Analysis

The Price-fixing Claims Look Worse for Teva Than They Really Are

It’s a nasty business but the financial impact on Teva is containable and the bigger picture for the troubled drug maker is looking brighter

Teva CEO, Kare Schultz, speaks in Tel Aviv, Israel, February 19, 2019.
Ofer Vaknin

You might think that after hearing the news about a massive price-fixing lawsuit against Teva Pharmaceuticals, its CEO Kåre Schultz is ready to pack his bags and go back to a peaceful life in Denmark.

When he took over the Israeli pharma at the end of 2017, Schultz knew the company had multiple ailments -- tens of billions of dollars of debt, intensifying competition in its core generics business, and the imminent onset of generic competition for its best-selling multiple sclerosis treatment, Copaxone.

He could foresee long hours of work, lots of setbacks, sniping from Wall Street, and political controversy from the layoffs and factory closings he would and did impose. If he was successful, he would be able to bask in the glory of being the man who saved Teva, but the odds were good that he would fail.

>> Forty U.S. states sue Teva, other drugmakers for 'multi-billion dollar fraud on the American people'

Schultz is getting paid well for his troubles, but they keep mounting. Teva got caught up in the opioid crisis in the United States (albeit as a bit player) and its bonds have been downgraded to junk. Now a group of 40 U.S. states led by Connecticut has named the Israeli drug maker as the lynchpin of a conspiracy to fix generic drug prices.

Schultz's brief honeymoon with shareholders when he took the helm at the end of 2017 is long over. But investors may be thinking it’s time to give up on Teva, too. Teva’s troubles, both financial and reputational, have laid it low.

Nevertheless, I don’t think Schultz will be going anywhere, and neither should investors. Here’s why.

Horror stories

The price-fixing allegations are serious business and, as they are wont to do, prosecutors have made sure the public is horrified by stories of 1,000% price hikes and conspiracies hatched at cocktail parties and on golf courses. The Justice Department is threatening to press criminal charges, too.

“We have hard evidence that shows the generic drug industry perpetrated a multi-billion dollar fraud on the American people,” Connecticut Attorney General William Tong, who is leading the lawsuit,  said in a statement Friday. “We all wonder why our healthcare, and specifically the prices for generic prescription drugs, are so expensive in this country — this is a big reason why.”

I’ll let others thunder against the sins of price-fixing, which are in any event self-evident, and focus more on what this means for Teva going forward.

It’s not very much. The states suing Teva and 19 other generic drug makers haven’t said the amount of damages and penalties they will seek, but one analyst, Steven Tepper at Israel Brokerage & Investments, doesn’t think the financial damage to Teva will be that great. He estimates that added the revenues Teva generated from the alleged price fixing amount to at most $1.5 billion. Adding in interest and penalties, Teva could be liable for $2 billion.

It’s not that $2 billion isn’t a lot of money, but keep it in perspective: That was less than Teva what recorded in operating cash flow last year. In any case, even if the suit is successful, it will take years to complete at which point Teva may well be a better position financially to cope with the cost.

Teva’s situation looks pretty bad right now, but most of its problems are the consequences of mistakes and unfavorable market conditions of the past. The future looks brighter -- it just has to come, and that should be starting next year.

Teva’s big problem was the fantastically ill-timed acquisition of Activis Generics under Schultz’s predecessor. The $40.5 billion deal saddled Teva with enormous debt just as the American generic market was turning sour for pharma companies.

In a bid to bring down drug costs, U.S. regulators accelerated the pace of generic approvals just as the power of group purchasing organizations over prices was growing. The result was that generic prices sagged and Activis failed to deliver the profits that could pay off the debt and justify the outsized price Teva paid for the company.

But the pace of new generic approvals has slowed, which is in Teva's favor: the fewer new generics on the market, the less competition. Most approvals are for second, third and fourth versions of the same generic. Once more than one generic version of a drug is available on the market, the price falls because there's more competition. Generic manufacturers like Teva make most of their profits being the first past the post (at which point they get a certain period of generic exclusivity). Price declines have been tailing off and should begin to turn around soon (presumably without the help of price fixing).

When that happens, Teva will be well positioned. For all its faults, the Activist deal ensured that Teva remained the No. 1 maker of generics. Teva has a strong portfolio of generic treatments and more in the pipeline. One market research firm sees global generic sales growing at a 6.8% compounded annual growth rate between 2016 and 2021.

That’s not all. Copaxone is no longer than cash cow it once was, but Teva has two new proprietary drugs, invented in-house: Ajovy for migraine headaches and Austedo to treat both tardive dyskinesia and chorea associated with Huntington's -- that promise to fill part of the gap.

Meanwhile Schultz has squeezed $2.5 billion of annual costs out of Teva and promises more cuts to come this year. The fact is the company was run so inefficiently before he arrived meant that Schultz could take a scalpel to it without fundamentally hurting its performance.

It would be overshooting to say that Teva is out of the woods. Lots of things could go wrong, like the generics market not recovering, or Teva’s new drugs not meeting expectations. That’s what will determine Teva’s future, not a price-fixing lawsuit.