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GlaxoSmithKline: what investors may lose - THE CITIZEN

By The Citizen
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The trend of reacquisition of once indigenized companies by foreign firms is continuing in the Nigerian market with GlaxoSmithKline Consumer [GSK] earmarked as the next candidate. The leading pharmaceutical company in Nigeria will soon revert to majority ownership by its parent company - GlaxoSmithKline Plc, according to a current proposal.

As a condition for providing a financial support required to upgrade the Nigerian operation, the parent company has demanded to acquire an additional 321 million shares from Nigerian shareholders in the company at a price of N48 per share. The deal, when consummated, will place in the hands of the foreign company 80% of the ownership of GSK, raising equity stake from the existing 46.5%.

For Nigerian shareholders in GSK, whose holding will be acquired at N48 per share, a loss is quite obvious for a company that is currently trading at about N68 per share. The total return for the Nigerian shareholder will be just 6.4% against the stock's opening price of N45.10 in January 2013. This is a stock that is capable of doubling its value in the current year.

With the rising stock market led by industry leaders and blue chips, the GSK stock could rise by another N20 or more this year, meaning an expected capital gain of about 95% for the full year. That, plus the expected minimum dividend of N1.30 per share the company paid for 2012 operations, will yield an expected total return of about 98%.

The difference in return between the 6.4% and the expected total return of 98% on the GSK stock in 2013 is the margin of loss that Nigerian shareholders are likely to sustain in the proposed acquisition. Already the company's stock has advanced by 50.7% in value as at the close of business last Friday.

GSK stated in its 2012 annual report that it is in need of new capital injection for extensive upgrade of its operations. It said that this is needed to enhance manufacturing capacities and permit development of new product portfolios. The required upgrade, it said, will require significant capital expenditure. And its directors seem to consider only its parent company to be the only option for providing the funds.

The company seems to be in a very good position to undertake a successful rights issue if all that it needs is new money. It is one of the few companies that have maintained earnings stability with regular dividend payments even through the financial crisis. It has maintained stable and continuing growth in sales revenue over the past five years. Profit growth has also been stable and consistent over the past five years.

The price of the company's stock almost doubled [96%] in 2012. At almost N68, the price of the stock is already N20 above the set acquisition price of N48 per share.

In terms of financial condition, GSK is apparently one of the most financially stable companies operating in the Nigerian market. Its balance sheet is entirely free of debts- that usually warrant new capital injection for refinancing.

At the end of its first quarter operations in March, the company had N4.5 billion in idle cash and short-term deposits, a sustaining improvement from N3.98 billion in the 2011 full year and N4.3 billion at the end of December 2012. From short-term deposits, it earned N196 million in net interest income in the 2012 financial year and has reported interest income of N29 million in the first quarter.

The current year is promising for the company in terms of stable earnings though growth in revenue is presently weak. Sales revenue declined at the end of the first quarter but profit is improving moderately. Turnover closed 17.4% down to N6.93 billion in the first quarter from the corresponding quarter in the preceding year. Despite the decline, reasonable projections indicate that the company could grow turnover by 15.4% to N29.2 billion at the end of the 2013 full year.  It had raised sales revenue by about 18% to N25.31 billion in 2012.

Net profit grew by 11.1% to N599 million at the end of the first quarter compared to the corresponding quarter in 2012. Based on the first quarter growth rate, full year net profit is projected at N2.75 billion for the company at full year. That would be a slight decline of 2.6% from the net profit figure of N2.82 billion reported for the 2012 full year operations.

Net profit margin has improved from 6.4% in the first quarter of 2012 to 8.6% in the first quarter of the current year. Profit growth is expected to step up in the subsequent interims.

The improvement in profit in the first quarter happened because of improvements in other income and interest income during the period. All major cost elements moved up during the period against the decline in sales revenue. Cost of sales rose by 7.1% to claim 60.9% of sales revenue, increasing from 47% in the corresponding quarter in 2012. This is against the cost of sales ratio of 59.6% recorded in the 2012 full year. Gross profit margin therefore went down from 53% in the first quarter of 2012 to 39.1% in 2013.

Selling and administrative expenses rose by 11.1% in the first quarter to also claim an increased share of sales revenue at 20.2% compared to 15% over the review period. Administrative expenses were flat during the period but other operating expenses soared by 161.8%.

At the end of the first quarter, the company earned 62 kobo per share for shareholders, improving from 56 kobo in the corresponding period in 2012. Earnings per share is projected at N2.87 for GSK at full year based on the forecast full year net profit. That would be a slight decline from the earnings per share of N2.95 recorded in the 2012 full year.

Improvement in earnings outlook is likely in the coming quarters. The company had improved earnings per share from N2.40 in 2011.

GSK paid a cash dividend of N1.30 per share in 2012, an improvement from N1.20 it paid in 2011. This is a dividend pay-out of 44.1%. Based on the earnings outlook so far, a dividend of N1.30 may be repeated by the company in 2013.

A rapid increase in trade and other receivables, which was a major event in the 2012 financial year, continued in the first quarter. Trade and other receivables advanced by 119% to about N3.50 billion in 2012 with its adverse effect on the cash flow position. The adverse impact on the cash flow was largely countered by an increase of 23.5% in trade and other payables to N8.30 billion during the year.

At the end of the first quarter, trade and other receivables increased by 59.6% to N4.4 billion and trade and other payables also rose by 3.7% to N8.83 billion. A decline of 25.8% in inventories enabled the company to improve its cash flow position in the first quarter. The company is giving more trade credit to customers than it is receiving from suppliers, which is impacting adversely on the cash flow situation.

The regulatory environment has improved somewhat for pharmaceutical companies though counterfeit and cheap imported drugs continue to seize a good part of the industry's market share. The improvement in the operating environment reflects some headway in NAFDAC's fight against fake drugs through the adoption of modern technology.

Importation of cheap drugs remains a major threat to market share of local drugs manufacturers. Government support is said to be on the way however through some efforts to set up a development fund for supporting local manufacturers to compete effectively with foreign drugs manufacturers.