Qualiport

Is the Irish drug company Qualiport bound?

After much deliberation and discussion, we have decided to discard Elan Corporation from Qualiport contention. For those who read Dave's article on Friday, this will come as no real surprise. Before I go any further, I'd just like to make it clear that this decision is not based on anything I've found wrong with the company, and in fact I haven't really looked closely at their numbers. As stated in the Elan 1997 annual report, the past 9 years has seen the company produce some exceptional sales and earnings growth, and the new financial year has begun in a similar vein. Elan have been particularly corporately active in the last few months, swallowing Sano Corporation in December last year and Carnick Laboratories in April, to be quickly followed by last week's acquisition of Neurex Corp. This fits in with their objective to increase sales to US$1 billion by 2001. So, why are they being dumped at this stage?

Buy what you know. Many of the great investors of our time have coined this phrase. Peter Lynch is an advocate of walking down your local high street and looking to see which products and shops are doing well. You can feel, touch and see what you are buying. Is your local Dixons store always busy? Are the Psions selling well, or has the Palm Pilot taken some sales from them? Ask the sales staff. With Elan, I personally found it difficult to get to know the company. I've had no dealings with them and thankfully no need to use their drugs. Luckily for us -- and this is a rare privilege -- we've got a doctor in Team Fool UK, and Dave was able to pass on his expert knowledge of some of their products and the competition that exists.

As some of you may have spotted, I was floundering with Elan last Wednesday. It was then that it dawned on me that I was getting out of my depth. It is all very well to read up about a company and get a feel for what they do, but if you can't actually put your finger on their products it is very difficult to make an objective decision about them. Then Dave stepped in to help me out. Elan was a company I decided to have a look at, and Dave knew nothing of them until I suggested we have a look. Elan's drugs currently available on the market did not hugely inspire him, although he did admit this was only one doctor's perspective.

Elan is obviously a company undergoing a huge amount of change. The three recent acquisitions have and will require a huge amount of management effort to integrate the new Elan into a lean, cohesive and creative unit. This will also require a huge amount of cash to be spent on restructuring. This is one thing that I would have had a closer look at if I'd got as far as looking at Elan's numbers. It is all very well to have an exceptional charge for restructuring in your accounts, and for analysts to ignore it when calculating the all-important earnings per share (EPS) figure, but if this is happening most years, it could be argued that it is an expense the company normally incurs in the course of running its business and not an exceptional item. Having said that, Elan appear to be a well managed company, given the consistent growth and success they've had over the past 9 years.

The recent acquisitions make it difficult to establish where the company is right now. How do you judge whether US$700m is the right price to pay for Neurex? It has a promising drug in the pipeline in Ziconotide, the pain reliever for chronic malignant pain, but how much is that worth and what about the competition?

Finally, there are more to pharmaceutical companies than discovering and then producing the drugs. The company has to go and sell them to hospitals, doctors, and distributors. Because of intense competition, this is often easier said than done. Without talking to any of the Elan sales people, it is impossible to gauge their competence or otherwise. Thinking back to the main reason why I'm rejecting Elan, it's another case of the "buy what you know" tenet, or the "avoid what you don't understand" doctrine.

This is not to say that we won't again consider a pharmaceutical company for the Qualiport. Quite the contrary in fact, as I'm sure Dave would love to have one in our model portfolio. We are in the unique position of having Dave to look at the company and its products, and myself to look at the numbers and valuation. At some stage in the future we'll be coming back to compare and contrast the three big UK drug companies -- Glaxo Wellcome, SmithKline Beecham and Zeneca -- to see if any of them make the grade.

Here are just a few personal notes about established drug companies. Dave and others may disagree, but hey, we're allowed to have different opinions even if we are both Fools. Pharmaceutical companies are often valued more on what drugs they've got in the pipeline than their existing products. This, to me, makes them inherently risky investments. The really blockbuster drug, like Zantac and potentially Viagra, comes along once every 10 years. In the meantime, billions of pounds are being spent worldwide on research and development in the hope that one day a company will come up with a miracle cure for Alzheimer's disease, AIDS or heart disease. The fact that no company has cracked those diseases suggests to me that we may never have a simple cure for them.

Is it a worthwhile strategy to invest in a large pharmaceutical company after they've discovered a blockbusting drug? Granted, you'll have to pay more for the privilege, but it would take much of the risk out of your investment. Warren Buffett said "It is better to be certain of a good result than hopeful of a great one." If Elan, or anyone else, suddenly discovered a proven cure to Alzheimer's disease, despite the inevitable instant hike in the share price, it probably wouldn't be too late to share in the success of the dug and the company. We can all debate this on the Qualiport message board.

So it's goodbye to Elan. We won't be upset if they continue to be a successful company, and in fact hope they are. The world would be thrilled and be in eternal debt to Elan if they came up with the elusive cure to Alzheimer's. We sincerely hope they can crack it. As usual, I've learnt a few lessons from the Elan experience, and hope you have too.

The Next Step

On Friday, I want to have another look at Marks & Spencer. Veteran Fools will remember that back in January we decided that the retailer was a well managed company and a worthy Qualiport entrant. However, we baulked at the then share price of 600p, arguing that there was not enough margin of error in their valuation. Since then, the share price has dropped back by 5% to around 570p and the market has risen by about 15%. I want to look to see if they represent any value now, and at what price we would buy them, assuming nothing about the company has changed. Another attraction of Marks & Spencer is that they could effectively act as an index tracking share for the portfolio. Although they've underperformed the Footsie by a long way in this calendar year, in the past they've at least matched the 12% historical returns of the stock market. Before Friday, if you've got any comments to make about this idea, feel free to share them on the Qualiport message board.

Bruce Jackson (TMF Googly)

Qualiport Numbers

Today's Numbers                   Date            06/05/98


          Change     Bid
          pence       £

RTO       -0.04      3.79
EMAP       0.01     11.92


Rec'd        #     Stock      Buy      Now    % Change   £ Change

19/12/97   1565  Rentokil     2.55     3.79     48.6%       1.24 
17/04/98    337  EMAP     11.85    11.92   0.6%       0.07 


19/12/97   1565 Rentokil  4,040.63  5,931.35 46.8% 1,890.72 
17/04/98    337 EMAP   4,043.37  4,017.04   -0.7%      -26.33 


Total                                9,948.39 



                Day    Month    Year    History

Qualiport      -0.6%   -1.4%    43.6%    46.9%
FTSE 100        0.1%    1.1%    16.7%    19.4%
FTSE All Share  0.2%    1.2%    17.1%    19.5%