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Fundamental Analysis Applied Case (Vertex Pharmaceuticals Incorporated)

 The following slides will describe how to “pick a stock” building on last week’s presentation  Slides will outline the top-down analysis process on Vertex Pharmaceuticals (VRTX)VRTX  The economic, industry and firm cases will be covered follow by an in depth look at financial data  The majority of the information was obtained from the Krause Fund websiteKrause Fund

 While searching for a stock it is very important to understand what economic metrics drive stock prices  In the case of VRTX the four factors are:  Demographics  Gross Domestic Product  Interest Rates  Consumer Price Index

 Vertex Pharmaceuticals is invested in the development of treatments for Rheumatoid Arthritis  The average age of an RA patient is 61 years old  Due to the “greying” of the baby boomers, the size of the 65+ population is expected to grow exponentially  This population also accounts for 30% of a health care spending

 Vertex’s most promising investment prospect is a treatment for Cystic Fibrosis  CF is an inherited diseases that affects children  There are 70,000 adults and children with the disease worldwide 30,000 of which are in the US  100,000,000 Americans are carriers of the disease bearing gene

 The healthcare industry accounts for 18.3% US GDP, and is expected to grow by a rate of 6% through 2022  This is driven by government legislation which will make health care more affordable  The demand for VRTX’s very expensive treatments will increase since consumers will be subsidized by the government

 Biotechnology is the concept of using biological process to provide technological solutions to a problem Biotechnology  The industry can be divided into three segments  Medical  Agricultural  Industrial  VRTX belongs to the largest segment of the group, medical biotechnology VRTX

 There are eight major players in the biotechnology industry, Vertex is one of them  Industry is very concentrated within a couple large companies  Amgen consists of 15% of the market share, Gilead accounts for another 7%

Government Regulation  Drug production is scrutinized by the FDA and is highly regulated  The investment companies make to produce treatments is often fruitless  There are incentives in place to encourage drug research and production Consolidation  Large drug manufacturers are acquiring small labs in order to diversify their drug portfolios  Preparing for the eminent “patent cliff”  Recently, companies have been trying to access offshore cash by merging with foreign companies

 Companies that have products late in the approval process have the potential for capital gains  Firms developing treatments that are “first- in-class” or treat rare diseases are attractive  Small nimble labs are producing the next generation of treatments and are acquisition targets

 “our (Vertex’s) strategy is to reach as many people with CF (cystic fibrosis) as possible and to enhance the benefits for those that we treat.”  VRTX is focused on developing new products to treat and existing market  The firm is creating a duo therapy to treat existing CF patients

 Vertex has two treatments for sale and is developing three others  Incivek and Kalydeco are currently for sale, but are expected to bring in decreasing revenues  There is lots of potential in the development of VX-809 as a partner a treatment to CF  Other treatments for Influenza A and RA are being developed

 Vertex has products all along the product development spectrum  The majority of their products are in the development phase as their approval awaits  Kalydeco is in the growth phase as its has seen increasing demand and is privy to patent immunity  Incivek is in the decline phase as consumers are purchasing a better, but more expensive treatment by Gilead

 Vertex Pharmaceuticals, Inc. has “first mover,” advantage.  The Kalydeco and VX-809 duo therapy will treat 75% of patients with CF.  VRTX has a ripening research pipeline with at least two drugs set to complete development and come to market in the next two years.  VRTX will have a continuing value growth rate of 5%, a percentage point lower than the expected growth in healthcare expenditures forecasted by the Centers for Medicare & Medicaid Services.  The synergies of these factors will drive value for VRTX and is we have placed a BUY rating on the company, which has an intrinsic value of $96.53 per share.

 In order to obtain the valuation $96.53 per share, historical financial data was analyzed  Items that were particularly important in deriving the population were:  Net Income  Sales Revenue  Research and Development  Property, Plant and Equipment  The value the firm will continue to grow after the model horizon is very important

 VRTX is trading at $112.64, compared to the $96.53 valuation and $67.53 spot price at time of writing  Vertex reported 3 rd quarter earnings on October 29 th  Earnings were better than expected  Loss per share was $.56 vs. the $.57 consensus  3 rd quarter revenues were $165 million, better than the $145 million consensus  Yearly revenues adjusted down to $525 million from $535 million (model predicted $1, million)

 There is no magic formula for “stock picking”  Research and modeling can improve the odds of picking a peach, but there are no guarantees  Understand your investment style and risk appetite

 Real GDP was 3.5% for the third quarter of Real GDP  Beat consensus of 3.0%, top end of consensus range 2.1%-3.5%.  Primarily driven from increased consumer discretionary spending.  Should put pressure on Fed regarding interest rates.

 Fed Funds Rate will remain at.25%.  Announced this month was the last month of bond buying program (QE3). bond buying program  However, plans for the Fed’s balance sheet have not been announced.  Expect continued strengthening in the labor market and inflation around 2%.

 Revenue grew 10% to $4.18 Billion, analysts expected $4.23 Billion. Revenue  Earnings $.74 per share, analysts expected $.74 per share.  19 th consecutive quarter with at least 5% of sales growth.  Guided earnings for current quarter lower than street expectation.

 Consumer Confidence Index reached its highest levels since October  Actual was 94.5 versus consensus of  Expectation of future recovery lead to a revision of 5.5 points.

 Revenue for Q3 was $3.2 Billion, beating consensus of $3.12. Revenue  Reported earnings of $.43 per share, beating consensus of $.40.  Lower guidance for Q4 and full-year due to rising costs.