2 for Tuesday: Buying the Pharmacia

Since the beginning of 1999, the pharmaceutical index has performed admirably. It's up 7% -- that's not fabulous by any means, but it's a heck of a lot better than the S&P 500, which is down 6.5% over the past three years.

One drug stock, however, has lagged behind the general trend: Pharmacia(PHA). It's down 3% since Jan. 1, 1999, which is still better than the S&P 500, but disappointing compared with Pharmacia's rivals.

But the tide may finally be turning for Pharmacia. The company has no patent expiration risk through 2006, unlike many of its peers, and has a strong new-product pipeline. Pharmacia is also on the verge of becoming purely a drug company again, as it prepares to spin off the controversial agricultural business it inherited after its merger with Monsanto(MON) in early 2000. Finally, the stock is relatively cheap, particularly when you consider that its earnings growth rate could be at least 15% over the next three years; that is well above the drug sector average growth rate of about 12%.

Pharmacia's product lineup probably doesn't include another home run (like its $3 billion arthritis and pain agent Celebrex, which came with its Monsanto merger), but the company does have a number of solid doubles and triples waiting patiently in the dugout. For example, Pharmacia's very strong oncology portfolio should exceed $1 billion in sales this year. Its leading drug, Camptosar, is used mainly for colorectal cancer, but the company is optimistic about its other potential applications; pancreatic cancer is one possible indication. Camptosar prescriptions are growing at a high-teens rate, and expectations for future sales will likely be exceeded.

Xalatan, at $800 million in sales per year, is the leading treatment globally for glaucoma. Xalatan is also growing at a high-teens rate and has the potential to reach $1 billion in sales. Detrol, the leading treatment for overactive bladder, is growing well into the double digits and has already passed the $500 million sales mark this year, driven by a new once-a-day version of the drug.

The Stock Pharmacia (PHA:NYSE)
Recent Stock Price:	$44.40
52-Week Range:	$36.50-$61.00
P/E Ratio:	35.35
Market Capitalization:	$57.2 billion
Float:	1.28 billion shares
Short Interest Ratio:	2.28
Institutional Ownership:	72%
Source: Yahoo! Finance

Many of Pharmacia's potential new products could add up to billions in sales a few years out. The company is on the verge of introducing two promising anti-inflammation agents in the same Cox-2 inhibitor class as Celebrex and Merck's (MRK) Vioxx. Pharmacia will be "first to market" with a second-generation Cox-2 class of drugs, giving it a competitive advantage over Merck.

The first of these drugs, valdecoxib (Bextra), received a surprising early approval from the Food and Drug Administration just last week. The announcement caused the stock to jump 9% in one day (it has now given back about 3% of that gain). Some analysts expect Bextra to add $450 million in revenue in 2002, and to reach $750 million to $1 billion at its peak. Another second-generation Cox-2 agent is parecoxib (Dynastat) -- an injectable drug that will be used mainly in hospital settings. Dynastat has been approved in Europe and could be launched in the U.S. in 2003 and reach sales of $500 million to $750 million at its peak. Last, there is eplerenone. Pharmacia will file for FDA approval for the use of eplerenone for hypertension by the first quarter of next year and then for congestive heart failure in 2003. Eplerenone could be a $500 million product by 2006.

Just Say No to (Anything but) Drugs

Investors have penalized Pharmacia's valuation because of the sizable and fairly controversial agricultural business (including genetically modified seeds and chemical herbicides) it picked up as a result of the Monsanto merger; roughly $6 in Pharmacia's current share price is driven by Monsanto's nondrug business. Not for long, though. In the fourth quarter of 2000, Pharmacia did an IPO of 15% of its ownership of Monsanto.

The Stats
Year	Revenue	EPS
1999	$16.32 billion	$1.11
2000	18.15	1.45
2001*	19.23	1.74
2002*	20.12	1.92
*Thomson Financial/First Call estimates. Source: Company reports

At a Nov. 28 analyst meeting, management confirmed that it would spin off the remaining 85% ownership of Monsanto to Pharmacia shareholders in the form of a tax-free dividend during the second half of 2002. This separation, combined with Pharmacia's strong product lineup, should help the overall valuation of the company's shares.

Pharmacia's strategic outlook after it spins off Monsanto also intrigues me. Lately, the pharmaceutical industry has embraced the notion that bigger is better; the Pfizer(PFE)-Warner-Lambert deal is a case in point. Pharmacia may make a good partner for another company that's looking to beef up its research and development muscle and its product pipeline. Pharmacia's CEO Fred Hassan hails from American Home Products(AHP). Could there be a deal with AHP in Pharmacia's future? Alternately, Pfizer may be interested because it shares co-marketing rights with Pharmacia on Celebrex. Either way, after Monsanto is cut loose, Pharmacia becomes a much more attractive target.

Finally, you can't ignore that this stock is a good deal at $44. The company's growth rate of 15% is one of the highest in the group, yet it trades right in line with the drug company average price-to-earnings ratio and is cheaper than companies with slower growth rates. On 2002 earnings per share of $1.92 (including Monsanto, which will be reported as discontinued operations), Pharmacia is trading at a P/E ratio of 23, a big discount to Pfizer's P/E of 27.4 and Lilly's (LLY) P/E of 30. Yet Lilly is growing just 12%. I don't think that disparity is going to last much longer.

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