FTSE Friday: GSK’s lawsuit result, where next for Vodafone?

Companies covered this week:

• GSK - shares surge after Zantac litigation thrown out
• Vodafone - Nick Read to step down as CEO
• Games Workshop - trading update

GSK: Relief in Zantac litigation

GSK (LON:GSK) shares surged on Tuesday after a court in Florida threw out 2,500 lawsuits which claimed its heartburn medicine, Zantac (which is also sold under the generic name, ranitidine), causes cancer. US district judge Robin Rosenberg said that the lawsuits were based on “flawed science”, and that the only reliable test of the medicine showed an “unprovable risk of cancer”.

GSK is still facing thousands of personal injury lawsuits in state courts, but the likelihood of exorbitant payouts to the 77,000 claimants (cancer patients who believe Zantac caused their illness) has been reduced following the ruling by the district litigation. In August when the lawsuits were first filed, analysts suggested damages could reach $45bn. In the third quarter alone, GSK spent £45m on legal fees relating purely to the Zantac case.

GSK’s many investors will be relieved by this ruling - the lawsuits have weighed on the share price for the last six months - but it still serves as a reminder of what a mucky business pharmaceuticals can be.

Zantac is not a new medicine. It was first approved in 1983 and was one of the first drugs in the world to generate over $1bn in annual sales. It has since changed owners many times and, following the expiration of its patent, has been manufactured and sold by generic pharma companies as well. Until 2020 - when cancer claims forced the FDA to advise it be removed from the market - it was sold over the counter and as a prescription medicine.

Claims that Zantac contains a carcinogen were picked up in 2019 by Valisure, a laboratory in Connecticut which specialises in independent drugs safety testing. The company claims (fairly) that during the drug approval process, the FDA relies on safety data from the pharmaceutical companies themselves, rather than tests conducted by an independent lab. It aims to change that. In addition to the Zantac case, Valisure’s findings have forced a product recall of Johnson & Johnson’s sunscreen due to Benzene (another carcinogen) contamination.

Scandals and lawsuits are nothing new in the big pharma industry. These are big businesses which tend to have legal budgets big enough to fight off small labs like Valisure. But occasionally a scandal is too big even for big pharma - it’s worth being wary of the fallout from major misdemeanours.

Vodafone: Job opening at the top

Nick Read’s four years as chief executive of Vodafone (LON:VOD) have not been successful. Here is a brief rundown of some key statistics since he took over from Vittorio Colao in 2018.

Share price: down 40%

It’s true, Read’s tenure has been blighted by the Covid-crisis and a surge in interest rates which have had an especially bad impact on heavily indebted companies. But still, Vodafone has underperformed the FTSE and the telecoms market substantially.

Annual dividend: cut from 15.1p in 2018 to 9.24p in 2019 and paid 8.95p in 2022

Cutting the dividend in 2019 was not a bad call. Vodafone needed to free up cash to spend on its mobile network in key markets. But repeated cuts have massively eroded the value of holding Vodafone shares.

Net Debt: More than doubled to €60bn, with net gearing now over 100%

Spinning out the telecoms towers business into a joint venture helped bring debt under control in the first year of Read’s tenure, but by 2020 the company had made a sizeable acquisition in Germany and cash flows continued to be negative. The debt position has climbed ever since.

Market Share: Major declines in key European markets

In Germany - Vodafone’s largest revenue and profit contributor - peers have cut their prices and the company has lost market share to cheaper rivals. In Spain, the merger of Orange and MasMovil has hurt the company’s dominant position (Vodafone had tried to merge with MasMovil but its bid failed). In the UK, it remains second billing to BT’s mobile operator EE - although a proposed merger with Hutchison’s Three might help solve that.

The question that investors face now is ‘what can a new CEO do?’

Arguably, something radical. Haemorrhaging cash to stay afloat is no way to run a business and a new CEO needs to get exorbitant spending under control by improving the operational performance. M&A activity needs to be completed with greater urgency - under Read, acquisitions and disposals have taken far longer than investors would have hoped. And the dividend needs to be placed under review until the cash flow situation is in better order. Dividends should be paid from excess cash profits, not borrowing. Until Vodafone can generate profits without increasing its debt, it shouldn’t be returning cash to shareholders.

Current CFO Margherita Della Valle has been appointed interim chief executive, handling both roles until a new CEO is found. She is likely to be considered for the top spot on a permanent basis. But Read was CFO before he took over from Colao - his mandate was to continue to work that his predecessor had started. It hasn’t worked. Vodafone needs fresh thinking, it should hire from the outside.

Games Workshop: Disappointing licensing revenues

Royalty revenue from licensing deals has been Games Workshop (LON:GAW) big growth driver in recent years. So much so that in the year to June 2022, management split it out into its own operating segment. In 2015, operating profit from royalties was £1.5m. In the most recent annual results statement, the reclassified licensing segment generated £25.4m of operating profit.

It is therefore disappointing to see licensing deals dry up in the current financial year. A trading statement released this week revealed that licensing income for the first half is expected to be £14m - that's £6m lower than in the same period of FY2022, as a series of major video game licences signed last year haven’t been repeated.

Licensing remains the far smaller contributor the Games Workshop’s revenues (retail sales are forecast at £210m in the first half of FY2023, up 10.5% on last year), but they are no longer insignificant. And with operating margins at over 90%, the licensing division has a more meaningful impact on profits than it does on revenues - in FY2022 the division contributed 6% of revenues and 16% of operating profits.

Still, it’s not worth being too down about the outlook for the company. Games Workshop has always been careful about the businesses it signs licensing deals with: “we believe we must do them on our terms and not prostitute the business to any and every deal that comes along.” That doesn’t mean the deals aren’t out there. The Warhammer brand has an incredibly loyal audience - the kind of audience than content producers outside of the traditional gaming universe are always on the lookout for.