Equity Research

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Gilead’s Quad Regimen Poised to Lead HIV Market, with over $3

Billion in Sales Forecasts as of 01 Feb 2012

Sector: Health Care | Industry: Biotechnology

Anant Vijay Analyst avijay@uwo.ca (519) 860 – 4974 Research as of 01 Feb 2012 Estimates as of 01 Feb 2012 Pricing data as of 01 Feb 2012

Profile: Gilead Sciences, Inc., established in 1987, is a biopharmaceutical company that discovers, develops and commercializes innovative therapeutics in areas of unmet medical need. Their mission is to advance the care of patients suffering from life threatening diseases worldwide. With headquarters in Foster City, California, they have operations in North America, Europe and Asia Pacific. They have focused their efforts on bringing novel therapeutics for the treatment of life threatening diseases to market. They continue to seek to add to their existing portfolio of products through their internal discovery and clinical development programs and through a product acquisition and in-licensing strategy.

Analyst Commentary | 01 February 2012 High barriers to entry have made Gilead a leading player in

the biopharmaceutical marketplace, producing operating

margins which currently exceed 50%. With Gilead’s HIV

therapies accounting for 36.6% of the global HIV market,

the company is forecasted to maintain its number one

position until 2020. By 2015, Gilead’s seven products are

poised to encompass 50.3% of the entire HIV market and

grow at a six-year CAGR of 4.6%. The company currently

has a strategic focus on antiretroviral HIV therapies that

has allowed it to lead the market dominated by larger

pharmaceutical companies the likes of: GlaxoSmithKline

(GSK), Johnson & Johnson (JNJ), Myers Squibb (BMS), et

al. The HIV franchise is currently providing Gilead with a

projected combined sales growth of $4.7 billion over a six-

year period. However, Atripla (currently Gilead’s leading

HIV treatment) is expected to decline after 2012 amid

increasing competition and an expanding trend towards

personalized treatment. We believe that the risk

associated with Atripla will be offset by Complera (the

second one-pill program for HIV treatment after Atripla)

and Quad due to its impressive safety and reliability

ratings. Both pills will be extremely instrumental in allowing

Gilead to maintain its dominance in the HIV therapy

marketplace.

Considerations For the past three months, the company has outperformed

the overall market with an average growth of +33.18%. In

addition to which, Gilead’s valuation ratios have been

trading at a hugely discounted rate, giving it considerable

upside potential. It is outpacing its industry’s benchmark

margins in profitability, operations and efficiency but has

been unable to trade at our target levels due to lack of

public information regarding its drug approval process.

GILEAD SCIENCES INC. (NASDAQ:GILD)

General

Fair Price: $89.68

Price: $47.00

Market Cap: $41.19 B

52-wk high: $54.90

52-wk low: $34.45

1-yr total return: 41.0%

5-yr Forward Revenue CAGR: 6.2%

5-yr Forward EPS CAGR: 8.8%

5-yr Expected PEG: 0.79

Forecasts ($ in millions, except share data) 2011 2012(E) 2013(E)

EBITDA 4,161 4,668 5,141

EBITDA y/y% -1.7 12.2 10.1

EBIT 3,856 4,339 4,844

EBIT y/y% -2.8 12.5 11.6

Sales 8,383 9,357 10,095

Net Income 2,833 3,136 3,627

ROA (%) 28.26 24.68 21.56

ROE (%) 47.44 46.17 47.68

P/E 10.9 13.01 12.35

Investment Thesis

+ Gilead is testing its ground in Hepatitis

C and mitigating its HIV franchise risk

by acquiring Arresto, Calistoga and

Pharmasset

+ Successful clinical trials have allowed

Gilead to consistently beat expectations

surrounding test results

+ Shares show extremely strong

resilience to negative news

+ Product sales are up 9% y/y with an

anticipated forecast of 40% free cash

flow to sales over the next 10 years,

given its current net profit margins

(TTM) of 33.65% and 5 Yr. Avg. of

28.57%, beating sector standards by 2x

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Complera and Quad both show promise and are forecasted to dominate the market with sales of $3 billion and $2 billion, respectively by 2020. Gilead is diversifying its product portfolio to include Hepatitis C treatments in an effort to mitigate HIV franchise risks.

Gilead’s Quad Regimen Poised to Lead HIV Market, with over $3 Billion in Sales 01 Feb 2012 Surrounding recent forecasts about the positioning of the

HIV marketplace in the years leading to 2020, we’ve

revised our valuation positively.

Gilead, in partnership with Janssen, has actively

introduced Complera to the market upon receiving FDA

approval in mid-2011. Large financial institutions have

projected the drug to bring in $537 million in sales alone,

during 2012. Complera addresses an essential gap, which

was made prominent, during the introduction of Atripla.

Atripla could not be used by women of childbearing age,

where the market for HIV flourishes. Complera has no

such restriction and is the second complete HIV therapy

(as a once-a-day pill) to penetrate the market. From a

bearish perspective, investors are still fixed on the Quad

pill to move Gilead’s share prices. Bears speculate that

consumers will continue to associate with Atripla, given its

similar pricing level and branding. Markets moved

positively in reaction to Complera’s approval due to its

improved safety profile over Atripla. We project the drug to

raise over $2 billion in sales by 2020 and become the

market leader, replacing its predecessor. In alternate

news, Gilead’s Quad regimen (the first integrase inhibitor-

based fixed-dose combination drug to take hold in the HIV

market) is expected to become the dominant player by

2020 with over $3 billion in sales. With the market for HIV

antiretrovirals forecasted to have a price of over $16 billion

by 2020, we’re certain that Complera and Quad will

become the key drivers of this growth.

Quad Pill The reason we most firmly believe that Gilead will become

the industry benchmark is due to the strong test results

surrounding its Quad pill. Gilead submitted the pill for FDA

approval in October 2011 and has already undergone two

late-stage trials, where it was consistently able to meet its

approval objectives. Johnson & Johnson (JNJ), currently

undergoing the FDA approval process as well, was

appointed disappointing results in comparison with Gilead.

J&J’s study revealed that 83% of the test patients had

undetectable viral levels, in stark contrast to Gilead’s most

recent two phase 3 trials producing results of 88% and

90% undetectable viral levels (level of HIV in the blood).

We speculate that the drug will receive

FDA approval on 27 August 2012 and is

positioned to take the market by storm

upon release.

Diversification In our opinion, Gilead has taken

exceptional measures to ensure its

continued industry-leading innovation

standards in its HIV division. Currently,

Truvada is Gilead’s flagship drug which

prevents uninfected individuals from

contracting HIV through sex. The drug

has substantial potential, given that

there are 50,000 people infected with

HIV every year in the US, with those

statistics reaching heights of over 33

million worldwide. Studies showed that

subjects, who took Gilead’s Truvada

consistently, reduced the risk of HIV by

73%. We are expecting that the

approval of the drug will result in

hundreds of millions of dollars in

additional revenues added to the

company’s sheets. Similar to Quad,

because the information is widely

unavailable about the drug’s testing

process, the market is unable to price

Truvada’s information in at this point –

resulting in Gilead’s current trading

price. In addition to Gilead’s HIV line,

acquiring Pharmasset has given the

firm an edge above the Hepatitis C

curve. The new drug candidate GS-

7977 showed excellent potential and

was enough to get many companies

interested in acquiring Pharmasset. The

drug is to be filed for FDA approval in

2014, where it will enter the market and

compete with Vertex.

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Gilead Up 6% After Hepatitis-C Trial Results 03 Feb

2012

Upon missing earnings yesterday, Gilead’s share prices

were up close to 11% today. The stock opened to news of

the new results surrounding its research on the anti-

hepatitis C treatment. The study consisted of 35 infected

patients – 25 of which had no prior treatment, and 10 of

which who had not responded to earlier therapy. The

product being tested was the experimental pill GS-7977

and ribavirin. The rights to GS-7977 were acquired with

the $11 billion Pharmasset transaction. The results of the

study showed that all of the genotype-1 Hep-C patients

were virus-free after the four week treatment. Although

patients aren’t considered cured until 12 weeks after

treatment, the tests showed considerable promise.

Similarly, Bristol Myers Squibb Co. (BMY) had been

attempting to develop a comparable all-oral treatment drug

after acquiring Ibhibitex, but has been unsuccessful thus

far. As expected, shares for BMY were down 0.37%. The

other major players in the Hep-C field: Idenix

Pharmaceuticals, Inc. (IDIX) and Achillion

Pharmaceuticals (ACHN) were down close to 11% and

5%, as well. Attempting to develop similar drugs, their test

results were unfavourable and Gilead was able to retain its

defensible and growing position. We believe that Gilead

still has space to grow in the industry. Already leading in

the HIV division, it is beginning to pioneer in the Hep-C

field as well, expanding its product focus. Street forecasts

were utterly trumped during the quarterly call but

management warned of lower revenue growth during

FY12 due to heavy expenditure in research and

development.

Risks & Catalysts

What we like: Gilead has long-term plans to release drugs

which strengthen the focus of its HIV and Hep-C sectors.

Given this, we realize how important it is for a

pharmaceutical company to release positive test results

and be the first to market. Because Gilead has taken

extraordinary steps in ensuring its leading position, we

expect it to grow at an average of 14.5% over the next 5

year period. This estimate is in part of its competitors’

inability to innovate drugs as rapidly as Gilead has through

acquisitions. Even though Gilead reported earnings per

share of $0.92, missing street estimates of

$1.05, it showed strong resilience in 4Q11

sales of $2.2 billion versus consensus

estimates of $2.18 billion. The share price

rallied 5% during after-hours trading due to

investor confidence. Full year revenues

experienced a 10% growth over FY10, with

non-GAAP net income up $3.55 per diluted

share from $3.32 a year earlier. Product

sales were up 11% in 4Q11 and were

driven predominantly by the company’s

antiviral portfolio. Atripla and Truvada both

saw growth of 8% and 11% y/y,

respectively. Complera, despite being

introduced in August 2011, managed to

bring in sales of $38.7 million during that

time. Letairis grew 22% y/y and Ranexa

realized an even greater growth at 33% for

the same period. However, R&D expenses

were substantial for FY11 at $1.12 billion

(compared to $838.8 million in 2010). The

reason behind this was due to the clinical,

developmental and collaboration efforts of

Gilead to ensure that their treatments were

first to market. Hugely successful in that

respect, FY12 should see a similar trend in

research costs. SG&A costs rose in FY11,

but not substantially, whereas, income tax

rates saw a decline from 26.2% to 23.6%.

Gilead has been able to maintain its

current position in the market despite

releasing a minimal number of products

last fiscal period. We expect the company

to report drastic revenue growth targets

during FY13 upon the promising approval

and release of the Quad pill.

What we don’t like: Gilead has numerous

operations in Europe and due to the recent

austerity measures the Eurozone has

taken, Gilead may face reduced pricing

power and slightly lower growth than

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anticipated. In addition, a substantial portion of the

company’s sales faced exposure from foreign currency

exchange rates. The forward contracts which are used to

hedge forecasted international sales were chiefly

denominated in Euro and any adverse movements, in

relation to US’s improving economic conditions, will have a

negative effect on the contracts. However, Gilead’s

contracts have played favourably for the past few quarters

with a positive impact of $19.9 million for 3Q11 and $42.9

million for the nine months ended 30 September 2011.

Other international factors include granting compulsory

licenses for products in countries that have considerable

need for a Gilead drug. Brazil, which purchased $50.0

million worth of Gilead’s HIV products in FY10, and

Canada have both permitted generic domestic competitors

to manufacture patented drugs, reducing Gilead’s product

sales for Viread by 3% y/y. Management further stated that

it may revise its FY12 revenue guidance to be lower at a

later date. Royalties from Roche have also been declined

close to 19% in accord with a lack of pandemic planning

initiatives globally, risking close to 5% of total revenue. On

an alternate note, expensive litigation has reduced Gilead’s

earnings in the past and most likely will continue to do so,

as challenges from generic drug producers wider to

produce Gilead’s patented drugs. Although Gilead has won

a significant number of cases against Teva

Pharmaceuticals, among others, it continues to consider

expensive options for further enforcing its patents. Various

other general risks include: complex compliance with FDA,

failure to attract and retain qualified personnel, tax rate

changes and business disruptions from man-made/natural

disasters. We realize that most of the abovementioned

risks are not company-specific and are faced by all global

brand name biopharmaceutical producers across the

board. We expect management to report poor revenue

growth for FY12 under weak international macroeconomic

conditions and lack of product releases. Furthermore,

patents for Viread and Hepsera (Hep-B treatment) expire in

2018, which currently accounts for less than 3% of all

product sales in 3Q11.

Despite the extensive risks which entail biopharmaceutical

firms on a broad range, Gilead continues to beat industry

standards in sales q/q and garner investor confidence. We

believe that Gilead has been and will continue to manage

itself extremely efficiently through the introduction of new

products to the market in 3Q12 and

FY13. R&D costs are initially necessary

to establish pre-approval trials, which

may possibly seep into part of FY13.

We’re maintaining our fair price

estimates based on the future value

creation expected of Gilead through to

FY20 with its upcoming pipeline of

products. Furthermore, we’re

encouraged that Gilead’s Quad pill will

be made with in-house ingredients,

allowing the company to retain all profits

and boost margins.

Recommendations

We iterate a strong buy rating on Gilead

Sciences, Inc. for its value-creating

fundamentals. The primary risk which

entails the investment is based on

healthcare and political policies. The

company’s sales of its products would

face a slight reduction if mandatory

reforms force the company to provide

essential drugs at a discounted price.

Management guidance included that

these changes will only impact 5-6% of

their U.S. net product sales.

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Present Value of Cumulative Free Cash Flow $16,903.76

Terminal Value 53,402

Enterprise Value $70,305.36

$89.68 1.0% 1.5% 2.0% 2.5% 3.0%

7.61% 92.92 99.31 106.83 115.84 126.79

8.11% 85.89 91.28 97.55 104.94 113.78

8.61% 79.79 84.39 89.68 95.84 103.09

9.11% 74.45 78.41 82.92 88.11 94.16

9.61% 69.74 73.17 77.05 81.48 86.58

Enterprise Value

Terminal Growth

WA

CC

Enterprise Value $70,305.36

Less: Debt 3892

Less: Noncontrolling Interest 116

Less: Preferred Securities -

Plus: Cash & Cash Equivalents 1500

Equity Value $67,797.36

Shares Outstanding 756

Implied Share Price $89.68

Current Share Price $47.00

DCF Upside Potential 91%

Equity Value & Share Price

Risk Free Rate 1.92%

Equity Risk Premium 7.48%

Beta 0.84

Expected Market Return 10.79%

Cost of Equity 9.37%

Pre-Tax Cost of Debt 3.39%

1-Effective Tax Rate 76.39%

Cost of Debt 2.59%

Weight of Equity 88.76%

Weight of Debt 11.24%

Weighted Average Cost of Capital 8.61%

Cost of equity

Cost of Debt

WACC 0

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40

60

80

100

DCF EV/EBITDA EV/FCF P/E 52 weekrange

AnalystEstimates

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