Teva’s No Good, Very Bad Year

Huge debts and a loss of faith by investors – how Israeli drugmaker’s dreams turned into a nightmare.

teva
Bloomberg

“This is a one-time opportunity to create a $100 billion company,” explained Teva Pharmaceutical Industries when the firm made an offer to buy Mylan for $40 billion almost two years ago. The deal never came through and in the end Teva announced in July 2015 its purchase of Actavis Generics for $35 billion, explaining that Actavis was actually its preferred purchase.

Five months after completing the asset that it so wanted, Teva shares are now selling at 36% less than what they were worth before the purchase. For now, it seems shareholders have already decided that the dream deal could turn into a nightmare, and instead of Teva creating more value for them over the next few years, the company will be focusing on paying off the huge $36-billion debt that it accumulated because of the purchase of Actavis and several smaller companies over the past three years.

The 7.5% drop in the price of Teva shares, on an enormous turnover of over $1 billion on the New York Stock Exchange on Friday after the company released a disappointing forecast for 2017, and the rising spread on the yields of its bonds compared to similar duration United States bonds in recent months, show that investors have been losing faith in the firm. Teva held a conference call on Friday after releasing its updated forecasts for 2017.

Teva shares ended down 5.5% at 136 shekels ($35.37) on the Tel Aviv Stock Exchange on Sunday.

For the first time, doubts are being heard as to Teva’s ability to continue to distribute dividends in light of the drop in its cash flow from operations, which will affect its ability to serve its debts.

It seems one of the key factors for paying down its debt will be fulfilling the commercial potential of two original drugs, one of which Teva is expected to launch: SD-809 for Huntington Disease and Tardive Dyskinesia; and TEV-48125 for treating episodic and chronic migraines, whose development will be completed in 2017.

The plunge in the stock price stemmed mostly from the forecasts for 2017, in which the main parameters were much lower that the analysts’ averages, as well as the forecasts Teva itself released in July 2016.

Under these circumstances, the promises made by Teva CEO Erez Vigodman to focus in 2017 on “execution” and “on extracting synergies related to the Actavis Generics transaction” in its guidance released on Friday have fallen on skeptical ears, which have grown ever more skeptical in recent months after a few bad surprises over the past year.

Even worse, Teva’s forecast is based on the central assumption of a lack of generic competition to its flagship Copaxone 40 mg/ml dose, which contradicts the basic assumption of almost all analysts. This only increases investors’ mistrust of the company.

How will Actavis contribute?

Teva expects a non-GAAP earnings per share of $4.90 to $5.30 in 2017, 5.7% lower than the analysts’ average forecast and 18% below the company’s own forecast from just six months ago. Analysts on average were expecting a profit of $5.41 per share on revenue of $24.82 billion. 

The updated forecast even assumes a 1% drop from the adjusted EPS for 2016; while last July, a few weeks before the completion of the Actavis purchase, the company partially explained the high price it paid on the expectations that the deal would increase EPS by 14% in 2017.

Vigodman said Teva continued to “make excellent progress on the integration of Actavis Generics and our promise of $1.4 billion in net deal-related synergies and tax savings by 2019.” The company forecast revenues of $23.8 to $24.5 billion in 2017, including a hit of $800 million from foreign exchange losses – 2.7% less than the analysts’ average forecast, and 6% less than the forecast from July 2016.

The reason for the lowered profit forecasts was the delay in launching new generic products in the U.S., which affected revenues in the second half of 2016 and will continue to have such an effect in the first half of this year, said Vigodman. The entry of two generic competitors in the U.S. in February 2017 “could reduce revenues by $1.0 billion to $1.2 billion, and could reduce non-GAAP EPS by $0.65 to $0.80,” he said.

In light of the expected drop in Actavis’ contribution to the bottom line in 2017, and the disappointing results in the U.S., the resignation of Sigurdur (Siggi) Olafsson as CEO of Teva’s Global Generic Medicines Group in early December was not such a great surprise. The drop in the contribution from Actavis strengthens the view that Teva overpaid, even if all the projected synergies from the purchase come about.

Another major factor behind the $1.6-billion gap between the updated revenue forecasts and Teva’s previous ones is the strengthening of the dollar. Exchange rate moves caused a $800-million adverse impact on revenues for 2016 and a drop of $200 million in operating income.

Teva CFO Eyal Desheh said $400 million of this exchange rate influence on revenues, and $120 to $150 million of the change in operating profits stemmed from Teva’s decision to use an exchange rate of approximately 300 bolivars per dollar for its operations in Venezuela, one of the company’s three largest markets outside of the U.S. and Europe, because of rapid deterioration of the economic situation in that country.

No more significant acquisitions

As a result of this decision, Teva will most likely have to write down assets in the fourth quarter of 2016, which were valued at $343 million at the end of the third quarter of last year. This comes on top of a previous write-off of $246 million for assets in Venezuela in the first quarter of 2016.

At the same time revenues forecasts were lowered, Teva updated its operating profits projections in the same direction. Non-GAAP free cash flow was estimated in the $6.3 to $6.7 billion range.

Desheh was asked during the conference call with analysts what the explanation for the company’s forecast free cash flow being higher than the free cash flow from operations ($6.5 billion compared to $5.9 billion). He said the company plans on completing this week the sale of assets belonging to Actavis in Britain for $800 million, as well as selling off financial assets, real estate and generic products with low sales for another $1 billion.

It seems too that Teva will complete the sale in 2017 of its holdings in Mylan, 4.2% of the firm, with a present market value of $870 million.

Because the forecast is based on the scenario that Copaxone 40 mg for treating multiple sclerosis will not face generic competition in 2017, despite most analysts’ opinions to the contrary, the share plunged. This assumption about Teva’s most profitable drug flies in the face of previous court decisions in the U.S. on Teva’s Copaxone patents, and an expected ruling later this month on four of the five patents protecting the drug from generic competition.

This scenario shows Copaxone revenues falling to $3.8 to $3.9 billion in 2017, with profits of $3.05 to $3.1 billion. But if the two rival generic versions of Copaxone are launched in February, then these revenues will plummet to only $1 to $1.2 billion, and profits will fall by 65 to 80 cents a share, or $700 to $800 million in 2017.

The drop in revenues and cash flow compared to earlier forecasts will have a major effect on the ability to reduce Teva’s debt and preserving its credit rating, which Vigodman says are two of his main goals in increasing efficiency and synergy from the Actavis purchase. Teva now estimates its net financial debts will total $35.8 billion at the end of 2016, and will drop to $30.5 billion by the end of 2017, which will be 3.64 times its EBITDA. In July 2016, the company predicted a debt of $31.8 billion at the end of 2016, and a fall to $27.2 billion by the end of 2017 – 2.75 times EBITDA.

This slower-than-planned reduction in its debt-to-cash ratio from operations will have a direct effect on Teva’s business development. Vigodman made it clear in the conference call that the company will not make any significant acquisitions until this ratio falls to 3.5, at the very most.

The most optimistic note in Teva’s forecasts is the faster-than-expected achieving of synergies and savings from the Actavis purchase, expected to reach $1.3 billion in 2017 alone. These will have an effect almost only on the generics sector for Teva. The second bright light in the forecasts is the expectations of continued improvement in both gross and operating profits in the generics sector, forecast to rise to 48.5% and 30.5%, respectively, in 2017, up from 47% and 28% for 2016.

The new CEO of Teva Generics, Dipankar Bhattacharjee, said the company would see improvement this year from its plans for launching new products that will bring in $750 million in the U.S. in 2017, along with the synergy from the purchase of Actavis and continued improvement in profitability in Europe and the rest of the world.