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Sanofi-Aventis (SNY) and Glaxosmithkline plc (GSK) From Third Avenue Int.

In last quarter’s letter, we discussed the Fund’s purchase of shares of Sanofi-Aventis S.A. (“Sanofi”), one of the largest pharmaceutical companies in the world. Numerous issues which are clouding the outlook for the pharmaceutical industry – including a stricter Food and Drug Administration, the upcoming Presidential Election in the U.S., intensifying generic competition, and the ongoing push by governments to contain health care costs – in addition to company specific issues, enabled Fund management to purchase shares of this well-financed, highly profitable and cash generative business at what we believe is an attractive valuation, without attributing any value to Sanofi’s pipeline. While we believe Sanofi represents an attractive investment opportunity for the Fund on a stand-alone basis, the company, and the pharmaceutical industry ingeneral, are subject to inherent uncertainties whose outcomes are difficult to predict with a high degree of certainty.

One of the most notable of these uncertainties is the ultimate level of clinical and commercial success attained by the potential drugs in companies’ pipelines. Therefore, we believe that, if (and only if) we find additional candidates which meet our strict investment criteria on a stand-alone basis, it would be prudent to invest in a portfolio of well-financed, attractively valued pharmaceutical companies, in order to provide some degree of diversification across various pipelines and product lines. We believe that GlaxoSmithKline plc (“GSK”) is one such company which represents an attractive investment in its own right and complements the Fund’s holding in Sanofi.

U.K.-based GSK, one of the largest branded pharmaceutical and vaccine manufacturers in the world, has seen its share price suffer in recent months due to general industry concerns, as well as company-specific issues, including negative press questioning the safety of its diabetes drug Avandia. Additionally, there are general concerns among the investment community that the company’s late-stage pipeline over the short term will not offset the loss in sales from upcoming patent expirations. Despite the various issues and uncertainties which drug companies currently face, the industry continues to benefit from favorable industry dynamics which we find attractive, including its highly profitable, cash generative nature, stable demand and solid long-term fundamentals (i.e., an aging population in the U.S., growth in emerging markets, etc.).

Furthermore, like Sanofi, we believe that GSK has a number of attractive, companyspecific attributes, such as its strong balance sheet, which should provide the company with the financial flexibility to pursue agreements or acquisitions to bolster its pipeline and/or research capabilities. GSK also benefits from a sound and diversified revenue base. Aside from Advair, GSK’s asthma medication which made up roughly 15% of sales in 2007, no other singledrug accounted for greater than 5% of sales. Its vaccines business, which has been growing briskly and is relatively more resistant to the threat of generics, made up about 9% of sales in 2007. Additionally, GSK’s consumer healthcare division (roughly 15% of 2007 sales), which produces and markets over-the-counter medicines, oral care, and nutritional healthcare products, has been a provider of stable cash flow to the company, having generated an average of over £750 million (roughly $1.4 billion) in EBITDA over the past four years.

Each of these businesses appears to possess elements of recession resistance and should mitigate the company’s exposure to individual drugs. Emerging markets, many of which have large populations which are increasingly able to afford quality healthcare, represent a significant source of potential growth for the company. The U.S. and Europe currently comprise a large majority of the global pharmaceutical market, highlighting the potential for longer-term growth elsewhere in the world. GSK has responded accordingly, recently announcing the reorganization of its corporate structure to emphasize growth in these markets; the company continues to steadily grow itspresence in these regions. GSK has also aggressively approached cost cutting, as its “Operational Excellence Program,” announced in October 2007, is projected to deliver £700 million in annual, pre-tax savings by 2010. The costs that are wrung out of the business should mitigate the impact of patent expirations and pricing pressures over the short term.

As was the case with Sanofi, shares of GSK were purchased at what we believe are modest multiples of earnings and cash flow, even in a “reasonable worst-case” scenario, which does not attribute much value to GSK’s pipeline. If one were to estimate a theoretical market value of GSK’s vaccines and consumer healthcare businesses, two areas which appear to be quite marketable and have seen transactions at healthy multiples in the recent past, the valuation of GSK’s core pharmaceutical business appears even more modest.


Holmes R. Osborne III, CFA
1223 Wilshire Blvd., #1471
Santa Monica, CA 90403

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