There May Be a Silver Lining to Teva’s Woes

On Thursday, Teva Pharmaceutical Industries Ltd. published its reports for the third quarter of 2017, once again falling short of forecasts and lowering its outlook for the year. Analysts were quick to react, most of them lowering the company’s target price.

Seasoned investors tend to say that rock bottom is a turning point.

The last years saw Teva going on a fast downward spiral. The company’s stock price peaked in July 2015, a month before it announced its acquisition, completed in 2016, of Allergan PLC’s worldwide generic pharmaceuticals business (Actavis Generics) for $40.5 billion, and just before the generic drug market started feeling price pressures in earnest.

In late 2016 generic drug makers Synthon and Alvogen received approval for marketing generic 20 mg/ml versions of Teva's cash-cow drug Copaxone in certain parts of Europe, a decision Teva contested in court. In October, the two received European approval for their generic 40 mg/ml versions. The real blow came later that month when Mylan N.V. received approval for both copycat versions in the U.S., casting doubts on Teva's ability to repay its debt load.

Teva might withstand the current crisis, but its ability to regain its previous heights seems unlikely. To stabilize, the company must take uneasy steps, avoid mistakes. It also needs a fair share of luck.

1. Turning headaches into money.

One of Teva's biggest promises is its migraine prevention drug fremanezumab, submitted to the U.S. Food and Drug Administration last month. During Thursday's earning call Teva brought the drug up multiple times, even though the approval process is estimated to take until 2018.

If approved, fremanezumab has the potential of being a market innovator like Copaxone was when Teva first released it. There are currently three other migraine prevention drugs in similar approval stages, and the market is estimated at $14-15 billion a year.

Another drug recently approved by the FDA is Austedo, a brand drug used for treating dyskinesia, a group of neurological movement disorders. The condition is estimated to affect 500,000 people in the U.S. alone, and informal estimates place Teva's potential annual revenues from the drug at $600-700 million a year.

While it's still too early to say whether these drugs will be enough to make up for what would be lost in Copaxone sales, currently netting Teva around $1 billion a quarter, fremanezumab might potentially reach a large enough market share to generate substantial alternative sales.

2. A generic turnabout.

Teva's Thursday reports disappointed investors and brought about a 20% stock crash the same day. The largest disappointment came from Teva's generic medicines revenues. Teva's acquisition of Actavis Generics was intended to help the company dominate the generic market and keep its position as the largest generic drugs company in the world.

The reports revealed the scale of the erosion the generic market experienced. Teva’s generic medicines revenues in the third quarter of 2017 stood at $3 billion, a decrease of 8% compared to the third quarter of 2016. The segment's gross profit margin stood at 38.5%, a significant decrease compared to 48.8% year to year. The trend reflected across the entire generic drug market, but lack of new generic copycats from Teva contributed to the companies woes.

The generic drought is expected to soon come to an end. Teva expects three major generic drug launches next month: a generic version of AIV/AIDS treatment and prevention drug Reyatazs; a generic version of chronic Hepatitis B drug Viread; and a generic version of Viagra, for which Teva signed a royalty agreement with Pfizer to secure a launch two years prior to the patent's expiration.

The details of the Pfizer agreement were not published, so it's unclear how much revenue Teva can expect to generate from its copycat version, but the brand drug generates $1.5 billion annually. These new generics might enable Teva to surprise investors for the better in the first quarter of 2018.

3. Cutting expenses is a must.

Teva's senior executives, and particularly its board and management team, have yet to comprehend their new reality. While the company’s profit and revenue are declining, but administrative expenses, already quite high, have risen.

General and administrative expenses for the third quarter of 2017 stood at $330 million, a 6% increase year to year. A calculation of the ratio between those expenses and Teva's reported revenues suggests that out of every dollar the company makes, almost 5.9 cents go to administrative expenses; in the third quarter of 2016, the ratio was 5.4%. Over the nine first months of 2017, Teva reported administrative expenses of around $1 billion. This is a relatively high ratio, especially for a stagnating company. This is the time to cut costs.

Comparatively, Novartis International AG had revenues of $12.4 billion in the third quarter of 2017 and reported administrative expenses of $510 million—a ration of 4.1%.

A 20-30% cut in administrative expenses will free $300-400 million a year for Teva, a significant sum for a company currently trading at a $11.57 billion market capitalization.

4. Enjoy the interests.

After the troublesome acquisition of Actavis created a $35 billion debt load for Teva, the company also made a good decision and made use of low market interests. To fund the deal Teva raised $15 billion in the U.S., around €4 billion in the European market, and 1 billion Swiss francs in Switzerland. Teva's interest rate is lowest on its Swiss francs loan, and its highest is in the U.S.

Teva's use of those low-interest rates, combined with a $100 billion demand for its issued bonds, enabled the company to raise funding at an average interest rate of 0.5% for its Swiss bonds, 0.9% for its European bonds, and 2.65% for its American bonds. The average interest rate for Teva's debt load is 2.32% a year, with an eight-year duration. Under its current profitability, Teva can meet its debt covenants.

Teva's challenge will be its short-term bank borrowings of $6 billion, which have financial requirements. Teva's results for the third quarter of 2017 hint that the company might face difficulties in paying this debt without further asset divestment, bond issue or the taking on of additional debt. Teva's long-term corporate credit is BBB, and on Friday S&P Global changed the company's outlook to negative.

In the Israeli market, a BBB- is equivalent to an AAA- credit rating. This means that Teva could still raise billions in the local market at very low-interest rates even with a lower global credit.

After many years of Teva's directors pursuing the international markets, Teva's management needs to consider raising bonds on the Tel Aviv Stock Exchange. There's no reason why Teva, for long years the flagship of Israel’s economy, can't enjoy the local liquidity.