The crash in the share price of Teva Pharmaceutical Industries Ltd. (NYSE: TEVA; TASE: TEVA) which sent the Israeli pharmaceutical company's market cap tumbling to below $9 billion, was not caused by any wild panic among investors. It is the direct result of new and aggressive regulatory pressure by US legislators on the business of Teva and its competitors in the US, who are being accused of making a decisive contribution to the cost of drugs in the country.
In order to understand the magnitude of Teva's exposure to a worsening of market conditions in the US, it is enough to note that North America accounts for $8 billion of Teva's $17.5 billion in annual sales. Teva's generics business in North America generates $3.9 billion in annual revenue for the company, with a 25% profit margin in the sector, and accounts for half of Teva's world wide profits in the sector. The great sensitivity of investors to the gloomy regulatory outlook in the US for drug companies is therefore justified.
This regulatory pressure is threatening to push down prices of generic drugs beyond Teva's predictions, and to detract from Teva's shrinking future cash flow. Teva has been unable to develop branded drugs that compensate for its loss of exclusivity for Copaxone. The company's new branded drugs, however successful they may be, cannot get the company out of the mud unless its generic drugs business stabilizes and regains its strength.
As if pressure from US legislators were not enough, several analysts are saying that Teva will have to pay several billion dollars to settle legal cases involving price fixing and soliciting greater use of opioids. These multi-billion-dollar legal liabilities, should they materialize, will be added to Teva's mountainous $26.7 billion net debt, and threaten its future.
Teva's low share price is misleading, because an investor buying Teva's share is in effect paying $38 billion for the company's assets, a $38 share price, if Teva's debt is included. In other words, the steep fall in Teva's securities does not reflect panic; it is an analytical insight that encompasses the debt rating agencies and most of the investment houses on Wall Street. It should therefore be treated with the necessary gravity and seriousness. It must be realized that Teva is fighting for its life.
Teva needs a magician of Houdini caliber
Teva's financial state is like the early 20th century "Chinese Water Torture" stage show of legendary magician Harry Houdini, in which he was tied up and placed upside down in a container filled to the brim with water, and tried to escape.
Houdini succeeded, but it is very doubtful whether Teva CEO Kare Schultz can bring off the magic necessary to complete his mission - rehabilitating Teva and freeing it of the stranglehold of its $26.7 billion debt.
Teva's net debt is 5.45 times its EBITDA, and the company has an enormous distance to cover before reducing this ratio to below 3 in three to five years. Teva's debt was reduced by $1.7 billion in the past four quarters.
The fact that only 10% of Teva's debt is due for payment in the coming year, and that the average duration of the debt was 6.6 years as of the end of the first quarter of 2019, gives the company financial flexibility in coping with its mountain of debt in the short term. While Teva's cumulative debt repayments in the next two years total $3.7 billion, the company will have to repay over $4 billion in 2021 alone and a total of $10 billion in 2021-2023, at a time when Teva's ability to reschedule debt n the capital market is virtually non-existent, given the lowering of its debt rating to junk bond level and the steep increase in yields on its bonds. Only a substantial improvement in Teva's business can reopen the debt rescheduling window in the capital markets.
I think that the company now regrets the arrogance that led its management to defiantly declare early this year that it would not raise capital at a time when the company's share price was at $20-25. A $4-6 billion financing round would have significantly increased Teva's chances of reaching a safe harbor, but Teva's management believed that diluting its shareholders at that point in time was incorrect.
A major sell-off of assets will only postpone judgment day to a later time
The leading measure taken by Schultz at Teva since becoming the company's CEO was cutting its cost base by $3 billion in two years. This was done in an impressive manner. Teva reduce its cost base from $16.3 billion a year in 2017 to $13.8 billion a year in the past four quarters. Projecting Teva's first quarter expenses over the year 2019 as a whole shows that the company is on the way to meeting its annual expenses target of $13.3 billion.
In Teva's current plight, it appears that another aggressive cost-cutting plan will be essential in order to survive. In my humble opinion, it is likely that such a plan will be published in the near future, and will restore a bit of color to the cheeks of the company's investors. The main problem with another ambitious streamlining plan is the difficulty in executing it without damaging the company's muscle tissue and backbone, which are essential for generating its future cash, and in focusing solely on Teva's dwindling concentrations of fat. Teva let 10,400 employees go in Schultz's streamlining plan, closed down and converted 18 plants in the past two years, and sold activities such as women's health. Another major sell-off of assets will put money into the company's understocked coffers, but will also damage its future ability to generate cash, and will therefore merely postpone judgment day to a later time.
Healthy logic leads me to assume that the best investment bankers on Wall Street are plotting merger deals in which Teva is likely to be involved, but it is very doubtful whether enough concerns will be willing to stick a foot into the enormous debt swamp in which Teva is stuck without conducting negotiations on a new debt rescheduling arrangement.
Splitting Teva's activity and selling or merging one of the company's arms at a generous price tag is also likely to be the first step towards enabling Teva to repay its debts. A potential buyer with suitable financial strength and economies of scale can theoretically benefit from Teva's assets and substantially downsize the cost base in the merged activity. These are complicated deals that involve obtaining the appropriate antitrust approvals, among other things. As someone looking at Teva's business situation from the side, the way I see it, selling all of Teva's original drug activity at an attractive price tag is an obvious scenario for rescuing Teva from its business situation, from which Houdini himself would have found it hard to escape.
In any case, I think that the logical scenario is that even if Teva survives its storm, the revised Teva 2G will be a lean small-to-medium-sized company, far from the vision of a global market leader that brought the company to the brink of financial disaster.
The author is chief strategist of the Ayalon Investment House. The author of the article and/or the company is likely to hold or trade in the securities mentioned in the article. Nothing in the article constitutes a substitute for investments marketing and/or investment counseling that takes into account each individual's special particulars and needs.
Published by Globes, Israel business news - en.globes.co.il - on July 4, 2019
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