Can Erez Vigodman Cure an Ailing Teva?

The drugmaker's new CEO gets a chance to perform the same turnaround magic he did at agro-chemicals maker Makhteshim Agan.

Erez Vigodman was not necessarily the obvious choice for CEO of Teva Pharmaceutical Industries.

Most of the candidates found by the company’s search committee and executive search firm Egon Zehnder fell into one of two categories: CEOs of pharm companies of all types, including developers of proprietary drugs, or division heads of drug companies more than double Teva’s size who also had experience managing smaller companies.

Teva’s new CEO would need proven ability managing a global company with a complex business model, as well as turning around corporate fortunes. Dozens of candidates were also evaluated for their skills in enlisting the support of subordinates and board members. Vigodman met all the criteria, in some cases with room to spare.

Teva’s hybrid business model — the company develops proprietary drugs as well as generics — probably compensated for Vigodman’s lack of industry experience. Running Teva is not like running either an all-generic manufacturer or a wholly innovative drug developer. In particular, the board saw no particular advantage in hiring the CEO of a smaller generic drug company to head the world’s biggest generic drug manufacturer. In fact, managing a company in the generic pesticide industry is very similar, in terms of regulation as well as research and development, to managing a manufacturer of generic drugs. Vigodman’s experience as CEO and president of Makhteshim Agan may, therefore, have made him nearly the ideal candidate for the top job at Teva based on the criteria set by the company’s board and Egon Zehnder.

How Vigodman turned around Makhteshim Agan

The great changes Vigodman brought to Makhteshim Agan may hint at his plans for Teva. First, he focused on improving the agrochemical company’s gross profitability. Old factories at the firm’s Brazilian subsidiary Milenia Agrociencias were closed and 300 of its 800 employees were laid off. Makhteshim Agan stopped manufacturing products with low gross profit margins, moving their production to subcontractors in China and cutting marketing for these products to the bone. A similar but slightly less drastic process took place at the company’s Israeli plants, rendered uncompetitive by the appreciation of the shekel.

Makhteshim Agan acquired plants in Mexico and South Korea and built a $50 million factory in India to cut the distance between production and target markets. The company’s offerings were reinvigorated by the acquisition of profitable product lines from other companies, such as the herbicide Diuron from DuPont, and the development of generic versions of by finding ways around patents, such as Bayer and BASF’s patent for the pesticide and insecticide Fipronil.

Vigodman also made significant strides to solve structural problems in the pesticide market and strategically carve out a space for the company in a future where Chinese and Indian manufacturers would gradually take over the production of older pesticides and erode their profitability. Makhteshim Agan signed a production agreement with U.S. chemical giant Monsanto to develop an herbicide for weeds that had developed resistance to glyphosate, its popular herbicide marketed as Roundup.

The agreement opened up to Makhteshim Agan the world’s biggest pesticide market, which until then had been controlled by six distributors with ties to the original pesticide manufacturers. The Israeli company’s sale to China National Chemical Corp (ChemChina) at the end of 2011, meanwhile, gave it entree to China, which is expected to displace the United States as the world’s largest consumer of pesticides. It also allowed Makhteshim Agan to return to the herbicide market by acquiring and folding ChemChina’s Chinese factories into the company.

The changes rebooted Makhteshim Agan, whose revenues grew at annual pace of 9% between 2009 and 2012. Gross profitability, the focus of the recovery plan, rose to 32.3% of revenue between January and September 2013 (the last period for which figures are available), from 26% in 2009. The company’s Ebitda jumped from 9.8% of revenue in 2009 to 17.1% of revenue between January and September 2013.

The difficult road ahead

Vigodman led the rescue plan for Makhteshim Agam while also serving on Teva’s board, watching the world’s leading generic drug company lose its competitive advantage due to problems fundamentally similar to those at the pesticide marker. His success at Makhteshim Agan will help Vigodman at Teva but is far from guaranteeing a similar outcome. Teva is in a much more complex situation, while the time to implement solutions is limited and the expectations of the U.S. financial market always hang overhead.

The U.S. capital market does not understand why Teva’s CEO isn’t on the company’s board. Some figures viewed Teva’s board as pushing out, without suitable explanation, CEO Jeremy Levin, a respected figure in the international pharmaceutical industry, in a ploy to take over the company with Vigodman brought in as a puppet.

Some of the funds that hold shares in Teva are rumored to be in favor of selling it to a larger company to receive a premium on the current share price and get rid of their holdings in the worst performing pharma stock in 2013. It will be critical for Vigodman to rapidly restore the faith of the U.S. capital market in Teva and stabilize its stock prize to head off a potential hostile takeover bid. Such a deal would likely lead to the selling off of parts of Teva and its end as an Israeli company.

One reason for the pressing need for Vigodman to implement change is the significant threat to Teva’s profitability posed by the entry of generic competition to its blockbuster drug for treating multiple sclerosis, Copaxone, expected in May 2014. In that month, two generic versions, one developed by Novartis together with Momenta Pharmaceuticals, the second from Mylan and Natco Pharma, are expected to enter the market.

Copaxone delivers 20% of Teva’s revenues and 60% of its profits. Teva has estimated that generic competition to Copaxone will reduce its revenues by $500 million and stated that even a one-month delay in the launch of a generic version will increase its net profits by $78 million.

Teva could find alternative original drugs to compensate for dropping revenues from Copaxone, but until now it has failed in its effort to develop or acquire a new drug. The most significant attempt in this regard was its acquisition of Cephalon in 2001 for $6.8 billion, a decision in which Vigodman participated as a board member, and that ended in a painful failure.

Vigodman’s job will also be harder than his predecessors at Teva due to its reported net debts of $11 billion. Off-balance sheet liabilities for tax payments on “trapped profits” under Israel’s revised Encouragement of Capital Investments Law and Teva’s loss to Pfizer in a patent infringement case for heartburn drug Protonix, mean the company’s total net debt is actually $12.5 billion A large part of this debt was accumulated as part of the problematic acquisition spree led by former CEO Shlomo Yanai.

This debt, combined with the expected drop in Teva’s cash flow in less than a year due to generic competition, will make it hard for Teva to make acquisitions that will reduce its dependence on Copaxone.

One of the less well-known causes of Teva’s weakening performance in recent years was the decline in profitability of generic drug manufacturing due to excess production capacity as a result of over-expansion, production sites with high labor costs such as those in the United States and Israel and inefficient buying of raw materials.

The decline in profitability caused Teva to lose market share in its two most important markets, the United States and Germany. To return its generic drug manufacturing operation to profitability, Vigodman will need to quickly close between 20 and 25 of Teva’s 75 production plants.

Vigodman will also need to revive Teva’s generic R&D program, which has lost its clear lead over competitors such as Actavis and Mylan. In particular, it must develop new generic drugs to reduce the dependence of its generics sales in the U.S. market on its version of asthma drug Pulmicort, which earns Teva $700 million per year in sales with a high profit margin and is expected to face competition in another 10 months.

Eyal Toueg