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«Studies in Applied Finance INVESTMENT THESIS FOR GILEAD SCIENCES, INC. (NYSE: GILD) Stephen Johannesson Johns Hopkins Institute for Applied Economics, ...»

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Figure 3 – Computation of annual bonus award for GILD Named Executive Officers Source: Gilead Sciences, Inc. (2016). Schedule 14A (2016). Retrieved from SEC EDGAR website http://www.sec.gov/edgar.shtml Long-Term Incentive Plan: The long term incentive plan is weighted equally (50%) between performance equity rewards and stock options. Performance based equity rewards are given to executives based upon an equal weighting of relative total shareholder return (TSR) and absolute product revenue as performance metrics. The firm’s TSR is compared to a subset of the S&P Healthcare Sub-Index, as detailed below, and the absolute revenue targets established by the compensation committee (Figure 4). Additionally, a portion of the equity compensation is awarded in the form of stock options. The amounts of these stock options are determined by the compensation committee and vest over a four-year period, with a minimum of one year until 25% of the award may vest. Said options then vest quarterly for the remaining three years.

Investment Thesis for Gilead Sciences, Inc. (NYSE: GILD) by Stephen Johannesson Figure 4 – Net revenue and TSR tranches which dictate the long term incentive compensation of the firm’s named executive officers.

Source: Gilead Sciences, Inc. (2016). Schedule 14A (2016). Retrieved from SEC EDGAR website http://www.sec.gov/edgar.shtml Stock-ownership guidelines for executive officers: Executive officers of GILD are required to maintain stock ownership levels which are determined by multiples of their base salary. The CEO is required to hold five times his/her base salary in equity, the President and COO are required to hold three time their respective base salaries, and all other named executive officers are required to hold two times their annual base salary.

Companies in Peer Group:

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Dividend and Share Buyback History:

Investment Thesis for Gilead Sciences, Inc. (NYSE: GILD) by Stephen Johannesson GILD announced its first dividend in 2015, paying out $1.29 per share in the fiscal year (FY). In the first quarter of FY 2016, they announced a $0.43 dividend per share, which, if extended over the course of FY 2016 will generate $1.72 per share for shareholders. This firm is likely to maintain its dividends going forward as its executives are compensated on a relative TSR metric and the firm has more than enough cash and earnings per share to maintain it.

In February 2016, the board of directors authorized a $12 billion repurchase program that remains untapped as of March 31, 2016. In 2015, the firm executed $8 billion in share repurchases (Figure 6). This can be interpreted as an attitude among the executive members of the firm that the stock is undervalued. No guidance appears to have been given regarding future buyback policies.

Management Guidance:

GILD’s management offers no guidance as on future capital expenditures as capital expenditures are a function of the firm’s merger and acquisition activity. However, their 2016 guidance indicates that they expect the firm’s 2016 revenue to be $30-$31 billion, values less than the annualized 2015 revenues in the model.6 This indicates that they expect the revenues of their largest revenue contributors to fall in the future.

Washington, Robin. “Q4 2015 Earnings Results.” Annual Shareholder Presentation. Online. 2 February 2016. Full Year 2016 Guidance Investment Thesis for Gilead Sciences, Inc. (NYSE: GILD) by Stephen Johannesson

Multiples Analysis:

Gilead has an average price-to-earnings (P/E) ratio of 17.30 over the last 5 years (see Figure 7).

Multiplying the average P/E by their trailing twelve months EPS of $10.10 yields an estimated share price of $174.73, more than double the company’s current stock price. This method of analysis is skewed towards a higher valuation than is appropriate, though, because Gilead’s earnings have increased nearly 300% in three years. Implying that an investor should be willing to pay $17.30 per $1 of earnings at this point in the company’s life span does not seem reasonable because there is little to justify such a premium on their earnings. Evidence of this is found in the firm’s current P/E multiple of 7.58, less than half of the 5-year average P/E ratio.

Insider Transaction Information:

Figure 7 – Chart of P/E ratio and stock price over the last five years, showing the decrease of the P/E ratio, as earnings have soared since 2012.

Source: Graph Fundamentals function – Bloomberg Terminal. Accessed 5/16/16.

Figure 8 – Table of major shareholders of Gilead, showing purchases and sales of shares over the last 5 months.

Source: Security Ownership function – Bloomberg Terminal. Accessed 5/16/16.

Gilead has been a topic of disagreement among major investors over the last 5 months with more sales than buys occurring (Figure 8). This is likely tied to concerns regarding Gilead’s market share in the HCV market, and its future ability to maintain such high earnings.

Investment Thesis for Gilead Sciences, Inc. (NYSE: GILD) by Stephen Johannesson Figure 9 – Graph of purchases, sales, and exercised options by firm insiders over the past two years, showing favoritism for sales in 2015 and a relatively neutral position in 2016.

Source: Security Ownership function – Bloomberg Terminal. Accessed 5/16/16.

Firm insiders have had a relatively negative outlook on the firm over the past two years, coming to a rather neutral or even positive looking position in the last 5 months. Given lowered earnings expectations, it appears that the firm’s insiders have a more bullish outlook on the stock price now than in 2015.

Conclusions:

The firm’s projected free cash flow per share is equal to its stock price when we assume that all revenues will drop to zero after IP expiration occurs, indicating that the market is most likely assuming such behavior will take place. GILD will either have to organically develop or purchase other IP that will be able to improve its current $30 billion revenue well past 2030 (when Harvoni and Sovaldi expire). Given that the firm’s current valuation appears to solely consider the firm’s current drug arsenal, any innovations or acquisitions that generate positive cash flow will improve the valuation of GILD. With its current high profits, GILD can evaluate acquisition opportunities rigorously and pursue organic drug development concurrently.

Investment Thesis for Gilead Sciences, Inc. (NYSE: GILD) by Stephen Johannesson Management is incentivized to improve overall revenues while focusing equally on the shareholder benefits. The value thesis of GILD resides on our belief in the firm to use its vast resources to make any intelligent improvements to the firm at all. Therefore we rate the stock a buy.



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