Okay — I spent some time last night [March 2, 2008], thinking about where SGP’s profitability really comes from, and here’s what I was able to deduce. But, first these are all simply my estimates, taken directly from the SGP Form 10-K figures, just filed (on pages 61, and 124 to 127).
So, what would SGP’s average 2007 gross margin be, if the Vytorin J/V profits were NOT included?
That is the question I have set out to answer, below. And, please, one and all, correct me if you see errors in my approach.
A few observations, as we start: per SGP’s Form 10-K, J/V sales are NOT included in the $12.69 billion 2007 SGP net sales total (and that turns out to be very useful, as will be explained in a moment). But the “equity income” from the J/V IS included in SGP’s net results — that was $2.049 billion in 2007. However, for the year, SGP reported a loss of $1.473 billion (due to Organon deal). So, we need to know what income would be, in a year with no Organon “one-time” write-offs.
Okay, SGP took a $3.754 billion write-off in 2007 related to Organon in-process R&D (plus $51 million in acquisition costs), so we will need to add those amounts back to the 2007 results, to figure out what post-Organon, “ongoing operating income” will look like.
So, ($1.473) plus $3.754 plus $0.051 equals $2.332 billion in “would be” total income, post-Organon for 2007.
Next, we know that the J/V accounted for $2.049 billion in 2007 income. So, let’s take that out (to find “all other” income), and we see that $2.281 minus $2.049 leaves SGP with only $232 million in income, on over $12.69 billion in 2007 sales. [This is where the fact that the $12 billion in sales does NOT include the J/V sales becomes very useful!]
Okay, but we know SGP would save on some expenses, if it didn’t have the SG&A, and other costs, it picks up from the J/V — so let’s give SGP credit for those (detailed on page 124) — those costs were $1.523 billion in 2007. Let’s assume that SGP would be able to avoid paying 20 percent of those amounts (SGP’s own half of the partnership, plus another one-fifth of its expenses — seems reasonable): We can add back another 609 million to 2007 “all other” SGP
income. [$1.523 billion divided by 2, times .8 = $0.609]
So, $232 plus $609 million equals $841 million in “all other” SGP income, on $12.69 billion in 2007 sales. Thus, SGP’s average margin on all other products is likely to be 6.6 percent [I had previously guessed it to be about 10 percent.] $0.841 / $12.69 = 6.6 percent.
That means the average margin on all the “other” SGP products (post Organon, but WITHOUT the J/V’s 70 percent margins!) is about 6.6 percent. So, SGP makes, on average, six and six-tenths cents on every dollar of all of its non-Vytorin J/V product sales.
That means, in order for SGP to replace $1 of lost J/V sales (which correspondingly, results in $0.70 of lost profits, for each dollar!), SGP needs the REST of its businesses
to generate, on average, $10.60 of NEW sales, for every $1 of lost Vytorin script sales. [$0.70 / $0.066 = $10.60].
That will never happen. No way, no how. So, is the low-estimate of $1.35 per share of 2008 EPS really so unbelievable, now? I’d say $1.35 looks positively optimistic.
Finally, remember that $510 million of SGP’s “operating” income in 2007 came from a one-time speculation on currencies during the pendency of the Organon transaction. It will not, and cannot, be repeated. If we back out the one-time $510 million gain on currencies, the rest of SGP, ex the J/V, actually has far worse margins. [$841 -$510 = $331 on all other products — leads us to $331/$1269 = 2.6 percent margins — or, $27 of NEW sales needed, for every lost dollar of Vytorin J/V sales!]
So, either $10.60 to one, or perhaps, $27 to one, wow — I wouldn’t like to be on the wrong side of those odds.