GLOBAL PHARMACEUTICALS: CAUTIOUS OUTLOOK, VALUATIONS TO STAY DEPRESSED; FIVE 57

POTENTIAL WINNERS

Valuation Framework for

the Pharmaceutical Industry
In our view, historical data looking at things like relative price performance in the
drug sector may be of only limited value, because, at most prior points in time, the
drug industry hasn't faced the number of challenges it now does. The next five
years could be unlike any prior point in the history of the drug group, but
quantifying these is difficult. For example, will the U.S. government directly
interfere with drug pricing? If so, when, and to what magnitude?
That said, the following exhibits capture the past performance of the drug
group using typical metrics such as relative P/E multiples, P/E-to-growth rates, EV-
to-EBITDA multiples, and normalized price performance. The valuation metric
used most often by the investment community to assess fair value of
pharmaceutical stocks appears to be relative P/E ratios (in the United States, most
often relative to the S&P 500 Index) and, at present, the drug industry is trading at
a 20% discount to the index using 2008 EPS estimates, and at a 23% discount to the
index using 2009 EPS estimates, but there is wide variance between individual
names that make interpreting the average problematic.
Absolute P/E ratios for the drug industry and the S&P 500 are shown in
Exhibits 44 and 45. The average forward P/E ratio spanning 1988-2007 is around
19.4x.

Exhibit 44 U.S. Pharmaceutical Companies: 20-Year

Historical Absolute P/E Ratios (1988-Present)

45x
40x P/E as of 7/31/2008:
Pharma: 12.1x 20-year average P/E
35x S&P 500: 19.8x
S&P 500: 14.1x
30x
25x
20x
15x
10x 20-year average P/E
US drug group: 19.1x
5x
0x
1/29/1988
11/30/1988
9/29/1989
7/31/1990
5/31/1991
3/31/1992
1/29/1993
11/30/1993
9/30/1994
7/31/1995
5/31/1996
3/31/1997

1/30/1998
11/30/1998
9/30/1999
7/31/2000
5/31/2001
3/28/2002

1/31/2003
11/28/2003
9/30/2004
7/29/2005
5/31/2006
03/31/07

01/31/08

S&P 500 U.S. Pharma Average

Historical U.S. Pharma Average (20-year) Historical S&P 500 Average (20-year)

Note: Excludes SGP from 2001 to 2007.

Source: FactSet and Bernstein analysis.

58 GLOBAL PHARMACEUTICALS: CAUTIOUS OUTLOOK, VALUATIONS TO STAY DEPRESSED; FIVE
POTENTIAL WINNERS

Exhibit 45 U.S. and EU Pharmaceutical Companies:

Five-Year Historical Absolute P/E Ratios (2002 – Present)

40x P/E as of 07/31/08

Pharma: 12.7x
35x S&P 500: 15.0x
Five-year average P/E of
30x
S&P 500: 20.3x
25x

20x

15x 5-year average P/E of

U.S./EU Pharma: 16.8x
10x
1/31/2002

7/31/2002

1/31/2003

7/31/2003

1/30/2004

7/30/2004

1/31/2005

7/29/2005

1/31/2006

7/31/2006

1/31/2007

07/31/07

01/31/08

07/31/08
S&P 500 Global Pharma Average
Historical Global Pharma Average (5-year) Historical S&P 500 Average (5-year)

Note: Excludes SGP from 2001 to 2007.

Source: FactSet and Bernstein analysis.

Historical drug industry forward P/E multiples, relative to the S&P 500, are
shown in Exhibits 46 and 47. Note the 30% discount in the 1993 timeframe
("Hillary Care"), followed by a five-year ascent to a 40% premium (no "Hillary
Care," and a pipeline that was brimming with new products), followed by a return
to an in-line multiple from 2001 onward. In 2006, the drug industry relative P/E
rose at a slight premium because of the Medicare Part D benefit that led to many
earnings upside surprises across the group that year. At present, the drug group is
trading at a slight discount (minus 7%) to the S&P 500.

Exhibit 46 U.S. Pharmaceutical Companies: 20-Year Historical

P/E Premium to S&P 500 Index (1988-Present)

80%
60%
1988-2008 Average = -3.5% Discount as of
40%
06/30/08: -14.6%
20%
0%
-20%
-40%
1/29/1988

9/29/1989
7/31/1990
5/31/1991
3/31/1992
1/29/1993

9/30/1994
7/31/1995
5/31/1996
3/31/1997
1/30/1998

9/30/1999
7/31/2000
5/31/2001
3/28/2002
1/31/2003

9/30/2004
7/29/2005
5/31/2006
11/30/1988

11/30/1993

11/30/1998

11/28/2003

03/31/07
01/31/08

Price to Est Forward Year Earnings Premium Historical Average Premium (1988-2008)

Note: Excludes SGP until 2007.

Source: FactSet and Bernstein analysis.
 GLOBAL PHARMACEUTICALS: CAUTIOUS OUTLOOK, VALUATIONS TO STAY DEPRESSED; FIVE 59
POTENTIAL WINNERS

Exhibit 47 U.S. and EU Pharmaceutical Companies: Five-Year

Historical P/E Premium to S&P 500 Index (2002-07)

20%
15%
10% 2002-08 Average: 1.4%
5% Discount as of 6/30/08: -10.3%
0%
-5%
-10%
-15%
-20%
-25%
-30%
-35%
-40%
-45%
-50%
1/31/2002

6/28/2002

11/29/2002

4/30/2003

9/30/2003

2/27/2004

7/30/2004

8/31/2006

1/31/2007

39263

39416

39568
12/31/2004

5/31/2005

10/31/2005

3/31/2006
Price to Est Forward Year Earnings Premium Historical Average Premium (2002-07)

Note: Excludes SGP until 2007.

Source: FactSet and Bernstein analysis.

Normalized price performance of the drug industry, relative to both the S&P
500 and the Dow Jones Industrial Average, is shown in Exhibits 48 and 49.

Exhibit 48 U.S. and EU Pharmaceutical Companies:

15-Year Historical Performance (1992 – Present)
2008/2007 2Q/1Q
Pharma -12% 1%
S&P 500 -15% -3%
DJII -15% -3%
As of: 7/14/2008

Pharma

450
DRG
Normalized Value

350

250

150 DJII
S&P 500

50
12/1/1992
6/1/1993
12/1/1993
6/1/1994
12/1/1994
6/1/1995
12/1/1995
6/1/1996
12/1/1996
6/1/1997
12/1/1997
6/1/1998
12/1/1998
6/1/1999
12/1/1999
6/1/2000
12/1/2000
6/1/2001
12/1/2001
6/1/2002
12/1/2002
6/1/2003
12/1/2003
6/1/2004
12/1/2004
6/1/2005
12/1/2005
6/1/2006
12/1/2006
6/1/2007
12/1/2007
6/1/2008

Source: FactSet and Bernstein analysis.

60 GLOBAL PHARMACEUTICALS: CAUTIOUS OUTLOOK, VALUATIONS TO STAY DEPRESSED; FIVE
POTENTIAL WINNERS

Exhibit 49 U.S. and EU Pharmaceutical Companies:

Five-Year Historical Performance (2002 – Present)

2008/2007 2Q/1Q
Pharma -12% 1%
S&P 500 -15% -3%
500 DJII -15% -3%
As of: 7/14/2008

Pharma
400
Normalized Value

DRG

300

200
DJII S&P 500

100
1/31/2002
4/30/2002
7/31/2002
10/31/2002
1/31/2003
4/30/2003
7/31/2003
10/31/2003
1/31/2004
4/30/2004
7/30/2004
10/31/2004
1/31/2005
4/30/2005
7/29/2005
10/31/2005
1/31/2006
4/30/2006
7/31/2006
10/31/2006
1/30/2007
4/30/2007
7/31/2007
10/31/2007
1/31/2008
4/30/2008
Source: FactSet and Bernstein analysis.

P/E-to-growth ratios, for both the drug industry and the S&P 500, are shown in
Exhibits 50 and 51. The four-year average ratio for the U.S. and EU pharmaceutical
companies is 1.65, versus 1.11 for the S&P 500.

Exhibit 50 U.S. Pharmaceutical Companies: P/E-to-Growth Ratio (1991 – Present)

6.0x

5.0x

4.0x 20-year average PEG

US drug group: 1.85x
3.0x

2.0x

1.0x 20-year average PEG

S&P 500: 1.71x
0.0x
1/1/1991
7/1/1991
1/1/1992
7/1/1992
1/1/1993
7/1/1993
1/1/1994
7/1/1994
1/1/1995
7/1/1995
1/1/1996
7/1/1996
1/1/1997
7/1/1997
1/1/1998
7/1/1998
1/1/1999
7/1/1999
1/1/2000
7/1/2000
1/1/2001
7/1/2001
1/1/2002
7/1/2002
1/1/2003
7/1/2003
1/1/2004
7/1/2004
1/1/2005
7/1/2005
1/1/2006
7/1/2006
1/1/2007
7/1/2007
1/1/2008

Source: FactSet and Bernstein analysis.

 GLOBAL PHARMACEUTICALS: CAUTIOUS OUTLOOK, VALUATIONS TO STAY DEPRESSED; FIVE 61
POTENTIAL WINNERS

Exhibit 51 U.S. and EU Pharmaceutical Companies:

Five-Year Historical P/E-to-Growth Ratio (2003 – Present)

4.0x

3.5x 5y average PEG

S&P500 - 2.3x
3.0x

2.5x

2.0x

1.5x
5y average PEG
1.0x
drug group - 2.0x
0.5x

0.0x
7/31/2003
9/30/2003
11/28/2003
1/30/2004
3/31/2004
5/28/2004
7/30/2004
9/30/2004
11/30/2004
1/31/2005
3/31/2005
5/31/2005
7/29/2005
9/30/2005
11/30/2005
1/31/2006
3/31/2006
5/31/2006
7/31/2006
9/29/2006
11/30/2006
1/31/2007
3/31/2007
5/31/2007
7/31/2007
9/30/2007
11/30/2007
1/31/2008
3/31/2008
5/31/2008
Covered Companies S&P 500 Historical 5y S&P 500 average Historical Global 5y average

Source: FactSet and Bernstein analysis.

Valuation Metrics We Use — In the context of what we think is a challenging outlook for the drug industry, there
Relative Valuation Using are certain names that we think will still be capable of broad market
P/E Multiples outperformance. Generally, investors will be best-suited by owning those names
whose R&D prospects are brightest, but this has to be balanced against each
company's base business and what in-line drugs are slated to face generic
competition over the next five years. Exhibit 52 is a scatter plot that shows where
our 10 covered companies fall along these metrics.
62 GLOBAL PHARMACEUTICALS: CAUTIOUS OUTLOOK, VALUATIONS TO STAY DEPRESSED; FIVE
POTENTIAL WINNERS

Exhibit 52 Drugs Going Generic vs. Potential Pipeline Contribution

High
GOAL: Who will will
maintain
maintainlead,lead,who
who will
lose
will it,
loseandit,who
andwill
who
move next in
will move thisin this
next
Generic Exposure Over Five Years (pct. of total

direction
direction
PFE AZN LLY

SNY
MRK
BMY

GSK

WYE The Ideal

The Ideal
NVS
)

Position
Position

SGP
Low

Low Ability of Late-Stage Pipeline to "Move the Needle" and Confidence in the Pipeline High
Represents outperform-rated stocks.

Source: Bernstein estimates and analysis.

In determining which of our 10 covered companies will outperform,

underperform or perform in line with the market, we rely on four main criteria: (i)
R&D abilities, competence and opportunity; (ii) generic exposure, both scheduled
and at risk from patent challenges; (iii) management's history and how consistent it
has (or has not) been; and (iv) growth over the intermediate term, which we define
as two years, a period where we believe we can more reliably assess various
structural elements affecting financial performance.
We then apply these criteria to our valuation framework, which primarily centers
around relative forward price/earnings (P/E) multiples. Exhibit 53 lays the framework
for the target P/E multiples we assign to our 10 U.S. and European names.

Exhibit 53 Framework for the Target P/E Multiples

Adjustment Criteria
'09 Current P/E '09 Target P/E R&D Generic Management Intermediate-Term Total
Multiple Multiple Qual/Opp Exposure "Delivers" Growth Adjustment
SGP 13.1 15.0 3 3 2 3 11
NVS 14.2 14.0 1 2 0 2 5
WYE 13.0 14.0 2 2 (2) 0 2
BMY 10.7 13.0 2 (2) (1) 3 2
MRK 10.0 12.5 2 (2) 3 (1) 2
LLY 11.3 12.0 1 (3) 1 2 1
GSK 11.8 11.5 (1) (1) (1) 0 (3)
SNY 7.3 9.0 (2) (2) (3) (1) (8)
AZN 8.8 9.0 (3) (3) (2) 0 (8)
PFE 7.2 9.0 (3) (3) (1) (2) (9)
Avg. 10.7 11.9
Scale: 3 is Far Above Average; 0 is Average; (3) is Far Below Average
R&D: "Core" abilities, faith in abilities (history), confidence in late-stage opportunities, size of late-stage opportunities
Generic: Imminent generic threats, uncertain patent challenges, size and timing of major expiries
Management: Consistent, handles investor expectations well, prior "bad actors"?, do they "get it"?
Growth: 2yr EPS growth ('09/'07), quality of growth (rev driven, exp driven, share repurchase driven), bias to upside/downside
TOTAL ADJUSTMENT SCORE: The degree to which we raise or lower the forward P/E relative to the starting average P/E multiple
* 2009 Target P/E Multiple

Source: Bernstein estimates and analysis.

GLOBAL PHARMACEUTICALS: CAUTIOUS OUTLOOK, VALUATIONS TO STAY DEPRESSED; FIVE 63
POTENTIAL WINNERS

Applying these target multiples to our 2009 EPS estimates shows us that there
are four names capable of outperformance: Schering-Plough, Novartis, Wyeth and
Merck. Our valuation framework says the remaining six names are likely to
perform in-line. As challenging as the fundamentals are on a few of these names,
their valuations are already low enough such that we think their likelihood of
underperformance is low.