Things have been going very wrong lately for Teva Pharmaceutical Industries Ltd., the drugmaker that has been a source of national pride and a fixture of local investment plans, earning it the moniker “the people’s stock.”
Thanks to a series of perceived missteps by management, and some unfortunate timing, Israel’s biggest company has struggled in recent months to fend off competition on a key product and, as its shares have plunged, billions of shekels have been wiped out from Israelis’ savings portfolios.
Teva’s share price dropped 46 percent on the Tel Aviv Stock Exchange in 2016, making it the worst performer on the benchmark TA-25 index. The company’s New York-traded shares fell almost 8 percent on January 6, after management estimated that its revenues and profits for 2017 would be significantly lower than had been forecast in July, due to foreign exchange fluctuations and a lower-than-expected profit from its US generics business.
Teva’s stock now trades at less than half of what it was in August 2015, when it reached an all-time high. And while shares of all global generic drug companies have been battered, Teva’s decline is greater than the 12 percent drop of the MSCI world pharma index in the past year.
Investors and analysts are concerned that the company, in which almost every household in Israel has a stake through pensions and savings plans, is zigzagging ineffectively in its efforts to find an alternative to its blockbuster proprietary multiple sclerosis drug Copaxone, which is being threatened by competition as its patents expire. A court decision will determine if Copaxone will see even more competition in the US as soon as next month.
Erez Vigodman, a wunderkind of the Israeli industry who has headed the company since 2014 and led the share to its August 2015 high, is now coming under fire for taking the company on an expensive acquisition spree in a effort to maintain its edge in the generics market.
To pay for these acquisitions the company’s debt has ballooned to over $30 billion, around as much as the company’s current market capital, and some analysts fret over whether the drugmaker will be able to service its debt in light of increased competition to Copaxone that would impact revenues. To top it all, the company has also been under investigation by US regulators for price-fixing and for bribing medical representatives to prescribe its drugs.
“It was not just one thing that went wrong with Teva. It was a series of things, some of which depended on the company and others that derived from changes in market conditions,” said Yaniv Pagot, an economist and head of strategy for the Ayalon Group, an Israeli institutional investor. Pagot estimated that the stock price drop has easily wiped out some NIS 2.5 billion from Israeli pensions and savings plans that are invested in the firm.
It’s about the Copaxone, stupid
“Teva’s strategy over the past five to seven years has been to find a replacement to Copaxone, the company’s biggest brand-name drug and a surprising success,” said Gilad Alper, head of foreign equity research at Excellence Nessuah Ltd., an Israeli investment bank. Brand-name, or proprietary drugs, are those that are protected by patents and can be sold only by the patent-holder.
Launched in 1996 by Teva as its first major brand-name drug, Copaxone is still today the leading medication for multiple sclerosis patients. Teva expects the drug to account for as much as $3.9 billion, or some 16 percent, of the company’s $23.8 billion-$24.5 billion revenue forecast for 2017.
The drug’s patents are now expiring and in 2015 competitors started marketing a generic version of this drug. While the classic dosage consists of 20 milligrams to be injected daily, Teva has managed to stave off some of the competition by developing a 40 milligram, three-times-a-week injection of Copaxone, which some 80 percent of patients have switched to.
Teva said it doesn’t forecast competition for the 40 milligram dose this year, but a court decision regarding its patents is pending, and is expected sometime in the first quarter of the year.
‘A series of missteps’
Vigodman was appointed by Teva because of his reputed ability to turn companies around and spur growth. He replaced the company’s first non-Israeli CEO Jeremy Levin, who was ousted in October 2013 because of differences with the board regarding how to lead the firm.
Levin had spearheaded cost-cutting measures and was pushing the company to develop and acquire more branded drugs. Vigodman felt the right move was to lead Teva back to basics, its generics business. And, while increasing efficiency at the company, he also set out on a shopping spree.
Last year the company completed the acquisition of Actavis Generics, the generics arm of rival Allergan, in a $40 billion deal. Unfortunately, soon after the acquisition, the generics market changed very quickly: US regulators suddenly and unexpectedly speeded up the approval process for generic drugs, a move that created more competition and cut prices. All this made the Actavis accord seem expensive.
“Why they paid such a high price for Actavis is indeed a $40 billion question,” said Pagot. “The timing was bad. The generics market deteriorated very fast and very violently just after the acquisition, and they were unable to change the conditions of the sale deal.”
Even more worrying, Teva said in December that one of the architects of the Actavis deal, Sigurdur Olafsson, would be replaced at the end of the first quarter of this year by Dipankar Bhattacharjee as chief executive for its global generic medicines group. Before joining Teva, Olafsson served in a variety of posts at Actavis.
“This has raised a red flag with investors as there are concerns that something is going wrong with the acquisition,” said Alper. And “that is a scary thought.”
Ayalon’s Pagot said the company may find itself struggling to meet debt payments and facing the threat of a credit rating cut should the Actavis deal not reap the promised sales and earnings benefits and should Copaxone be undermined by increased competition. A credit rating cut would make it harder for Teva to recycle its debt, he said. The company could also perhaps become an acquisition target, he speculated.
Chaim Hurvitz — the son of Teva’s legendary CEO and one of its founders, Eli Hurvitz, who built the company into a generics pharma giant — defended Vigodman’s acquisition of Actavis.
The deal “may have been” expensive, said Hurvitz, a former executive and director of Teva, in a phone interview last week. But “sometimes you have to pay for leadership. This deal ensures our long-term leadership as the number one player in generics and sometimes to buy an insurance policy costs money.”
Hurvitz is a member of Teva’s founding family, which is still the largest private shareholder in the company.
Under Vigodman, Teva also bought Mexico’s Representaciones e Investigaciones Medicas SA, known as Rimsa, to expand its activities in emerging markets. But a year after spending $2.3 billion on the deal, Teva sued the sons of the company’s founder, alleging fraud and a breach of contract. They filed a countersuit, saying Teva is trying to get out of a deal it regrets.
“The Rimsa $2.3 billion deal also turned out to be a mistake, putting a cloud on the reputation of management, and raising the question about how they could have fumbled the due diligence on the company in such a way,” Alper said.
In December, the company also said it reached a half-billion dollar settlement with the US government for the resolution of criminal charges in the bribery of officials in Russia, Ukraine and Mexico, and is facing a class action suit by US investors as a result of a US Department of Justice probe into alleged price fixing alongside a number of other pharmaceutical companies.
Some investors, like activist shareholder Benny Landa, believe the choice of Vigodman to focus on generics was a mistake. “It’s a misguided return to the comfort zone, based on the idea that what worked so well in the past will go on working,” Landa said in an interview to the Globes website earlier this month. “The world has changed, however. Generics is now competition over price — who can produce the most cheaply. Is that Israel’s advantage? Cheap production? That’s not what we are.”
Teva should follow the trail blazed by Copaxone, he said, which made use of Israeli innovation and technology.
The series of unfortunate events has undermined investors’ faith in management, Ayalon’s Pagot said, and is likely to create investor pressure for Vigodman to be replaced.
Financial services company UBS on January 11 cut its 12-month target price for Teva by $7 to $35, saying it assumes a generic version of the Copaxone 40 milligram dose will enter the market in 2017. The UBS analysts maintained their neutral rating on the share. Citi analyst Liav Abraham said in a January 6 note that 2017 should all be about execution and cash flow generation, given the company’s leverage and “following a series of missteps by the company during 2016.”
“Skepticism over the near term by the investment community is likely to remain, we believe, given the large delta” between the preliminary 2017 outlook provided in July 2016 and the company’s formal 2017 guidance on January 6, the note said.
‘Not bad for a crazy small company’
Not surprisingly, Hurvitz says he is still an “optimist” about the fate of Teva.
“In a company that is 115 years old, you have to look at things in the right perspective. There are cycles. Good ones and bad ones, and you don’t measure a company by a 6- to 9-month period,” he said.
Looking ahead, one must evaluate the strength of the company, and Teva is a “very, very strong company,” he said, even at its current debt levels. “High leverage can be an issue if you are paying very high interest rates. But we were able to borrow the money at a very very low cost — at the lowest point of interest rates. So in fact we did a fantastic job in getting money and therefore I don’t see it as a problem.”
He understands the concern of analysts regarding the future of Copaxone, he said. But the product is 21 years old. It “is unprecedented in the industry to have a product that maintains such a strong position for such a long time. So for [what was once] a crazy small Petah Tikva company, it is not bad. I don’t think we have seen any example like that from Pfizer or from Merck or from anybody else,” he said. “So I feel good about it, but the product is reaching the end of its life cycle. No question about it.”
Whatever the future holds regarding competition for the drug, he said, he believes that the results in the short term will not be “that dramatic.” Over time, he said, “you will see a decrease, but I don’t think it is something that will happen overnight.” In addition, he said, Teva has made a “tremendous effort” to reduce its dependence on Copaxone over the years, and he believes the results of these efforts will be felt in the next two to three years. Meanwhile, he said, Teva needs to make sure it defends its product in the best possible way, “and I think we will.”
Vigodman has managed to refocus the company and bring it back on track, he said. “I back him. My backing is not unconditional, and I will always keep myself open and alert, but for the moment I think he is absolutely the right guy in the right time.”
Teva is “still very expensive” — too much so to become an acquisition target, he said. “I don’t think that it is easy to buy. There aren’t too many companies that can afford it.”
Cash will pay off debt, Teva says
Cash generated by Teva in 2017 will be primarily used for paying down debt while the company will continue to drive organic growth and attain savings from the Actavis acquisition, Vigodman said in a conference call on January 6. “2016 was a transition year for Teva, and one filled with significant milestones,” including the purchase of Actavis and the “significant headwinds” the entire healthcare sector has faced, he said.
“We continue to face challenges as a company and as an industry and we expect some of those challenges to continue in 2017,” he said. And just as 2016 was a “transition year, 2017 will be a year of execution.”
Following its acquisition of Actavis, Teva is witnessing an increase in the significance of its global generic business, and is moving further away from its reliance on Copaxone, Vigodman said. The Actavis deal is expected to generate some $1.4 billion in deal-related synergies and tax savings by the end of 2019, he said. The company also expects approval to launch its drug for Huntington’s disease in the first half of the year and for Tardive dyskinesia in the second half of the year, which will contribute to the value of the company.
Deleveraging and maintaining its investment grade rating is a top priority for Teva, Vigodman said in the call. The company forecast net debt to decline to $30.3 billion at the end of 2017, from an estimated $35.8 billion at the end of 2016.
Teva’s share closed at $33.68 in New York on January 25, bringing its market cap to $34.2 billion.
Citi maintained its buy recommendation on Teva shares on January 6 with a target price of $47, as its analysts said they were “reassured by Teva’s breadth/depth/mix of business” and its relationship with customers.
Teva’s management has been successful in cutting costs and the jury is still out on the Actavis deal, said Excellence’s Alper. The company also has a “fairly interesting” pipeline” of new drugs. “So not all hope is lost, but there is a wall of worry,” he said.
Even so, “after all these years and all the efforts, Copaxone continues to be the main issue for Teva,” he said. “This is a sign that Teva’s strategy is not working. It is a sign of failure.”
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