Abbott Laboratories Investment Recommendation November 3, 20111

Investment Managers: Jonathan Barki, Su Chen, Lele Liang (Layla), Nan Liang, Ran Mu (Renee)

Macroeconomic, Industry and Stock Market Overview

The ongoing economic recession has hurt the market demand for drugs. This has led to slower industry growth and lower stock returns for the sector. The healthcare industry is heavily regulated, relatively fragmented and highly competitive with the replacement of patented drugs by generic drugs after patents expire. The success rate of drugs reaching the market from the research lab can generally be as low as one in 10,000. This adds significant uncertainty to the drug manufacturing business. The industry growth opportunities are mainly in emerging markets. Abbott’s shares outperformed both the S&P and the S&P Healthcare Index in a 5-year period, while roughly matching the performance of the S&P Healthcare Index in a 10-year period, and underperforming both indexes in the 3-year period after the 2008 financial crisis.

Company Overview

Abbott Laboratories (ABT) has four main business segments: Pharmaceuticals, Nutritional, Diagnostic and Vascular products. Each business segment takes up 56%, 16%, 11% and 9% of sales respectively. ABT has been actively acquiring small biotechnological companies especially in emerging markets to enrich its portfolio of products and reduce R&D costs. ABT’s financial performance in the last 5 years has been very stable and positive. Its current blockbuster drug is Humira, which takes up 48% of sales but will lose its patent protection in 2017. Bardoxolone may potentially be its successor by 2014. In mid-October 2011, ABT announced a prospective spin-off of its pharmaceutical business by the end of 2012. ABT believes this split will unlock a greater overall value as each of the companies can better tailor their strategy and operations to appeal to their respective target markets. One of them will be a new pharmaceutical company offering Humira, Other Branded Drugs and Generic Drugs I in their product portfolio. The other company will be a diversified medical company they call New Abbott. This company will offer ABT’s Generic Drugs II, Nutritional, Diagnostic and Vascular products. Products of the new pharmaceutical company are currently generating $22 billion of ABT’s sales while products of New Abbott are currently generating nearly $18 billion of sales.

Valuation

Our discounted cash flow (DCF) analysis treats ABT as two individual divisions and has resulted with a $69.09 target share price. The impact of patent expirations has been factored in the forecasted terminal value and a higher WACC has been assigned to account for the uncertainty surrounding Bardoxolone’s success. Our comparables analysis has come up with a $56.22 share price when using companies comparable to ABT’s current structure. While the use of companies that concentrate on products of the respective segments of New Abbott yielded a $43.49 price.

Final Recommendation

We have put an 80% weight on the DCF target price, a 10% weight on the first comparable analysis, and a 10% weight on the second one, as the DCF model takes comprehensive factors into consideration. We have also noticed some discrepancies between ABT and its comparables. With our final target price of $65.24, we recommend a buy of 100 shares at its market price.