Equity Research

GILEAD SCIENCES INC. (NASDAQ:GILD)

Sector: Health Care | Industry: Biotechnology

Gileads Quad Regimen Poised to Lead HIV Market, with over $3 Billion in Sales
Forecasts as of 01 Feb 2012

General
Fair Price: Price: Market Cap: 52-wk high: 52-wk low: 1-yr total return: 5-yr Forward Revenue CAGR: 5-yr Forward EPS CAGR: 5-yr Expected PEG: $89.68 $47.00 $41.19 B $54.90 $34.45 41.0% 6.2% 8.8% 0.79

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 Gileads 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, Gileads 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 sixyear period. However, Atripla (currently Gileads 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, Gileads valuation ratios have been trading at a hugely discounted rate, giving it considerable upside potential. It is outpacing its industrys 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.

Forecasts ($ in millions, except share data)

EBITDA EBITDA y/y% EBIT EBIT y/y% Sales Net Income ROA (%) ROE (%) P/E 2011 4,161 -1.7 3,856 -2.8 8,383 2,833 28.26 47.44 10.9 2012(E) 4,668 12.2 4,339 12.5 9,357 3,136 24.68 46.17 13.01 2013(E) 5,141 10.1 4,844 11.6 10,095 3,627 21.56 47.68 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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Equity Research Gileads Quad Regimen Poised to Lead HIV Market, with over $3 Billion in Sales 01 Feb 2012 Surrounding recent forecasts about the positioning of the We speculate that the drug will receive HIV marketplace in the years leading to 2020, weve FDA approval on 27 August 2012 and is positioned to take the market by storm revised our valuation positively. upon release. 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 Gileads 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 Compleras 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, Gileads Quad regimen (the first integrase inhibitorbased 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, were 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&Js study revealed that 83% of the test patients had undetectable viral levels, in stark contrast to Gileads most recent two phase 3 trials producing results of 88% and 90% undetectable viral levels (level of HIV in the blood). Diversification In our opinion, Gilead has taken exceptional measures to ensure its continued industry-leading innovation standards in its HIV division. Currently, Truvada is Gileads 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 Gileads 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 companys sheets. Similar to Quad, because the information is widely unavailable about the drugs testing process, the market is unable to price Truvadas information in at this point resulting in Gileads current trading price. In addition to Gileads HIV line, acquiring Pharmasset has given the firm an edge above the Hepatitis C curve. The new drug candidate GS7977 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.

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.

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Equity Research Gilead Up 6% After Hepatitis-C Trial Results 03 Feb 2012 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 companys 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 Risks & Catalysts last fiscal period. We expect the company What we like: Gilead has long-term plans to release drugs to report drastic revenue growth targets which strengthen the focus of its HIV and Hep-C sectors. during FY13 upon the promising approval Given this, we realize how important it is for a and release of the Quad pill. pharmaceutical company to release positive test results and be the first to market. Because Gilead has taken What we dont like: Gilead has numerous extraordinary steps in ensuring its leading position, we operations in Europe and due to the recent expect it to grow at an average of 14.5% over the next 5 austerity measures the Eurozone has year period. This estimate is in part of its competitors taken, Gilead may face reduced pricing inability to innovate drugs as rapidly as Gilead has through power and slightly lower growth than acquisitions. Even though Gilead reported earnings per Upon missing earnings yesterday, Gileads share prices were up close to 11% today. The stock opened to news of the new results surrounding its research on the antihepatitis 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 arent 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.
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Equity Research anticipated. In addition, a substantial portion of the companys 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 USs improving economic conditions, will have a negative effect on the contracts. However, Gileads 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 Gileads HIV products in FY10, and Canada have both permitted generic domestic competitors to manufacture patented drugs, reducing Gileads 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 Gileads earnings in the past and most likely will continue to do so, as challenges from generic drug producers wider to produce Gileads 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
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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. Were maintaining our fair price estimates based on the future value creation expected of Gilead through to FY20 with its upcoming pipeline of products. Furthermore, were encouraged that Gileads 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 companys 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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Enterprise Value

Equity Value & Share Price

Present Value of Cumulative Free Cash Flow Terminal Value Enterprise Value Terminal Growth 1.5% 2.0% 2.5% 99.31 106.83 115.84 91.28 84.39 78.41 73.17 97.55 89.68 82.92 77.05 104.94 95.84 88.11 81.48

$16,903.76 53,402 $70,305.36

Enterprise Value Less: Debt Less: Noncontrolling Interest Less: Preferred Securities Plus: Cash & Cash Equivalents Equity Value Shares Outstanding Implied Share Price Current Share Price DCF Upside Potential

$70,305.36 3892 116 1500 $67,797.36 756 $89.68 $47.00 91%

$89.68 7.61% 8.11% 8.61% 9.11% 9.61%

1.0% 92.92 85.89 79.79 74.45 69.74

3.0% 126.79 113.78 103.09 94.16 86.58

WACC

Cost of equity

Risk Free Rate Equity Risk Premium Beta Expected Market Return Cost of Equity
Cost of Debt

1.92% 7.48% 0.84 10.79% 9.37%

Valuation Metrics
100 80 60

Pre-Tax Cost of Debt 1-Effective Tax Rate Cost of Debt

WACC

3.39% 76.39% 2.59%

40 20 0 DCF EV/EBITDA EV/FCF P/E 52 week range Analyst Estimates

Weight of Equity Weight of Debt Weighted Average Cost of Capital

88.76% 11.24% 8.61%

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