Teva Pharmaceutical Industries
I have had Teva on my watchlist for a while now. In my spare time I scan the market for many companies and recently quite many have been Pharma companies. A few of them has sparked my interest and Teva was one of them, at the time due to the “low” valuation and attractive dividend. So I kept it on my watchlist without taking further action. A few days ago when the stock lost another 30% after news that the company risks a breach of bond covenants, I decided it’s time to take a closer look. Teva is a huge and well researched company, I might need to spend weeks analyzing every detail of the company and it might still be hard to get any edge knowledge wise. But, I think that matters less right now. I think something else is dictating the market value of the company. Right now that is investor panic and fear, which is fairly obvious if you look at the stock performance below. So without having a very deep insight in the company I take a stab at this to see if there is a case for taking a position.
First some background on Teva
To understand why we today are looking at such a sharp stock decline, we have to look at Teva’s history. First starting with some general company background. Teva Pharmaceutical Industries Ltd. is an Israeli multinational pharmaceutical company headquartered in Petah Tikva, Israel. Teva specializes primarily in generic drugs, but also has patented drugs. The main patented drug, Copaxone, has been the companies largest cash cow for many years. Teva is in fact the largest generic drug manufacturer in the world and if I have understood things correctly a very important part of Israels economy. Many Israeli are proud of their Pharma giant, which has grown to a world leader. Teva shares trade on both the New York Stock Exchange (via ADRs) and the Tel Aviv Stock Exchange, the main volume of the stock trades through the ADR.
Teva has a very long history, the modern day Teva was formed in 1976, so it’s hard to give a comprehensive backdrop. As many Pharma companies it has grown through a number of acquisitions throughout the years. Some larger acquisitions were made already before the 08 crisis, but it was really after 2010 that the shopping spree began.
5 year spending spree
The is just an overview of the largest acquisitions made from 2010 onwards. This is important obviously because of the assets that now form Teva, but also to understand how Teva’s huge amount of debt (which we will come back to later) was built up.
Teva started of in 2010 and acquired German generic Ratiopharm for US$5 billion. The deal was completed in August 2010. In May 2011, Teva bought Cephalon for US$6.8 billion. The same month, Teva announced the ¥40 billion purchase of a majority stake in Japanese generic drug company Taiyo Pharmaceutical Industry, a move to secure a Japan-local production facility. Teva completed the $934 million acquisition on July 2011. In June 2014, Teva acquired Labrys Biologics for up to $825 million, the aim being to strengthen the company’s migraine pipeline. In March 2015, Teva acquired Auspex Pharmaceuticals for $3.5 billion growing its CNS portfolio.
And after 5 years of intensive fairly large scale buying. One would think that Teva probably planned to slow down a bit and consolidate, no, not at all. In April 2015, Teva offered to acquire Mylan for $40 billion, only a fortnight after Mylan offered to buy Perrigo for $29 billion. Teva’s offer for Mylan was contingent on Mylan abandoning its pursuit of Perrigo. However, both Mylan’s bid for Perrigo and Teva’s bid for Mylan were rejected by the boards of the intended acquirees. Things became messier almost by the day, as Mylan activated a “poison pill” defence against Teva. The entire process could have degenerated into a nasty, lengthy and very expensive legal battle, had a “white knight” not emerged, totally unexpectedly. This was Brent Saunders, CEO of Allergan — the pharmaceutical giant that had emerged from a rapid-fire series of mergers. The essence of the deal Brent had was simple: Teva will buy Actavis, which is the generic arm of Allergan, so that Allergan exits generic pharma and Teva becomes a bigger and more powerful player in that sector, cementing its position as global leader. And so it became, Teva paid $40.5bn ($33.75 billion in cash and $6.75 billion worth of shares) for Actavis. It followed that up with being Allergan’s generic distribution business Anda for another $500m and in October, the company acquired Mexico-based Representaciones e Investigaciones Medicas (Rimsa) for around $2.3 billion.
To read the full story of this “mess” where Teva bought Actavis I recommend this article: Why Teva Paid $40.5 Billion for Allergan’s Generic Business.
Capaxone the world’s best selling MS drug for treatment of Parkinson’s disease has generated a substantial part of Teva’s revenue/profit over the years (20% of revenue and 42% of profit last year). The Copaxone 20mg patent expired in 2015 and Novartis subsidiary Santoz is now selling a generic version. Teva has extended it’s patent right by introducing a new long-lasting Capaxone 40mg dosage. Teva obtained new US patents covering pharmaceutical formulations for long-acting delivery. Litigation from industry competitors in 2016-2017 has resulted in four of the five new patents being judged invalid, and the fifth remains under challenge. The case reflects the larger controversy over evergreening of generic drugs. At the same time as they sue Teva, Sandoz is now also developing a long-lasting 40mg generic called Momenta Pharmaceuticals M356.
Cash generating company
We will soon move over to a lot of nasty negatives, before that, we should know that Teva has been a very cash generative company, partly due to Copaxone, but also thanks to other parts of the business. Coupled with strong dividend payments one can understand that as long as the business has shown good profits it has been a fairly attractive investment case (although one have had to turn a blind eye to the debt pile).
Although GAAP numbers are far from perfect, I prefer to use those over the numbers Teva wants to focus on, where a lot of adjustments are made. This is back to basics, not trusting anything but an accepted accounting standard (although there is plenty of room to fiddle around with those figures too).
Although this is not the first time the company is forced to Goodwill impairments, it was still a massive blow a week ago when Teva needed to announce a large write-down on it’s US generics business, which is related to the Actavis acquisition. The impairment was $6.1 billion, and although it’s not a cash outflow now, it shows how the company overpaid for Actavis from Allergan. From a GAAP earnings perspective it will also affect the Net Income. If it had only been a goodwill impairment things would still have been OKish, but second quarter earnings fell short, the company warned that if proceeds from divestment or cash flow fall short, the company could breach debt covenants with lenders. It therefor slashed dividends with 75%.
Due to this Teva has also announced the intention of divesting non-core companies, to raise cash.
So lets list all the negatives
I would argue that almost everything that could go wrong, has gone wrong. And the worst part seems, most of it is still far from solved. In my opinion Teva really is in a perfect (shit) storm right now. I will list all the negatives I have been able to find over the last few days of due diligence.
You all have understood by now that Teva has amassed a huge debt pile and risks to break it’s covenants to it’s debtors. Teva’s MCAP today at 18.5 USD per ADR is about $18.8 billion, whereas it’s debt is a grand total of $34.7 billion. With everyone focusing on this debt and the risk of the company not being able to meet it’s obligations, it’s very important to look at the maturity profile. As with any debt, it’s easier to survive if you just need to pay the interest, rather than paying back principal. Teva is still a cash generating company and if given time, should at least in theory be able to survive this, if the just have time. This is the maturity profile of the debt
As we can see, Teva does actually have a bit of time. Nothing of it’s debt does actually mature before 20th of July 2018, then 1.5 billion USD of bonds mature. That amount the company should be able to scrape together just from the cash the business generates. It’s actually all smooth sailing until Q3 of 2019, when a huge amount of debt matures. So if Teva is not allowed to roll the Term Loan they need to come up with about 4.5 billion USD in cash and they basically have 2 years to do it, most likely by sales of parts of it’s business. Is that a tight deadline? Yes I would say so, but far from impossible to execute. If all debt including Q3 2019 is paid off, the debt load of Teva will have shrunk by almost 10 billion USD and if the business generates cash at same levels as historically, that should be manageable. But that might be a big if, which leads us to the next negative.
2. The Generics industry
By buying Actavis, Teva doubled down on the Generics industry, one would hope that was a good bet. Well short term it does not really seems so. The pricing pressure on generics seems to have increased a lot lately. The U.S. Food and Drug Administration sped up drug approvals, flooding the market with products from smaller companies that compete on price, while pharmacy chains and retailers began consolidating their orders to the point where four groups account for 80 percent of the purchases, Teva said on its recent earnings call. So they doubled down on a business which is in a decline, at the same time as they are in dire need of strong cash flow to meet the debt obligations.
So how bad is this pricing pressure, short term and long term? Well that is very hard to say. But without knowing all the details about the generic drug markets, reasonably the worlds largest player should have a scale advantage and a distribution advantage to smaller players. So the margins might be smaller than in the past, but as a well run company that ought to be positive at least.
3. Company Leaders
Again, we have already understood that some of these acquisitions that were made during the last 7 years, were value destructive for shareholders. So from that point of view the management and board of the company has failed the shareholders. In a time of crisis one would look to a strong CEO to steer the ship through the storm. Well the next problem is that the company hasn’t managed to find one. The previous CEO Erez Vigodman was ousted in February 2017 and currently Yitzhak Peterburg acts as the interim chief executive. A very odd appointment, given that Yitzhak was chairman of the board of directors which supported the Actavis bid. The current chairman, Dr. Sol Barer, said that in the past six months he has devoted all of his energies into appointing a permanent CEO. Barer said repeatedly that the next CEO will be a person of stature with extensive experience in the pharmaceuticals industry. This requirement makes Peterburg’s candidacy irrelevant.
Benny Landa the largest active private investor in Teva, did not go easy in his latest round of comments: “Landa adds that someone on the board of directors is trying to undermine the efforts of Teva chairman Sol Barer to bring a CEO with an international reputation to the company. He explains, “There’s a person on the board of directors on whom we pinned great hopes — Sol Barer. We assumed that he would be able to bring a well-known CEO to the company, but it’s clear that someone on the board of directors doesn’t want him to succeed, and is trying to undermine his efforts.”
So there is plenty of drama to go around in the upper echelons of Teva management now when they have a crisis on their hands.
4. The 100 million shares
Another “small” detail when Actavis was acquired, was that part of the payment was in Teva shares, 100 million of them. Meaning that Allergan is the largest shareholder in Teva, holding 10% of outstanding shares. The lock-up on those shares happened to expire a little bit more than a week ago. Allergan has stated that they have no intention to stay as shareholders in Teva. That is a pretty big overhang on the stock. They might have sold some already, the stock has turned over about 300 million shares in the last 3 full trading days. But it would surprise me if Allergan got it’s 100 million shares out in the middle of that selling panic, I think honestly the share would have traded down much more than that. A lot of volume in these cases is not true sellers or buyers, but traders flocking to a highly volatile stock, buying and selling back and forth, creating huge turnover. Most likely they are still sitting on all the shares, a lot less rich than just 4 days ago.
End of Part 1
This is the end of Part 1, in Part 2 we will make an attempt to see if its worth to try to catch this falling knife. Since we are in the middle (or at the end? Stock trading up right this moment) of the free-fall. I will try to be quick to produce a follow up. Although as we see from all the listed problems above, the will most likely not have gone away, by next week, or perhaps not even by next year. Anyhow this might be the first investment case I present, which I will not invest in, depending on where the stock trades when Part 2 is finalized. Right now I don’t know the answer either, so please fill in with your comments to help me make a wise decision in Part 2.