An Appealing Play in Pain Management

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Company Finances

We have a largely favorable view of Alpharma's financial position, with its total assets of $1.3 billion at the end of 2007, including $303 million in cash and cash equivalents; $255 million in receivables inventory; $284 million in property, plant, and equipment; and $446 million in other assets. Current liabilities were $198 million, other liabilities $48 million, long-term debt $311 million, and stockholders' equity $731 million as of yearend.

Long-term debt consists primarily of $300 million in convertible senior notes that were sold in March, 2007. We believe those funds have provided Alpharma the flexibility to take advantage of attractive product acquisitions such as the in-licensing of the ketoprofen gel product.

Excluding the $60 million up-front payment related to ketoprofen, earnings before interest, taxes, depreciation, and amortization (EBITDA) totaled $114 million in 2007, with free cash flow of $45 million. Capital expenditures were $60.5 million, of which $41 million consisted of spending for the API division (which is being divested).

After adjusting for closing costs and other payments, Alpharma expects to net about $365 million from the proposed sale of its API division. We think the deal, which we find attractive at eight times API's 2007 EBITDA, makes long-term strategic sense, as it should allow Alpharma to invest in higher-margin and faster-growing drugs, as well as provide funds for potential share buybacks.

Valuation

Our 12-month target price of $30 is derived from a blend of our discounted-cash-flow, price-to-sales, and sum-of-the-parts valuation models.

Corporate Governance

We view Alpharma's overall corporate governance position as superior to most peers in the pharmaceutical industry. Positive factors, in our view, include that only one insider director (the CEO) serves on the board, and no affiliated outsiders serve on the board; the nominating, compensation, and auditing committees are composed solely of outside directors; the CEO serves on the board of two or fewer other companies; and the company does not have a poison pill antitakeover defensive in place.

Negative factors, in our view: Shareholders do not have cumulative voting rights in director elections; the board is authorized to increase or decrease the size of the board without shareholder approval; and a plurality standard is employed in director elections.

Investment Risks

Risks to our recommendation and target price include greater-than-expected competitive pressures and an inability to achieve significant growth in key Kadian and Flector pain drug lines. Unexpected weakness in the animal health business, problems in developing and commercializing new products, and failure to complete the planned sale of the API business represent additional risks, in our view.