs, food products, housewares and
household products. AHP’s family of companies also produces vaccines,
cancer treatments, and pain and inflammation medications. Their vaccines
prevent childhood and adult diseases such as whooping cough, diphtheria,
poliomyelitis, meningitis, pneumonia, and influenza. Orimune, the only oral
polio vaccine sold in the United States, is a familiar product of Wyeth-
Ayerst. AHP is also known for their anti-cancer agents used by oncologists
throughout the world. AHP’s oncology and hematology franchises were
strengthened.

Hipolito, Jerelynn B. American Home Product Corporation 12 November 2015

 Place and Distribution

American Home Products has a number of distributors under the AHP

name and reputation. One of those is AHP’s Laboratories. AHP
concentrates its efforts on the distribution and sale of pharmaceutical and
vaccine products and the distribution of Whitehall-Robins consumer
products in the United States. AHP provides more prescription products to
Americans than any other pharmaceutical company and offers one of the
broadest and most diverse product lines in the industry (Tardiff 112). AHP is
also among the largest manufacturers of generic oral and injectable
products in the United States and is a leading supplier of injectables to
hospitals (ahp.com). Headquartered in Philadelphia, Pennsylvania. AHP
employs more than 40,000 people worldwide, who bring to the company a
full range of talent in research, marketing, sales, and manufacturing .
American Home Products has the ability to respond quickly to shifting
market conditions and changes in the pharmaceutical industry. AHP’s large
family of companies allows for the quick development and marketing of
new products. They are positioned to deliver new, advanced therapies
quickly through its research and development skills. AHP’s productivity
efforts have allowed them to double the number of Investigational New
Drug applications filed compared with five years ago.

Financial Profile

Profitability

Business risk is related to make a firm’s operation without any debt,

whereas financial risk requires that the firm’s common stakeholders make a
decision to finance it with debt. AHP has been operating on four main lines
that are less uncertainty about product demand; for example, one of its
business lines is food products because whenever people buy foods, it
means that AHP’s business risk is low. As mentioned, if a firm does its
operation activity regularly without leverage, it means that its business risk
is not significant high. Thus, ratio of cash to total asset is calculated by
following:

Hipolito, Jerelynn B. American Home Product Corporation 12 November 2015

In this figure, AHP’ cash was about 23% of total assets. It has enough cash
flow to finance its daily operation.

Also, return on asset can show that the ability of the company to cover its
operating cost by generating income. According to the calculation below.

AHP relies on strong marketing skill to promote copies of new innovative

drugs to reduce competition’s head start advantage. For the performance
of the company, it is characterized by stable, consistent growth (10-15%)
and profitability

Its ROE had risen from 26% in 1960 to 30% in 1980 because of its passion
for parsimony, and finance this growth internally while paying out 60% of its
annual earning as dividends. AHP’s stock is widely held by the major
institutional investors.

It has excess liquidity and low degree of leverage reflecting the good
condition of the company. The company seems to have low business risk
because of me-too strategy which reduces the cost of R&D, its stable
growth and profitability, its stable demand for medicine and its
diversification of operations. In addition, it has less financial risk as it has
no debt; lots of cash balance and bond credit rating of AAA.

Turnovers

Though we cannot compute the net working capital turnover and other
liquidity ratios because of the limited data of the case.

Hipolito, Jerelynn B. American Home Product Corporation 12 November 2015

Capacity Utilization

According to ReadyRatios, “Capacity utilization rate is a metric which is

used to compute the rate at which probable output levels are being met or
used.” Although there was no definite value that the company seeks for its
capacity usage, AHM need to utilize their capacity and make sure to
increase its sales and corporate force, diversify and expand the production
facilities and increase the products in the product lines.

Financial Leverage

According to Investopedia, financial leverage is the “degree to which a

company uses fixed-income securities such as debt and preferred equity.
The more debt financing a company uses, the higher its financial leverage.
A high degree of financial leverage means high interest payments, which
negatively affects the company's bottom-line earnings per share”. The
financial leverage describes the company’s dependency in using the
borrowed money. The more debt financing the company uses, the higher its
financial leverage. Leverage can be computed by dividing long term debt
by the equity. Based on the case. AHP’s track record of almost no debt on
the balance sheet and a very substantial cash balance.

COMPETITIVE ADVANTAGE

STRENGTHS

* The company had an almost debt-free balance sheet and growing cash
reserves. At the end of 1980, AHP had almost no debt and a cash balance
equal to 40% of its net worth. Being debt-free gives AHP an advantage in
pricing that competitors will find challenging.

* AHP had a commendable marketing expertise in their prescription drugs.

Because of this, they are the preferred choice of consumers over their
competitors.

* AHP's managerial philosophy was frugality and tight financial control. It is

precisely because of this philosophy that they are debt-free and all
expenditures greater than $500 are personally approved by Laporte even if
authorized on the corporate budget.

Hipolito, Jerelynn B. American Home Product Corporation 12 November 2015

WEAKNESSES

* AHP's culture of conservatism and risk aversion can be seen as strengths

but it can also be considered as weaknesses. In business, there should be
a calculated risk in venturing into expansion or into new products. But if a
business is too hesitant in taking risks, there is a possibility that their
products can stagnate and do not have innovation anymore.

* A substantial portion of AHP's new products were clever extensions of

existing products from competitors. Personally, since I work for Pfizer, I am
aware of the millions of dollars that pharmaceutical companies invest on
research, development, and patents. Once a patented product goes
generic, these companies lose a substantial amount in sales because
cheaper versions of their products come out, while these companies didn't
invest as much in R&D. AHP can do well to take risks and invest on R&D in
developing new products, so that its reputation as an innovator can also be
known.

OPPORTUNITIES

*The barriers to entry in the pharmaceutical industry are extremely high.

The regulatory hurdles represent a significant deterrent.

*Consumers becoming more discerning and active participants in their own

health care

*Strong brand name and credit rating facilitate acquisitions and takeovers
of promising small biotech firms.

*Strong drug pipeline garnered through mergers and acquisitions may

provide blockbuster drugs in the future.

THREATS

*The threat posed by potential substitutes for prescription pharmaceuticals

is low. Conventional medical options such as surgery, hospitalization, or
psychiatric care are often far less attractive on a cost to value basis.

*Despite pressure from internal rivalry and more aggressive suppliers and
buyers, the prescription pharmaceutical industry continues to be highly

Hipolito, Jerelynn B. American Home Product Corporation 12 November 2015

profitable. This is primarily because of the lack of viable substitutes and the
extremely high barriers to competitive entry.

Conclusion and Strategic Decision

It illustrates the total debt and financial risk have straight correlation with
each other and AHP’s total debt increased, so its financial risk would rise.
Then, if AHP could not pay its loan and interest by schedule, it would meet
the financial risk and the risk of bankruptcy. According to Exhibit 3 AHP
uses excess cash of 233 million dollars on each of the proposed levels if
repurchase stocks and remaining amounts were financed by debt; thus, its
common shares outstanding would decreased by 19.8 million shares on
30% debt ratio and 36.6 million shares on 70% debt ratio. It means that
equity will goes down, so its return on equity will rise. AHP should consider
about financial risk to change the capital structure.

Hipolito, Jerelynn B. American Home Product Corporation 12 November 2015

AHP can save taxes to pay by increasing debt.

If the company’s structure is 70% debt to total capital, comparing to 0%

debt to total capital structure, it can save approximately 1.9 times greater
money, thus, its shareholder would benefit from it.

Grand Design and Execution

Most appropriate capital structure of AHP is 30% debt to total capital.

Several reasons will explain why this structure gives advantage to AHP.
First, using 30% debt ratio, the company would be able to recapitalized;
hence, common shares outstanding of 19.8 million can be purchased.
Second, AHP would have advantage to save taxes and its shareholders
benefit by getting more values.

Exhibit 2 shows that Warner Lambert Company’s debt ratio is

approximately 32% and its bond rating is AAA or AA. It means that if AHP
uses 39% debt and 70% equity, its bonding rating will be same as Warner
Lambert; consequently, bond interest to pay will not increase much due to
bond rating. Addition of these reason, AHP would face less risk to compare
heavier capital structures, Finally, AHP’s annual growth in sales decreased
in 1981 by 2.9% from previous year, so getting debt could be helpful to
manage its operation effectively and increase its sales growth.

References:

http://www.slideshare.net/aortae/fnce203-case-presentation
The History of American Home Products." 123HelpMe.com. 11 Nov 2015
http://www.referenceforbusiness.com/history2/64/American-Home
Products.html#ixzz3rEnmUwum
http://hbswk.hbs.edu/item/new-learning-at-american-home-products

Hipolito, Jerelynn B. American Home Product Corporation 12 November 2015