Analysis

Drug Giant Teva Has No Choice: It Must Cut Its Ties to Israel to Survive

Drug manufacturing in Israel is becoming too expensive and makes Teva uncompetitive

Boxes of tablets, produced by Teva Pharmaceutical Industries Ltd., sit on a pharmacy counter in this arranged photograph in London, U.K., on Thursday, Dec. 29, 2016. The rapid pace of innovation among drugmakers may continue to be overshadowed by broader investment themes, such as the switch away from defensive stocks into more cyclical industries, during 2017, according to Bloomberg Intelligence. Photographer: Chris Ratcliffe/Bloomberg
Chris Ratcliffe/Bloomberg

Only a month after he took over as the new CEO of Teva Pharmaceutical Industries, Kare Schultz is facing the thankless task of firing thousands of employees and selling off factories. At the same time he is facing fierce political and public opposition in Israel, and elsewhere, in his last ditch attempt to save the drug company that must pay off $9 billion in debts over the next two years.

Firing 1,700 Teva workers is a mass terrorist attack, wrote MK Shelly Yacimovich (Zionist Union) in her weekly email newsletter. The workers are simply human sacrifices of a failed management, stupidity and greed. We are sick of the policy of excessive tax benefits for companies such as Teva, which provide zero obligation in return. Yacimovich noted that Tevas tax breaks have reached 20 billion shekels ($5.7 billion). In short, when the company makes a profit, the huge profits flow into its kitty, and when it declines – only the public pays the price, she added.

Kare Schultz, Teva's new CEO.

To have a chance to survive, Schultz – and Teva – will have to end part of its manufacturing in Israel because costs here are too high and this makes the company uncompetitive. Teva has three main manufacturing centers in Israel: an active raw materials plant in Neot Hovav in the Negev, just south of Beer Sheva, which houses 1,150 employees; a tablet and multi-purpose manufacturing facility in Jerusalem that employs 1,100 workers; and plants in Kfar Saba, where 1,250 employees work.

It will be difficult to end the production in Neot Hovav because it will be necessary to receive regulatory approval to transfer the raw material production for existing drugs, though in the long term it could be financially worthwhile to manufacture the raw materials for new products in a plant where manufacturing costs are much lower – similar to the costs in the facilities Teva now operates in India.

In addition, Teva has peripheral operations that are not losing money, but their contribution to the bottom line is marginal, such as its plant in Kiryat Shmona, which manufactures laboratory equipment and other medical supplies. The same applies to Teva Medical in Ashdod, which produces medical equipment for hospitals for dialysis, diagnostics and intravenous feeding. Teva will most likely sell off these assets to avoid the public protests layoffs would cause in a sensitive location like Kiryat Shmona.

Yacimovich, who is the chairwoman of the State Control Committee, will convene the committee in the Knesset for an emergency session on Monday. She is expected to raise her proposal for more respectable layoff agreements, with small golden parachutes to benefit the good people who worked well at low wages, at the same time their managers got rich and also failed.

Will innovation be let go, too?

Such comments are among the obstacles Schultz faces, and his own salary package has attracted a deserved amount of attention. The deal includes a $20 million cash signing bonus, $15 million in restricted stock grants and an annual salary and bonus in the $8 million to $12 million range.

Medicine men Teva's global workforce, '000s

Aharon Gal, a senior pharmaceutical analyst at Sanford C. Bernstein, says this is the first real test for Schultz and Tevas board of directors. If they cannot meet the challenge, Tevas chances of recovery are very small, he says. Gal is not one of the many who believes Teva will raise capital now because it will seriously dilute the holdings of existing shareholders given the huge drop in the share price recently.

A massive program of cutbacks will be able to lower Tevas risk levels, as reflected in the credit default swap contracts on the companys debt – and allow Teva to refinance its debts, says Gal. Only when the stock returns to a level of $20 to $25 a share, compared to $13.70 today, will Teva consider a share issue, he adds.

Teva is scheduled to repay $9.1 billion in debt in 2018 and 2019. The payment schedule demonstrates the firms serious financial condition, so the likelihood that Teva will hand out golden parachutes to workers is not very likely, even though no one disputes that some of the companys employees will be the ones to pay the price for the gross mistake of management and the board that led to the $39 billion acquisition Actavis Generics.

Teva spends $4 billion a year on salaries for its 56,000 employees. The difference in wages between salespeople in the United States and manufacturing workers in India is enormous. By giving up unprofitable products and markets, Schultz could find a source to save some of these wage costs in a manner that could make up for some of the expected drop in cash flow. This reduction stems from increased competition to its flagship Copaxone product for treating multiple sclerosis.

Giving up some less profitable products might lose Teva the title of the worlds largest generic drug company, but could make it much more profitable by getting rid of some of its manufacturing and logistics operations, such as in Latin America or in Eastern Europe.