GlaxoSmithKline Can Swallow Bitter Pill

Glaxo's mammoth scale enables it to digest the multibillion-dollar legal charge with only a minor impact to valuation

Damien Conover, CFA 16 July, 2010 | 11:26AM
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GlaxoSmithKline announced a $2.4 billion charge for expenses relating to long-standing legal disputes including investigations into a manufacturing site in Puerto Rico, liability cases regarding diabetes drug Avandia, and an anti-trust case over antidepressant Paxil. Despite the large charge, we don't expect any meaningful change to our fair value estimate for the company, and we are reaffirming our AA- credit rating for the firm. Overall, we believe the reduced uncertainty with potentially even higher legal charges, particularly around Avandia, largely offsets the company's slightly lower cash position following the charges.

Glaxo's mammoth scale enables the company to digest the multibillion-dollar charge with only a minor impact to valuation. With close to $10 billion in cash flow expected from operations in 2010, along with well more than $10 billion in cash on the balance sheet, the legal charges are a surmountable headwind. Additionally, given that the charge is one-time in nature, we believe getting the legal cases behind the company will reduce the risk overhang on the company, opening the door for potential multiple expansion.

Turning to the specifics of the charges, $750 million is related to a settlement with the US government over manufacturing problems at a Puerto Rico plant. The rest of the charges are related to an anti-trust case over Plavix and liability cases with Avandia (the company didn't breakout the split between the Plavix and Avandia cases). We believe the recent FDA panel's vote of 20 to 12 in support of Avandia remaining on the market helped secure a lower payout for the Avandia liability lawsuits. As a reference point, Merck settled the majority of its Vioxx liability cases for $4.8 billion after the product was withdrawn from the market. If the panel had recommended the removal of Avandia, we believe the legal costs to settle the liability cases would have been much higher.

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Security NamePriceChange (%)Morningstar
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GSK PLC1,339.50 GBX0.41Rating

About Author

Damien Conover, CFA  is an equity analyst and associate director at Morningstar.

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