Valuation of GlaxoSmithKline Plc

As of our monthly review, we enclosed in our report based on our analysis of last report of 2009 with more details about our last valuation of our company GSK for making decision for investor purposes. In order to make a clear decision about what stocks to buy or to sell, investors need to know the value of those shares to make sure of the real value of it. In fact, there are many methods which we can use to evaluate the value (Vo) of the share of any public company and compared it to the price in the market (Po) the market and then see if it is over valuated (sell) or under valuated (buy) . For, the GSK shares valuation, we used five options available to do so: Discounted Dividend Model (DDC), Free Cash Flow to Firm (FCFF), Free Cash Flow to Equity (FCFE), Residual Income Approach (RI) and Economic Value Added (EVA). A brief introduction about GSK, will be discussed further with calculation details through the appendix related to them and also an analysis of the performance, cash flow and position of GSK. The company was very performing during the last 3 years and the share of GSK under five option of calculation was underpriced in the market which a good opportunity to buy in the market. While calculating the share price by DDM, the value of company is coming to be £17.02 compared to price in the market which was £ 11.485 (FTSE100) on 07/05/2010. GSK share is underpriced and as an investor we should buy instead of selling. The use of FCFF, the company is positive cash flow which means it is able to generate cash flow from its mean activity and is a good reason for investor to buy. In 2009 the firm generated a positive cash flow as £13361.6327 million compared to (£16538.07 in 2008 and £11203.47 in 2007) and based on the model, we expect £14431.90 million for next year 2010. While using the FCFE, the value of the share was £71.76 compared to £11.485 in the market. Again, the share is underpriced in the market, and a good opportunity for investors to buy. On one hand, by using the RI, to compute the value, we found, £16.47 compared to £11.485 in the market. The GSK share is again under valuated in the market and should buy instead of selling it. On the other hand, the method of EVA, gives a value of £4279.53 million as an add value to shareholders after paying whole debtors and investors. It is an economic profit of £1389.47 million which means that the company is creating the wealth for investors and maximising their profit. It is a good opportunity for investor to buy GSK shares. We recommend that the company can buy back some of the outstanding shares, in the market with the positive cash flow if not used, and maximise the EPS (earning per share) in the mean time, reduce the cost of capital and improve its ratios like gearing and leverage. Or, current investors, can keep their shares and buy more shares, and hope in future to realize a good value while selling them, but it will decrease the EPS because of dilution effect. The company also can interest new investors because of under pricing shares in the market and wait for potential future gain on sales by improving more the management of the company, The company can make some synergies (horizontal or vertical) with others by paying them by issuing new shares at market price, which means a purchase at low cost and become leader in the market. XYZ,

Introduction

Before making an advance step into this, we will first put a light in the background of company. GSK is a public limited company and is the second largest pharmaceutical company in the world after Pfizer. It is basically a British based research and pharmaceutical company and its global headquarters of GSK House are in Brent ford, London, UK, while U.S GSK plc is listed on both London and New York stock exchanges. It was incorporated on 6th December 1999 under English law. On December, 2000 the company acquired Glaxo Wellcome plc and SmithKline Beecham plc by the scheme of merger of two companies. The major markets for the company's products are the USA, France, Japan, UK, Italy, Germany and Spain.

Analysis of performance, profitability and financing of GSK_ Appendix VI

As far as the performance of our company GSK, we can say that it has done a very good progress during the last 3 years even the market conditions and the crisis of 2008. If we look at the Return on Equity ROE compared to the market [1] , GSK realized a very important progress last years as of 2009, it was 59.49% (51.70% in 2008 and 54.30% in 2007), with slight decrease from 2007 to 2008 because of raising new debt and increase the financing cost of about 50% (843 in 2008 compared to 453 in 2007) . GSK, made in 2009, sales of £28368 million (£24352 million in 2008 and £22716 million in 2007) and decrease from year to year. The company distributed each year dividend to shareholders respecting its commitment to them. The whole ratio as current and quick ratio are very good and more than the market. Here after, we will give a summary of the evaluation of the company described above, and the more detail calculation will be in the appendix indicated below.

Valuation of GSK

1_Dividend Discount Model (DDM)_Appendix I

GSK is operating in a very volatile industry and its dividend is not constant during time, so we choose a period as long as we can to better have a rate growth for our calculation (9 years). Using Gordon Model described below and by looking at Appendix I for more details, The value of the GSK share was £17.02 far bigger than the market value which was on 7th of May 2010 date of our valuation, only £11.485 in London Stock Exchange (LSE) which means that the company is under valuated in the market and it is time to buy shares instead of selling them. As investor, we recommend to buy as it was about 50% less than what it worth as a real value Vo ((17.02-11.485/11.485)*100= 48.19%).

2-Free Cash Flow to Firm (FCFF) _Appendix II

This is a measurement [2] of a company's profitability after all expenses and reinvestments. It's one of the many benchmarks used to compare and analyze financial wealth. A positive value would indicate that the firm has cash left after expenses.A A negative value, on the other hand, would indicate that the firm has not generated enough revenue to cover its costs and investment activities. In that instance, an investor should dig deeper to assess why this is happening - it could be a sign that the company may have some deeperA problems.

FCFF = Net Income + Depreciation + Interest (1 - Tax rate) - Inv (FC) - Inv(WC)

Or

FCFF = EBIT (1-Tax rate) + depreciation - Cap. Expend. - change in working capital - change in other assets

As of 2009, the firm generated a positive cash flow as £13361.6327 million compared to (£16538.07 in 2008 and £11203.47 in 2007) even if that period covered the crisis of 2008 which hit all the market regardless of the type of activities. The company was solvent which means that it was able to generate enough surpluses after respecting all engagements from its mean activity. Based on our growth rate (g=8.01%), we expect that the company will be able to generate £14431.90 million in 2010, which is a good motivation for potential investors.

3-Free Cash Flow to Equity (FCFE) _Appendix III

This [3] is a measure of how much cash can be paid to theA equity shareholders of theA company after all expenses, reinvestment and debt repayment Is the cash flow available to the firm's common equity holders after all operating expenses, interest and principal payments have been paid, and necessary investments in working and fixed capital have been made. FCFE is the cash flow from operations minus capital expenditures minus payments to (and plus receipts from) debt holders. FCFE = Net Income - Net Capital Expenditure - Change in Net Working Capital + New Debt - Debt Repayment

FCFEo

13,361.63

Kao(r)

11.88%

G

8.01%

Equity Value

372,889.49

nb moyen d'actions

5,196.15

Vo

£71.76

Po

£1,148.50 the market value on 7th of May 2010 in FTSE100

4-Residual Income approach (RI) _Appendix IV

Bo is the current book value of equity, Bt is the book value of equity at time t, RIt is the residual income in future periods, r is the required rate of return on equity, Et = net income during period t, RIt = Et - rBt-1. After calculation (Appendix IV)

= £16.47

Po= £1.148,5 on 7th, May 2010 FTSE100

5-Economic Value Added (EVA) _Appendix V

Economic Value Added [4] , a measure of the superiority of the return a company is able to realize on invested capital above the baseline return expected by the investment community. The formula is EVA A  = A  NOPAT - (C x Kc ) Where C is the amount of capital a company plans to invest in a project, and Kc is the cost of capital, i.e. the return rate expected by investors. Positive EVA means the project will add value for shareholders; negative EVA means they would be better off if management just gave them the money as a dividend. EVA is analogous to earnings; but where earnings expenses debt financing only, the CA xA Kc term in EVA is expensing the cost of all capital, equity as well as debt Our company is generating a positive value of EVA, which means there is a creation of an add value for shareholders and will be more interesting to buy instead of selling shares. AŽA² = 0.5057143643 AŽA² adjusted=1/3 + 2/3 * AŽA² AŽA² adjusted= 0.670476243 Kao = Rf+ ( Rm- Rf ) * AŽA² adjust Kao = 11.88%

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