For the first time since it was founded in 1901, Teva Pharmaceuticals announced two weeks ago its intention to fire 5,000 employees, 10 percent of its international workforce. The announcement aroused great anger among the public because of the lavish tax breaks the company has received over the past five years and the expectation that Teva would, in return, maintain its workforce here.
It is doubtful, however, that the move came as a surprise to those in the capital market. The frantic instability of the company’s share price only underscored the feeling that layoffs are an unpleasant necessity at a company that is in such deep crisis.
On the face of it, describing Teva, which earned $2 billion in 2012, as being “in crisis” may sound like a wild exaggeration. Presumably, however, those who have been unfortunate enough to hold shares in the company over the past five years will be less likely to argue with that terminology.
Teva’s share price did not budge during that period, whereas the index of pharmaceutical companies on the New York Stock Exchange rose 75 percent. The apparent explanation for the poor yield on shares is that the capital market has long been predicting a dwindling in the not-so-distant future in the company’s enormous profits, which had been touted by politicians in the Knesset’s corridors.
To understand the basis for this assessment, we need to go back to April 2011, when Teva stock bid farewell to the NYSE Pharmaceutical Index after underperforming. At the time, Teva posted lukewarm results on a trial of Laquinimod, a medication in tablet form that was supposed to be the next generation of Copaxone, the multiple sclerosis drug that is Teva’s only significant proprietary drug, and its main profit maker.
The disappointing results of Laquinimod are one important cause of the earthquake that shook Teva and sparked a public outcry. That unsuccessful day back in April 2011 sealed Teva’s fate, leaving it with a drug whose patent was to expire in May 2014. Worst of all, the medication is outdated, providing patients with this chronic and incurable disease and inferior quality of life, as compared to the new drugs that compete with it.
The American capital market was quick to grasp the far-reaching significance of this failure. Copaxone gave Teva an operating profit of $750 million in the second quarter of 2013, which is equivalent to 59 percent of the firm’s operating profit for that period, so Teva’s dependence on Copaxone and its future is absolute.
Teva defines itself as the world’s biggest manufacturer of generic drugs, but the main reason its market value skyrocketed from $9.5 billion in early 2004 to a peak of $54 billion, in March 2010, is the enormous profits from Copaxone. When the capital market has reasonable cause to presume these profits are destined to shrink significantly, it rushes to lower the share price to a level that reflects the growing risk.
Teva executives also recognized the ticking time bomb in recent years and defined the dependence on Copaxone as a challenge, not to say strategic threat. But their failure to deal with that dependence − be it by acquiring companies or by developing original drugs to take the place of Copaxone, with its soon-to-expire patent − is the story of Teva’s downfall: from a growth company in which every private and institutional investor wants to hold shares, to one where 5,000 global employees will lose their jobs in the first, and not necessarily final, round of layoffs.
Copaxone is the main cause of the present plight, but a crisis usually has more than one cause, and so it is in Teva’s case. The company also began singing off-key in recent years in a field that was supposed to be its strong suit: the generics market.
Its supremacy in the manufacture of copycat drugs stemmed from its ability in many cases to be the first to launch the generic version of an original drug. On more than one occasion, Teva was the only generic company marketing the drug for six months, when it won a patent trial against the company that developed the original drug. (American law states that the first generic company that proves that a patent on a drug is invalid is entitled to supply the drug exclusively for six months.)
A leading generic company has to be able to manufacture a product in large quantities, at low cost and high quality, to meet the uncompromising standards of pharmacy chains in the United States and the FDA, and of European health ministries. Teva, which was such a company for many years, lost its spotless reputation for quality control three years agon and suffered from its inability to supply drugs of a suitable amount and quality to its clients.
The result was an ongoing shrinking of its share of the American generics market, which is the world’s largest, as well as a consistent narrowing of the gap between it and its competitors, which began during the tenure of former CEO Shlomo Yanai. Therefore, the immediate suspect in the failure is Yanai, who served in the post from early 2007 until the beginning of 2012. It is unreasonable to have expected his successor, Jeremy Levin, to have come up, in less than 18 months, with a solution to such profound problems, both with Copaxone and the generics. And since development of a new drug takes close to a decade, and formulating a strategy and implementing it is a matter of three to five years, Yanai’s predecessors − Israel Makov and the late Eli Hurvitz − are not exempt from sharing at least partially in the failure, although Levin has done his part, too.
Under Hurvitz, Teva’s chairman from 2002 until 2010 (and CEO for the 25 years preceding that), no real attempt was made to acquire start-up companies that could come up with the next Copaxone. In fact, it seems Hurvitz did not believe Teva would hit the jackpot again, as he himself did in the late 1980s when he acquired the right to develop and market Copaxone for $50,000; today it sells at a rate of $10 million a day. (The purchase also included generous royalties to the Weizmann Institute and its scientists: Michael Sela, Ruth Arnon and Dvora Teitelbaum).
In Hurvitz’s time, Teva was offered companies such as Crucell and Cougar Biotechnology. The latter was bought in 2009 by Johnson & Johnson for $1 billion because of one product that was then in its pipeline: Zytiga, a drug for treating prostate cancer, sales of which totaled $1.2 billion in the first three-quarters of 2013 alone.
That may not be equivalent to all the profits from Copaxone, but it certainly would have been a promising start. Up until Hurvitz’s last days at Teva, the company refrained from entering the innovation field with the goal of finding a real solution to the Copaxone problem. It is no coincidence that shortly after his death, a CEO was appointed who had built his career at an original-drug manufacturer, with no affiliation with the generics field.
Hurvitz’s replacement, Makov, gambled on the wrong molecule for the role of an oral therapy drug for MS to replace Copaxone eventually, when, in June 2004, he acquired the rights to develop Laquinimod from Sweden’s Active Biotech. Today, when the oral MS drug Tecfidera, developed by Biogen Idec at the same time as Laquinimod, has grabbed 12.3 percent of the MS market in the less-than-six months since its launch, it is clear that Teva backed the wrong horse.
Makov’s successors, however, Yanai and Levin, continue to believe in Laquinimod and claim that poor design of the trial caused its weak results. If they are proved right, then Makov oversaw a trial that was designed deficiently and caused Teva a two- or three-year delay in entering the market, which will probably also wind up costing it primacy in the market with annual sales of $13 billion.
Yanai liked to say that the best road to generating value for investors goes through corporate acquisitions. He certainly put that strategy into action, but he squandered immense amounts of ammunition shooting at the wrong targets. Between January 2008 and September 2011, Teva spent $22 billion on acquisitions, an astronomical sum for a company with a current market value of $33.7 billion.
The series of acquisitions increased annual sales from $8 billion to $18 billion, but the impact on profit and profit per share was negligible. Teva’s profits grew by only $800 million during that period, and its profit per share grew by just 71 cents. That is a paltry result, so it is no wonder Teva shares registered a negative yield of 28 percent during his tenure.
Moreover, Yanai, who was handed a company with a debt of $3.3 billion, passed on to Levin a net debt of $11.6 billion. This limited the incoming CEO’s maneuvering room in advance − especially considering that the company’s cash flow, 60 percent of which derived from Copaxone, was facing an inevitable decline.
As if that were not enough, Yanai left Levin to deal with one of the more unfortunate messes he had made: Less than a year after taking up his post, Yanai gambled that he would be able to prove in court that the patent Pfizer had registered on the heartburn drug Protinix was invalid. In December 2007, Teva began marketing the generic version of the drug, and notched up sales of $1.1 billion by early 2011. But the gamble failed, when, in June 2013, an American jury ruled that Teva had to pay Pfizer $1.6 billion in compensation. The stinging legal defeat resounded throughout the second half of Yanai’s tenure and negatively impacted company policy in the generic market.
Yanai’s buying spree was meant to serve two out of the three components of the strategy he set for the company: One was coping with fiercer competition in the American generic market and the decline in the potential of exclusive launches, while the company entered less-developed generic markets than the American one. The other was reducing the dependence on Copaxone by buying up original-drug companies, thereby acquiring the know-how for developing an original drug. That was an area in which Teva failed again and again even though it allocated 30 percent of its R&D budget to innovative research.
Yanai’s acquisitions suffered from a combination of miserable timing and few successes in vetting the assets in question. Under him, Teva regularly overpaid for companies. Some of these, like Germany’s Ratiopharm and Spain’s Bentley Pharmaceuticals, were facing a dramatic downturn in the level of prices in their generic markets, because of a change in the pricing levels in insurance company bids and government tenders.
Others were supposed to give Teva access to markets for unique drugs where there was relatively little competition. One example of this was Barr Pharmaceuticals, which was considered a leader in the women’s health market, and which Teva bought out in 2008 for $7.4 billion. However, major assets like the morning-after pill turned out to have shaky patent protection and collapsed under pressure from rival Watson, headed by Paul Bisaro, formerly a senior executive at Barr.
Yanai did succeed in acquiring a leading company in the Japanese generic market and increased its geographic spread, but failed to break into the fast-growing Brazilian market when he forfeited the company Medley to Sanofi because of concerns over irregularities and a substandard organizational culture. To Yanai’s credit, it should be said that toward the end of his tenure, he tried to grab the bull by the horns and provide a solution to the growing dependence on Copaxone by acquiring a company that develops original drugs and ostensibly had proven experience in overcoming the technological and regulatory obstacles with which Teva was not good at dealing.
Apparently, during Hurvitz’s gradual withdrawal from the stage and due to the growing influence of the current chairman of the board, Phillip Frost, Yanai acquired, for $6.5 billion in cash and in addition to a debt of $1.9 billion, full ownership of Cephalon, a company that specialized in developing drugs to treat the central nervous system, primarily sleep disorders and cancer.
Acquiring Cephalon, a company that 26 others had previously considered, including BMS, where Levin was previously employed, turned out to be the fiasco that concluded Yanai’s term. Cephalon’s main drug is Provigil, for treating narcolepsy, which lost exclusivity less than a year after the acquisition. As a consequence, its sales plummeted from $300 million in the third quarter of 2011, when the acquisition went through, to $48 million in the second quarter of 2012, when generic competition began, and down to $19 million in the second quarter of 2013.
Hydrocodone, one of Cephalon’s main drugs, which is used for treating pain in cancer patients and was supposed to provide Teva with annual sales of $400 million, failed in the final stage of its clinical trials − less than half a year after completing the acquisition. A substantial part of what was left in the company’s development pipeline was simply wiped out when Levin took over. The new CEO made his opinion of the acquisition of Cephalon and its assets very clear on the day he arrived, which coincided with the resignation of Cephalon’s former CEO, Kevin Buchi, who was supposed to bring Teva the know-how to develop and register original drugs.
Big debt, new strategy
The South African-born Levin took the helm as CEO in May 2012 and devised a new strategy. Its main thrust was stopping the big acquisitions, a decision largely born of necessity because of the massive financial debt Teva had racked up in the failed procurement quest. Levin made it clear that he would focus on acquisition of and collaboration with companies that develop original drugs for central nervous system disorders, as well as on development of new medications based on combinations of existing generic drugs. He expressed a commitment to the generic field but emphasized that acquisitions in this area would be limited to small- and medium-sized companies that could complete Teva’s geographic spread.
Less than a year after it presented the new strategic plan known as Project Spring − prepared with the help of the management-consulting firm McKinsey at a cost of tens of millions of dollars, and also after defining its pretentious goal of being “the most vital drug company” − it seems Levin ran up against the wall of reality. The organizational message he began to convey, under such euphemistic headings as “we will not compete in generics where we do not have a relative edge,” “we will forgo unprofitable bids,” “the era of big acquisitions is over” and more, was heard loud and clear.
The generic research and development field lost several of the prominent figures who had led it, such as Chris Pelloni, Teva’s former vice president for global generic R&D. The result is very apparent in the dearth of new generics being launched and an ongoing drop in the company’s market share, which stands out in view of the thriving of its two main generic rivals, Mylan and Actavis.
Levin united the R&D for both generic and original drugs under Michael Hayden, who lacks any real connection to the unique organizational culture of the generic market, which needs alley cats more than learned professors. The move appeared to be another step toward sidelining generics and an almost voluntary relinquishing of Teva’s leading status in this market.
Teva is also no longer a player in the vibrant market of mergers and acquisitions, both in terms of generics and in general. It did not engage seriously in the bidding for the South African company Adcock Ingram, the second-largest pharma in that country’s market, and lost it in September to the Chilean company CFR, which also stripped Teva of its standing as market leader in Chile. CFR bought Adcock Ingram for S1.3 billion and excluded Teva from involvement in the South African market, which is thought to have important growth potential.
Levin, so it would appear, also introduced an organizational culture that does not suit a company that is meant to be going through a painful withdrawal process. Someone who plans to lay off between 700 and 900 workers in Israel, as reported in Haaretz, probably shouldn’t begin by increasing personnel by 151 employees within six months, many of them headquarters staff members brought in from other multinational companies at considerable cost, including their expensive relocation to Israel.
Levin has also failed when it comes to setting a personal example: starting with his decision not to cut his salary, even as he was announcing the plan to lay off about 10 percent of the company’s workforce, and ending with his insistence that the modest office used by Hurvitz, Makov and Yanai undergo massive renovation before he would occupy it himself.
The streamlining plan announced earlier this month might decide the question of Teva’s future independence and also share price, which is still held by many Israelis at a total value of $5.5 billion.
Strict adherence to the cuts in expenditure appears, at this stage, to be practically the only chance for the stock to go up and for the recovery process to succeed. A company that over too many years was lulled into complacency by the easy profits from Copaxone now faces the need to pay off financial debt of $12.5 billion, even as it faces a future in which it will be unable to count on the cash flow of $2.5 billion a year that Copaxone provided if generic competition does indeed begin early as May 2014.
Precise acquisitions and collaborations that show signs of hope early on are another critical component, but it is not certain Levin has enough time for such moves to ripen. Unless the share price moves upward in the near future, Teva will become a target for acquisition by private investment funds and giant corporations, which will be delighted to swallow up its remaining assets and leap like pirates aboard what was once the flagship of Israeli industry.
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