The Next Cash-King
by Tom Gardner
Alexandria, VA (July 29, 1998) -- In just about a week, we'll be adding $2,000 of new savings to our account, leaving us with $2,095 in cash. The moment the money lands, we'll be 9% in cash, and there's nothing wrong with that. The public markets are ever sending another pitch over the plate -- there's no rush to swing. There's always another train coming down the tracks -- no reason to risk a jump through closing doors.
But when that money lands, if we can be prepared to invest it in a company that we believe in, all the better. The Cash-King Portfolio is up 4 percent on the S&P 500. But we'd be sporting a much larger lead on the market if we'd gotten fully invested back on January 1 -- our initial aim! That's just the way life goes. If success depends on excellent timing, we're doomed. We've instead chosen to bank our future on making good decisions, without much regard for the timing of them.
So, if we can't find a business to fall in love with for a decade before August 3rd, we'll play the waiting game. I happen to think we should be able to find a great business pretty quickly, though. With your help. The last company we bought came from your suggestions and your vote. We added Cisco to the portfolio on June 23. In just over a month, it's up 11 percent versus S&P 500 gains of 1 percent. And we have very positive feelings about the industry, the business, and Cisco's management going forward. Thanks, Fools.
We're now coming to you again for assistance, but this time we're going to play a little differently. Rob and Al and Phil and I have decided that we want to add another pharmaceuticals company to the portfolio. The baby boomers are heading toward retirement. The worldwide demand for treatments is on the rise. The Food and Drug Administration (FDA) is improving the process for drug approval. And the economics of the pharmaceuticals industry are extremely attractive to us.
There are some negatives to the business. Let's think about them, first. Drugmaking requires a substantial up-front investment in research. Pfizer will spend well more than $2 billion on research and development over the next 12 months. And there's risk tied to that investment, because not every concoction makes it through FDA trials. Pfizer's antipsychotic drug, Zeldox, got a non-approval letter in June from the FDA, demanding more evidence in support of the efficacy and safeness of the drug.
And then finally, even when a medicinal makes it through the trials and reaches the market, a pharmaceuticals company is exposed to liability. Consider Pfizer. The FDA has confirmed that 39 men now have died while taking Pfizer's impotence drug, Viagra. Drug companies can never be 100 percent certain that they've listed warnings for the full suite of side effects. Therein lies my best guess as to why Warren Buffett has never made any major purchases among the drugmakers. Liability. It's much safer to bet on the public's craving for sugar and serotonin as seen through their repeat-purchasing of chocolate bars than to bet on the safety of medical treatments.
Take a look at the list of lawsuits headed Pfizer's way:
July 17 - Pfizer Inc. confirmed that a lawsuit has been filed by Diegro Padro, a New York man who claims he suffered a heart attack as a result of using Viagra. Padro is suing for $85 million in damages.
July 20 - Pfizer Inc. was sued today by three men in three separate lawsuits for a combined $255 million. The men claim they suffered heart attacks after using the company's impotence drug, Viagra.
July 29 - Pfizer Inc. confirmed that it is being sued by a New Jersey man, Joseph Moran, who claims that the anti-impotence drug Viagra made him see blue flashes from his fingertips, causing him to crash his car. Moran, a used-car salesman, is suing the drug maker Pfizer Inc. for $110 million.
Those lawsuits total $450 million, surpassing the $411 million in sales of Viagra during its first three months on the market. And if you're a Pfizer shareholder, that might set your own heart to erratic thumping, generating hot flashes, and turning your stomach over twice. That is, until you noticed that the five separate suits have all been filed through the same New York City lawyer, Ronald Benjamin. Pfizer has responded: "These cases appear to be more in the nature of lawyers' advertising than good-faith litigation."
Well said. But, we do have to note that liability is a risk with pharmaceuticals.
Now what about the upside of drugmaking, though?
It's been reported that Pfizer has sold more than 3 million prescriptions for their $10-a-pill impotence drug -- which amounted to less than 15 percent of the company's sales last quarter. Viagra had $411 million in sales in its first three months on the market, making it the hottest-selling new drug ever. And only $2 million of Viagra sales came from foreign markets. The low cost of mass producing and distributing the drug makes it an extremely attractive offering for Pfizer. The same holds true for Pfizer's other blockbuster drugs -- Norvasc and Zoloft.
That's the general model of a healthy pharmaceuticals business -- 1) heavy up-front investment, 2) risk through the FDA trials, 3) exposure to liability, but then 3) inexpensive mass production of a repeat-purchase product. A bottle of tiny pills costs a lot less to make and transport around the world than a box of books or refrigerated beef or a ship of automobiles. And that's why Pfizer has gross margins of 84%, net margins of 21%, and $1.8 billion in cash (against $729 million in long-term debt).
With the population aging, with the standard of living on the rise, with the drug approval process getting more efficient, and with economics of the industry translating into the repeat purchasing of high-margin solutions, we don't think dropping a second pharmaceuticals company into the Cash-King Portfolio engenders much risk.
And so, Fools, we're coming to you for help in the research.
We are requesting your thoughts on pharmaceuticals companies ranging from Abbott Labs, Bristol Myers, Eli Lilly, Johnson & Johnson, Merck and Schering Plough to Warner Lambert and others in our Cash-King Companies folder on the Web. Which should we buy? Please share your thoughts there. Then we'll also be looking for guidance from the valuation squad developing in the Buffetology folder. Given our proposed holding period of at least a decade, valuation will be tertiary to quality and value. But we'll be very interested to see what the Foolish gang there turns up for us.
The last time we opened up the floor for opinions, discussion, and nominations, we turned up one of the greatest companies in America -- Cisco Systems. (And they said Fools and their money were soon parted!) This time we come to you for assistance in our search for a second drug company to add to the King's account. Because we won't be holding a vote this time, your attendance in and contribution to the Cash-King Companies folder is in great demand.
See you there, Fool on!
Tom Gardner, Fool
Erratum: Yesterday, I prattled on about our Foolish Four holdings, mistakenly citing a purchase date of February 12th. We bought those four companies on March 12th.
Day Month Year History C-K -0.95% 1.68% 15.97% 15.97% S&P: -0.44% -0.76% 12.38% 12.38% NASDAQ: -0.