Pills and Hope

For Teva Pharmaceuticals, Stagnation Is the New Growth

CEO Erez Vigodman is preparing the ground for Teva’s fall from the ‘patent cliff’ onto the generic plateau. ‘Acquisitions will be a larger component in 2015.’

Reuven Kopitchinski

The swift implementation of the efficiency plan presented by CEO Erez Vigodman last February has breathed new life into Teva Pharmaceuticals and restored some credit to the drug company’s management that had been lost in the capital markets. To paraphrase Teva CFO Eyal Desheh, during recent years the company promised a lot and fulfilled very little.

Vigodman tried to make use of the credit he has gathered over the past 10 months as he presented Teva’s business outlook for 2015 last Thursday, describing the expected trends in coming years.

Adam Reynolds/Bloomberg

The main message he tried to convey – time after time – at the meeting with analysts in New York was that Teva can guarantee a minimum profit of $5 per share from 2016 onward, which is $4.3 billion a year.

Teva can do this even if it “falls off the patent cliff” – in other words, it can handle generic competition to its flagship Copaxone drug (for treating multiple sclerosis), even if it loses exclusivity on marketing four other branded drugs.

In light of Teva’s achievements in 2014, Vigodman felt comfortable talking about something Teva forgot a long time ago – growth, starting in 2017. The stock responded cautiously, rising 1%, similar to the general rise that day for all shares, showing that investors are willing to stake Vigodman another round of credit.

The need to convince the markets that the floor beneath the patent cliff is a profit of $5 per share is critical to preserving one of Vigodman’s major achievements during his short tenure: The 40% rise in the stock price to $57 per share, which reflects a price-to-earnings ratio of 17.7.

Back in the game

The share price revival will aid Vigodman in returning Teva to the mergers and acquisitions game, where it has been missing in action for the past three years – the best period in the history of the pharmaceutical industry.

Returning to M&A will make it easier for Vigodman to convince the markets that Teva is capable of returning to organic growth, and that it really does have a bright new future – two of the four main goals he set for Teva in 2014, which were only partially achieved. Vigodman mentioned Teva’s achievement in fulfilling two other goals in 2014: Strengthening the company’s fundamentals, and protecting Copaxone.

Teva estimates that it will cut $650 million in costs this year – mostly in the generic division – and improve the operating profit of the division by 4%.

Vigodman made clear that one of the company’s goals in 2015 will be to reduce expenses by another $500 million, and also improve the generics division’s operating profit an extra 2%. The plans for 2016 are another $200 million in cuts, which, all told, will produce savings of $1.35 billion over the 2014-2017 period.

One of the most important ways of reaching this ambitious goal is the implementation of a plan to lower production costs to less than $10 per 1,000 pills: within five years, 60% of production will be transferred to countries where production costs are in the range of $6-$7 per 1,000 tablets.

Not just trimming fat

Protecting Copaxone was another critical mission for 2014. Teva launched a new version of the drug last January with a dosage of 40 milligrams, switching 60% of patients taking the original drug to the new version. The company received approval for marketing the new version in Europe, starting in the first quarter of 2015. Teva forecast it would transfer 70% to 80% of patients to the new version by the time the generic version of 20-miligram. Copaxone is launched in September 2015 by two expected competitors.

Strengthening Teva’s foundations as a generic drug company and the successful Copaxone launch helped cash flow reach $4.5 billion in 2014 (based on the company’s forecasts). This allowed for the reduction of financial debt by $1.6 billion to $10.6 billion, which is 31% of the balance sheet and 1.76 times EBITDA.

Such a level of leverage allowed Vigodman to say what he was expected to say in order to convince analysts that Teva was capable of creating value through developing the business and not just by trimming the fat that accumulated over the decades of selling Copaxone: That Teva is positioned for a sizeable acquisition.

When asked to say what type of company tops the list of targets, Vigodman said an American firm that develops original drugs, a manufacturer of complex generic drugs, and a generic company in emerging markets.

Sigurdur Olafsson was brought in from Actavis Pharma to raise the profitability of the world’s largest generic drug company to that of its rivals. The Icelander’s (U.S.-based) job is to provide this profit cushion in 2015 and 2016, the years in which Copaxone will start to face competition from generics – when Teva’s pipeline of original drugs will still not be able to provide much in the way of support.

Olafsson explained how he had improved the profitability of the generic division in 2014, and how he intends to improve operating profits from generics by 53% from 2013 through 2015 – even though the division’s sales are forecast to fall 6% over this period.

The key to a further 6.5% improvement in operating profits for generics in 2014-2016 is selective and focused targeting on profitable markets, as opposed to the previous strategy of gaining market share, which characterized Teva until 2012. The best test of this new strategy will be in Europe. Teva’s previous strategy there saw market share be the main target, with Teva rising to third place in 20 European countries, but at the cost of low profitability – 12% of revenues in 2013.

Teva has started optimizing its basket of products and geographic presence – in other words, it will concentrate its marketing efforts on large markets with large potential growth and profit, at the expense of some markets where it now operates and does not show adequate returns on investment. This is the case in some markets because of the large amount of competition and burdens of regulation, such as in Norway. In addition, Teva has weeded out products with low profitability from its product line.

Teva expects its sales in Europe to drop between 11% to 25% from 2013 through 2015, but its operating profit to climb to 20% of revenues by 2015. Its European profits in 2014 are already on track to show a growth of $130 million, compared to last year. A similar strategy is already bearing fruit in the United States.

Olafsson summarized Teva’s new strategy for emerging markets by saying the focus will be fewer markets, but bigger in all of them. In addition to BRIC (Brazil, Russia, India and China), Teva has chosen to focus and increase its presence in Mexico, Argentina, Turkey, Indonesia, South Korea, Australia and Venezuela.

As for where Teva will be forced to bridge its weaknesses with acquisitions, Olafsson said Teva is number 81 in Brazil, and that it is not an appropriate position for a company of its size. He said it will also make a significant effort to increase its presence in Mexico.

Another part of the strategy is a move to complex generic products, where entry barriers are higher and competition lower (if it exists at all). Potential areas include quick-dissolving thin films and patches, vaginal rings, injectibles, inhalators and suspensions given through the nose, as well as long-term injectible drugs.

Short of expectations

In conclusion, Teva forecast its 2015 revenues to be below analysts’ expectations, due to adverse foreign exchange moves and the generic competition for Copaxone, which accounts for about 20% of sales and 50% of the company’s profit. The injectible drug faces new competition from oral treatments as well as cheaper generics in coming years.

“Earlier entry by generics could reduce operating income by $30 million to $50 million per month,” the company said.

Teva forecast 2015 diluted earnings per share excluding one-time items of $5-$5.30 on revenue of $19-$19.4 billion. Analysts currently forecast EPS of $5.06 and revenue of $20.1 billion. Teva is expected to earn $5.06 a share on revenue of $20.3 billion in 2014.

It expects its generic version of AstraZeneca’s Pulmicort treatment for asthma to be hit by additional generic competition in the first half of 2015. Vigodman said he expects approval for four specialty drug products and five submissions in 2015.

“We are pleased with the progress we have made this year, which has created a strong foundation from which our business can continue to grow while delivering value to patients. We remain committed to utilizing our strong cash flow to return cash to shareholders and invest in long-term organic growth, while maintaining the flexibility to engage in strategic business development opportunities,” said Vigodman.

“As we look to the future, we will continue to deliver on our operational, financial and strategic goals to further explore the unique space Teva has at the intersection between generics and specialty, and increase access to health care to patients around the world,” he added.