Teva’s Small Print Gives Rise to Optimism

In November 2019, Teva Pharmaceutical Industries Ltd. CEO Kåre Schultz released his first optimistic statement regarding the company’s future since he stepped into the role in November 2017. Barring any external negative events and if things continue as they are, he said following the publication of the company’s earning reports for the third quarter, 2019 will be the year Teva hits rock bottom and 2020 will see better operating profit. Teva jumped on the New York Stock Exchange in response.

Wednesday, when Teva published its fourth quarter and annual reports for the fiscal year 2019, it had seemed at first glance that Schultz’s optimism was unwarranted. The company’s outlook for 2020 forecasts revenue of between $16.6 billion and $17.0 billion, and non-GAAP earnings per share of between $2.30 and $2.55. Not worse than 2019, but not the improvement Schultz hinted at, either. Teva ended 2019 with $16.9 billion in sales, a 10% drop year-over-year. Adjusted EBITDA was $4.685 billion, and is expected to be similar in 2020. Free cash flow was $2.1 billion and no big changes are expected for 2020 in this regard, either.

But, a closer look at the data could explain Schultz’s optimism in recent months, as well as why Teva jumped 9.02% on NYSE by Wednesday market close. Rather uncharacteristically for Teva of the last few years, the company provided in its report extensive detail of its revenue breakdown according to individual drugs, which showed that it might be on the road to find a suitable replacement for its former breadwinner, multiple sclerosis drug Copaxone. This time, it is not one blockbuster drug, but Teva’s two relatively new brand drugs—Migraine-treatment drug Ajovy and Austedo, meant for the treatment of Huntington's disease and tardive dyskinesia—that are starting to significantly make up for the dwindling Copaxone revenues.

Teva forecasted copaxone will bring in $1.2 billion in sales in 2020, a $300 million decrease from 2019. But, together, Austedo and Ajovy are expected to bring in $900 million this year. Austedo is beating market expectations and is slated to bring in the majority of the sum in 2020, $650 million, an almost 60% increase. There is a possibility for even more income, as Teva is expected to finalize its results of a phase III clinical trial testing Austedo’s effectiveness as a treatment for Tourette syndrome. Good results will edge Teva closer to a U.S. Food and Drug Administration (FDA) approval for another indication for the drug.

Ajovy, on the other hand, was a letdown in its first year, with sales of under $100 million despite the initial outlook forecasting $150 million. Now that Teva received FDA approval for an autoinjector version of the drug, however, it can begin to catch up to rivals Amgen Inc. and Eli Lilly and Company, which both offer a similar drug in an autoinjector. Teva stated Wednesday it expects to reach a 25% market share now, and thus forecasts $250 million in sales for Ajovy in 2020, more than double its 2019 sales. Teva is also working on new indications for Ajovy, the most promising being for pain following head injury and for fibromyalgia, a condition characterized by widespread musculoskeletal pain, fatigue, and cognitive difficulties. According to Schultz, Teva intends to expand to the Japanese market with Ajovy and is currently conducting clinical trials for that purpose.

In the fourth quarter of 2019, Teva released Truxima, a biosimilar for Roche’s oncology drug Rituxan. Rituxan brings in $4.2 billion annually and, unlike generic drugs, biosimilars are usually priced more closely to brand drugs. On Wednesday, Teva’s senior executives discussed selling Truxima at a discount of only 10% compared to Rituxan. The company is currently being vague regarding its actual sales of the drug—it was listed under generic drugs and not discussed in the report individually—but during Teva’s earnings call, Schultz said Truxima had managed to reach a 12% market share.

A closer look at Teva’s quarterly generic sales shows an increase between the third and fourth quarter of 2019. The first three quarters showed a slow drop in sales, from $966 million in the first quarter to $914 million in the third quarter, before jumping to $1.1 billion in the fourth quarter. Truxima, therefore, could be the positive surprise Teva has been counting on.

But Teva’s challenges are not limited just to countering its declining copaxone revenues; the company has to create a big enough cash flow to be able to carry the debt covenants it had taken on following its $40.5 billion acquisition of Allergan’s generic business Actavis. Shareholders are also concerned by the legal threats Teva is facing, paramount of them the judicial backlash following the U.S. opioid abuse crisis. During the last months of 2019 it seemed Teva and other drugmakers and distributors were close to reaching an encompassing settlement with U.S. authorities, but the year ended without one.

In October, Teva said it had reached a tentative agreement to pay a fine of $250 million over the next 10 years and also donate buprenorphine naloxone, a medication used to treat opioid use disorder, in quantities valued at around $23 billion in wholesale acquisition costs. On Wednesday, Schultz said the company is still negotiating the global settlement framework with U.S. authorities, and that he is cautiously optimistic. A trial is set to start on March 20 in New York, so Teva is aiming to reach an agreement beforehand.

Teva ended 2019 with a further $2.2 billion decrease in its net debt, to $24.9 billion. The company’s new chief financial officer Eli Kalif estimated during the earnings call that Teva’s debt to EBITDA ratio will drop to below 5 by the end of 2020. If the company manages to do so, it will be much closer to achieving its target of a debt to EBITDA ratio of 3 by 2023. This target is based on the expectation that Teva’s debt will decrease to $17 billion by 2023 while its adjusted EBITDA will increase to between $5.5 billion and $5.8 billion.

In November, Teva completed a $2.1 billion debt tender offer, upping it from an initial $1.5 billion due to demand, and used to for bond buyback. Kalif told Calcalist that the company is now balanced regarding its debenture to cash flow ratio until 2023, but is constantly tracking market returns. “If something looks attractive, we will act on it,” he said.

Teva ended the fourth quarter of 2019 with a free cash flow of $974 million, half of it generated operating activities. Non-GAAP operating margin for the quarter increased to 23.8%, but Non-GAAP gross profit margin dropped to 50.6%. GAAP net income attributable to ordinary shareholders in the fourth quarter was $110 million. Schultz attributed the decrease in gross profit margin to a combination of high manufacturing costs and dwindling Copaxone revenues, though it was somewhat offset by Austedo’s rather high profit margin and the now completed two-year reorganization plan.

Teva reached its spend base reduction target of $3 billion in 2019 as a result of extensive layoffs and facility closures. Schultz said the company is now planning its next reorganization phase: the company still has almost 60 manufacturing sites and around 20,000 different products, he said, but some locations are not synergetic enough, for example when it comes to acquisition procedures. If until now Teva focused on asset divestment, in the next few years the company will focus on increasing the efficiency of every site, he said. He repeated his target of reaching a Non-GAAP operating margin of 28% by 2023, something some analysts are skeptical about.

Alongside its debt hump, Teva is still writing off losses due to its Actavis acquisition: $1.6 billion in 2019, $259 million of them in the fourth quarter. According to Kalif, the company expects to write off a similar amount in 2020. The new reorganization plan highlights what had been said about Teva’s acquisition strategy in years past—that the company neglected integration, letting each new asset operate individually. That is about to change now. Today, every company conducts its purchases separately, losing out on the advantages of size, Kalif said—now Teva will manage all its locations with a more global outlook.

Both Schultz and Kalif are starting to think of future growth engines now that it seems Teva is starting to get past the troubles they have both inherited from their predecessors, and they are looking to China. Penetration of the Chinese market is a slow process and you need to dedicate time to launching, Schultz said. It is not something that will happen within 3-5 years, but he did it successfully for both his previous companies, he added.