An Overview of the Health Care Industry JULY 28, 2010 RYAN GREGG WILLIAM LIUSUDARSO MELANIE MCFARLAND CAITLIN MCTIGUE BRIAN MILLER

Agenda y Sector Overview y Business Analysis y Economic Analysis y Financial Analysis y Valuation Analysis y Recommendation

Sector Overview y Economic sector concerned with the provision,

distribution, and consumption of health care services and related products. y Stocks in the Health Care sector tend to be more

defensive when compared to the broad market. This is because most products in the sector are more essential to consumers and have an inelastic demand curve. This means Health Care products are not dependent on the direction of the economy. Source: Investopedia

Sector Overview y Global Industry Classification Standard (GICS) Health Care

Sector Industry Group Industry

HC Equipment & Services

Health Care Equipment & Supplies

Health Care Providers & Services

Pharmaceuticals & Biotechnology

Pharmaceuticals

Biotechnology

Source: Standard & Poor’s

Sector Overview

* As of July 22, 2010

Source: Vestek

Sector Overview S&P 500 Index Sector Breakdown Materials, 3.4%

Telecom Services, 3.0% Utilities, 3.7% Consumer Disc, 10.1%

Info Tech, 18.8%

Consumer Staples, 11.5% Industrials, 10.3%

Energy, 10.7%

Health Care, 12.1%

Financials, 16.3%

* As of June 30, 2010

Source: Standard & Poor’s

Sector Overview

* As of June 30, 2010

y Health Care, typically a defensive sector, held up relatively well

in the month of June as stocks sold off on macro concerns and fears of a double-dip recession. Over the trailing 12 months, we are still seeing the effects of the high-beta rally from mid-2009 through March 2010. In times where higher-beta stocks outperform, expect Health Care to lag from their defensive nature. Health Care reform has also been a large overhang on recent performance against the broad market S&P 500. Source: Standard & Poor’s

Growth of the Health Sector y Demographics affecting growth: { Aging population – baby boomers retiring and requiring more medical care { Around 32 million more currently uninsured Americans will be covered with the new healthcare reform

y Estimated Growth { National healthcare spending is predicted to grow 34% within the next 5 years { Public and private healthcare facilities will propel demand (but not without cost)

Projected Growth in Healthcare Sector

5000 4000 3000

Spending

2000

Year

20 19

20 18

20 17

20 16

20 15

20 14

20 13

20 12

20 11

1000 0 20 10

$ (Billions)

Projected National Healthcare Spend

Pressures on Supply

{

Year

19

20

18

20

17

20

16

20

15

20

14

20

13

20

12

20

11

Payments to doctors may drop 20% No incentive to take Medicare patients

20

{

Percentage

10

Medicaid enrollees

3.5% 3.0% 2.5% 2.0% 1.5% 1.0% 0.5% 0.0%

20

y Over 18 million new

% of Population Age 65 & Older

%

y More insured patients { Large capital investment requirement to increase capacity – cost pressures { Doctors will be paid less – 46% have said they will leave profession if bill passes

Impact of Health Care Reform y Increase in insured Americans through expansion of

Medicaid y Increase in prescription drug use (Closing the “Donut Hole”) Ù

Seniors enrolled in Medicare will have assistance and increase the demand for prescription drugs

y Increase in the utilization of prevention services Ù

Mandates for insurers to cover certain screenings without copayments

Impact of Health Care Reform y Lower salaries for doctors Ù

Medicaid reimbursements are often below cost, students not as incentivized to enroll in medical school

y Shifting cost structure Ù

With less reimbursements, industry is likely to incur some of the increased expenses, shrinking their margins

Five Forces Analysis Threat of New Entrants Buyer Power Supplier Power

• Barriers to entry are very high • Large capital investments necessary •Consumers have little bargaining power over their own health care •Varied among Industry, but not significant in pharmaceuticals and medical devices

Threat of Substitutes

• Relatively low, no real substitute to health care

Rivalry

• Pharma/Biotech rivalry very intense to be firstto-market with new drugs

Economic Overview Consumer Spending vs. Health Care y

Consumer spending has tended to correlate well with health care names. When discretionary spending rises, health care stocks tend to rise with it.

y

Strong consumer spending is generally a strong indicator for the market in general, as consumers are putting money back into the economy as opposed to saving it.

Economic Overview Consumer Confidence vs. Heath Care y

Consumer confidence is a strong indictor of health care stock performance. When consumer confidence rises, consumers tend to spend more money on health care items, such as prescriptions, discretionary surgeries or discretionary medical devices.

y

Consumer confidence also is a strong predictor for the market in general.

Economic Overview

Over the last 5 and 10 Year periods, the aging demographic has not helped health care stocks.

Economic Overview

Broad Market S&P 500 vs. Heath Care y

Over time, health care names have tended to rise and fall with the broad market S&P 500.

Financial Analysis – Health Care Sector y Operating Earnings Growth Rates: 2008

2009

2010 (Estimate)

2011 (Estimate)

S&P 500

-40%

14.9%

44.4%

15.2%

Health Care Sector

5%

7.9%

12.5%

10.1%

y Sales Growth Rates: (in millions)

2Q 2010 Sales

Prior Year Sales

% Growth

Gilead Sciences Inc.

$1,927.22

$1,647.15

17.00%

Johnson & Johnson Co.

$15,330.00

$15,239.00

0.60%

Stryker

$1,758.20

$1,634.30

7.58%

Major Sector Companies:

Per www.standardandpoors.com/indices/sp-500

Financial Analysis – Health Care Sector Net profit margins of the Health Care sector have been fairly steady over the last 10 years:

Per THOMSON REUTERS Baseline

Financial Analysis – Health Care Sector In contrast, the net profit margins of the S&P 500 have been quite volatile, although the most recent trend is positive.

Per THOMSON REUTERS Baseline

Financial Analysis – Health Care Sector Other Ratios y ROE: 16.44%, which is the second highest sector in the S&P 500, second to only Consumer Goods. y Price to Free Cash Flow: 3.58, which indicates that the sector as a whole is generating cash flow. Note that this ratio is lower than most of the other sectors, however. Per Yahoo! Finance

Sector Valuation

• Sector is close to its 10-year low in absolute basis. • Discounted in its P/E, P/Forward E, P/S, and P/CF to its median level

relative to S&P 500

Biotechnology

Pharmaceuticals

Health Care Distributor

Health Care Managed Care

Health Care Supplies

Industry Comparison in Absolute Basis

Industry’s Comparison discounted by its median

Individual Company Comparison of Health Care Industry Gilead Sciences

Absolute Valuation P/Trailing E P/Forward E P/B P/S P/CF

Boston Scientific

High

Low Median

Current

281.6 94.4 23.6 33.7 135.4

9.4 9.0 3.9 3.8 8.7

9.4 9.0 3.9 3.8 8.7

30.7 26.4 12.4 13.5 33.4

Abbot Laboratories

Absolute Valuation P/Trailing E P/Forward E P/B P/S P/CF

High

Low

Median

Current

29.8 26.5 10.7 6.1 23.4

12.2 10.8 3.5 2.2 8.9

19 17.4 5.1 3.4 14

12.4 11.1 3.6 2.3 9.1

Cardinal Health

Absolute Valuation P/Trailing E P/Forward E P/B P/S P/CF

Absolute Valuation P/Trailing E P/Forward E P/B P/S P/CF

High

Low

Median

Current

68.4 41.6 12.8 11.4 51.6

9.7 10.4 0.6 1.1 5.5

22.2 21.6 3.9 2.7 11.7

14.9 17.1 0.8 1.1 6.3

High

Low

Median

Current

101.6 74.2 3.0 1.4 22.5

5.5 5.5 0.3 0.1 3.0

15.1 13.1 1.4 0.5 11.7

10.2 9.9 1.2 0.3 7.5

High

Low

Median

Current

28.5 24.7 5.1 3.5 24.8

12.3 12.1 2.2 1.6 10.2

21.8 19.6 3.7 2.6 17.4

15.8 15.0 2.4 1.9 12.7

Aetna

Absolute Valuation P/Trailing E P/Forward E P/B P/S P/CF DENTSPLY International

High

Low

Median

Current

26.6 22.1 5.4 0.7 22.4

6.1 5.9 0.9 0.1 4.8

14.1 12.9 2.4 0.3 11.5

13 14.2 2.3 0.1 9.8

Absolute Valuation P/Trailing E P/Forward E P/B P/S P/CF

Technical Analysis

Recommendation

y Recommendation: Reduce Health Care sector by

2.25% to 11.95% of the SIM portfolio

Recommendations y Positives More end-users from Health Care Reform Ù Valuations Ù Aging Demographic Ù

y Negatives Overhang from Health Care Reform Ù Cost structures increasing as a result of Reform Ù

y Uncertainties Political Party Control Ù Implementation and Regulations from Reform Ù

Recommendations y Bias towards high-quality names with strong

margins and cash flows y Tend to overweight Pharma & Biotech y Underweight Medical Devices & Supplies