It’s inevitable that troubled drug companies find themselves compared to sickly patients. That was Teva Pharmaceuticals’ fate last week when it turned in another quarter of dismal earnings, yet again. “Ouch! Teva Needs An IV, Stat,” the investor magazine Barron’s wrote.
In Teva’s case, the atmosphere is positively funereal. The "doctors" – equity analysts, bond rating agencies, and pundits – all diagnose Teva’s many problems in a cool, clinical manner, but the faint scent of death is unmistakable. Its stock is down about 70% from its peak.
Umer Raffat, an analyst at Evercore, said it “will be a long road ahead for Teva" but many investors were thinking more like “the road ahead is a dead end.” But it isn't.
From cash cow to chopped meat
To be fair, many of Teva’s immense problems are beyond its control, which gives its new CEO, Kare Schultz, uncomfortably little room to maneuver.
The company’s core generic drugs business has been pounded by declining prices in America. The big drug buyers – like pharmacy chains, wholesales and drug-benefits managers – have ganged up on makers likeTeva and pressed them to cut prices. Meanwhile, the U.S. Food and Drug Administration has begun to speed up generic approvals, which means more competition and added pressure on prices. In addition, Indian pharma companies have emerged as low-cost player.
Profits for Teva’s generics segment fell 37% in the third quarter from a year earlier, and the company now admits that revenues from new generic products are going to be lower than expected.
Then there’s Copaxone, the multiple sclerosis drug that is the company’s biggest-selling non-generic drug and over the years, has generated an outsized part of its profits. Copaxone sales were down 7% in the third quarter year over year, and are about to seriously plummet after Mylan got U.S. approval to make a generic version in the 40-milligram dosage that has been the mainstay version of Copaxone in recent years. Teva will have to slash its prices on the drug to match Mylan’s and it will still lose market share. Once a cash cow, Copaxone is now chopped meat.
The loss of Copaxone exclusivity and the problems in the generics market couldn’t come at a worse time for Teva: It need to makes payments on some $35 billion in debt in ran up buying the generic-drugs division of Allergan just as the generics business was going sour.
The math and the aftermath
Teva has slashed its dividend, it’s cutting costs, and it’s selling off businesses to help repay the debt, but its ability to repay is getting squeezed by its Copaxone and generics woes. Analysts at Bernstein predict that the free cash flow Teva needs to generate to pay down the debt will shrink next year to $3 billion from $4 billion. As it is, Teva admitted last week it might come up as much as $1.5 billion short of its $5 billion target for cutting debt this year.
Last week Moody’s estimated that Teva’s debt will grow to five times earnings before interest, taxes, depreciation and amortization next year and ease only moderately to four times EBITDA in 2019.
Add in years of management upheaval and legal problems: it’s no surprise that Teva shares are down to their 2000 level. And, with Allergan saying last week that its plans to offload a 10% stake in Teva it acquired in partial payment for its generics business, the shares are going to fall further still.
Yet, if Kare Schultz can keep the company afloat through a stormy year or two, things may start looking better.
The Allergan acquisition certainly looks like a disaster from the perspective of November 2017, but that may well change. The deal ensured Teva’s place as the world’s biggest generics maker, just ahead of Mylan and Novartis, and that should give it an edge once the generics market stabilizes, as it inevitably will.
The demographics and the generic pot
For one, the U.S. and world populations are aging, and the elderly are much bigger consumers of drugs than younger people. Meanwhile, governments are under pressure to contain healthcare costs and generic drugs, which are far cheaper than branded ones, is one way to do that. As the largest generics maker Teva is in a good position to benefit from the demographics.
Secondly, analysts at UBS estimate that some $90 billion of branded drugs are due to go off patent over the five years from 2016, putting up for grabs by generics makers like Teva. That is actually less than in the years 2011 to 2015, but the figure doesn’t include the emerging sector of biologicals, which are drugs derived from living cells. UBS says biologicals going off patent could add $15 billion to the generic pot.
Teva is a leading player in generic biologicals, known as biosimilars, which means that it should benefit from the trend. Moreover, generics in general are becoming increasingly sophisticated, which requires expensive and complex regulatory and compliance procures that favor the biggest drug makers like Teva.
Finally, generics prices have to turn higher. The consensus is that that’s not going to happen in 2018 but that eventually, low prices will lead to mergers and acquisitions that will remove some players and ease the competitive pressure. On that account, Teva’s Allergan generics purchase puts it ahead of the game.
What remains to be seen is whether Schultz can fix Teva’s finances until the business environment turns around. His track record is promising and interestingly, reports emerged over the weekend that the U.S. billionaire Len Blavatnik might buy up to a $3 billion of Teva stock. That would not only give the company a badly needed cash infusion but a strong vote of confidence.
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