Pharm Exec's 13th Annual Industry Audit

Sep 01, 2014

Back on Track

2013 delivered a decisive stroke of good luck to the 27 companies participating in Pharm Exec's 13th Annual Industry Audit on shareholder performance. Revenues were up sharply from 2012's unprecedented plunge into negative growth, but the turnaround accentuates a larger trend apparent for several years: the growing divide between companies stumbling with the legacy of tired pipelines and the expectations burden imposed by sheer size, and those smaller, more nimble players with the price freedom that comes from charting a clear course toward therapies driven by unmet medical needs. The lesson is a simple one—on that strategy and vision thing, clarity counts.

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The Pharm Exec Industry Audit occupies a unique position in the increasingly crowded field of data sets evaluating industry performance. Since its debut in 2002, the audit adheres to a simple objective: to identify how well companies are doing in advancing shareholder value. Our goal is to rank this performance on 10 metrics among the top 25 publicly traded companies by sales revenues. Most, but not all, of these metrics are financial.

This is admittedly a measure open to interpretation because there is no other standard accepted reference point that looks at performance from this perspective. But no one can argue that the approach is not relevant, given how "shareholder value" has become the rationale of choice in driving the surge in M&A and licensing transactions to near record levels so far this year.

Idiosyncratic or not, we like that the audit reveals the importance of metrics that often escape scrutiny by the major investor ratings institutions. One example is the return on assets against profits, which allows for the valuation of intangibles like patent holdings. More important, shareholder value is also a good indicator of long-term success because of its association with stability: when the investment community is happy, there is less pressure for changes in the "c-suite" and management has some leverage to place riskier bets on investments that may play out only over time.


This year's audit has been expanded to 27 companies, three of which are new to the ranking: Regeneron, Vertex, and Valeant. Regeneron and Vertex were included due to their strong impact on the product mix through home-grown innovations that especially in the former case have fueled a fairly spectacular rate of growth in both sales and share price. We also looked for evidence of any correlation between shareholder value and the high pay packages awarded to their CEOs, at $36.3 million for Dr. Leonard Schleifer of Regeneron and $13.1 million for Dr. Jeffrey Leiden of Vertex. As for Valeant, its Tyco-like strategy of eschewing organic growth in favor of acquisitions of undervalued and underperforming assets has coined a new business model, not to mention empowering a new industry stakeholder: the activist hedge fund investor.

The 2014 scorecard relies on data from the 27 companies' 2012-2013 reporting periods. We rely on 10 metrics to assess performance, up from nine last year. The new entry is a powerful one: return on invested capital (ROIC), which is a measure of how well a company uses its capital investments to generate profits. This is a hot issue in the financial press. The others are unchanged from last year, and include sales growth; growth in enterprise value; enterprise value to sales; gross margins; earnings before interest, taxes, depreciation, and amortization (EBITDA) to sales (a key measure of profit margin); sales to assets (or asset turnover); EBITDA to assets, combining margin management, or profit margins, with asset management and sales to assets, resulting in a much more powerful metric than simply profit margin alone; sales per employee; and sales, general, and administrative costs to sales, an indicator of overhead.

Audit Data Sources & Table Key
With the exception of this last metric, on overhead, each metric is weighted, with the highest weight of three given to growth in enterprise value; enterprise value to sales; EBITDA to assets; and return on invested capital. Weights of two are given to the remainder—sales growth; gross margin; EBITDA to sales; sales to assets (asset turnover); and sales per employee.

The higher a company scores on each metric, the better the performance. For example, if a company places 27 on a metric, that is the highest performance compared to a score of one, which is the lowest performance. Each placement rank per metric is multiplied by the weight of that metric. Hence, if a firm places 22 out of 27 on enterprise value growth, that firm would score a total of 66 points (Rank 22 times a weight of 3 = 66). Each company's points over each metric are then added to arrive at a total point score per company from which the 27 firms are ranked to determine the audit's top performer of the year.

In addition to the above nine weighted metrics, the audit includes a few "macro" benchmarks designed to capture external influences on companies in the audit. These include economic indicators like US GDP and CPI, standard market measures like the Standard & Poor investor grade rating and the Nasdaq and Dow Jones indices, and some specific sector growth metrics. While the exposure to broad market forces is shared, companies often react—or are affected—differently. We find that those who adjust well to such forces tend to have a leg up on competitors in the final rankings.

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