Some people called it an almost crazy move from a business point of view. Others mentioned the daring displayed, uncharacteristic of a normally conservative company. It was obvious to everyone that generic pharmaceuticals giant Teva Pharmaceutical Industries Ltd. (Nasdaq: TEVA; TASE: TEVA), a company that could open a world-class university on mergers and acquisitions on its premises, had jumped up a league. Never before had it thrown a net over a company as large as Sicor.
Teva acquired US company Sicor for $3.4 billion, an almost incomprehensible sum, even for the well-oiled Israeli pharmaceuticals machine. This sum represents the largest-ever deal by an Israeli company to date. It won't be easy to beat it.
At the end of the week, Teva will mark the first anniversary of the merger. First announced in October 2003, the deal was concluded the following January. Exactly one year ago, feverish and tortuous negotiations for the acquisition of Sicor came to a close, marking Teva's entry into two new fields: injectibles and biogenerics. Although it is difficult at present to know exactly how much Sicor contributes to Teva, and how much it will contribute in the future, we can state with assurance that we're talking about a success. Putting aside the fundamental question - the price, and the argument whether it was realistic, or reflected wild multiples outside the norm for the industry, it seems that Teva made a successful deal businesswise, which has contributed to its revenue, profits, and future growth engines.
Makov's test
"Why buy the whole cow for such a price, just to get a glass of milk?" was more or less the opening comment from a number of analysts as they wondered about the deal. After all, if Teva wanted to enter the biogenerics field, it could have only bought that unit. It has enough injectible drugs and active pharmaceutical ingredients (APIs). But such a deal could apparently not have been made, and besides, it seems it wasn’t worthwhile for Teva. For Teva, Sicor was a bulls-eye.
The acquisition was followed by a huge $1 billion bond issue, and heavy one-time expenses - elements that many analysts and investors justifiably do not care for, and that undoubtedly disturbed their slumber. Teva president and CEO Israel Makov did not sleep well, either. This was his first significant move as CEO, steering the company instead of serving as copilot to Teva chairman Eli Hurvitz, when the latter was CEO and Makov was VP business development.
"I handled other deals for Teva," says Makov, "but obviously this was the largest, the first that I handled as CEO. It was necessary to invest a lot of expertise, because this was a sophisticated deal. This is another reason why I am greatly pleased by the results. It wasn’t that the price for Sicor was so high, but it involved a great deal of money, an unprecedented amount in Israeli terms. I am pleased not only that we made the deal, but that it has been a success. In retrospect, too, I can say this."
A day after the acquisition, Makov held an intimate dinner for three of Sicor's top executives at his home in Carmei Yosef to begin building relationships. He sent a letter to Sicor's 2,000 employees welcoming them into the Teva family.
"We fulfilled all our expectations, and we've had no disappointments. If there are any, they're marginal," concludes Makov about the absorption of Sicor. "One of the best things we did, and one of the most challenging, was integrating the company. Nonetheless, Sicor is spread over several continents and countries. I cannot think of another example in the world, not only in our industry, of such a rapid integration of a company like this."
"Last week, we held an interactive conference for all Teva managers worldwide. 750-800 managers at 28 different points around the globe, including Israel, participated by video conferencing or ordinary telephone conversations. The points included four Sicor units, in Italy, Mexico, the US, and Lithuania, as well their own managers. They are in no way separate from us; they're Teva people in every respect, including at the personal level. Today, when I see a manager, I can no longer telll the difference, whether he or she is a Sicor or a Teva person. Marvin Samson, the former president and CEO of Sicor, sits with me at executive meetings, and contributes greatly. The fact that it's already difficult to distinguish who originated at Teva and who originated at Sicor is the best sign of the success of the acquisition, as far as I am concerned."
Makov adds that there is cross-fertilization. Teva learns work methods from Sicor and vice versa. "We had four production units in Italy, which were managed from Israel, and Sicor had three. We combined all seven units into a single new unit, whose management resides at Sicor's plant in Italy. In effect, it's Teva Pharma Italia, and naturally its corporate culture is already integrated. We carried out similar integrations in the US, in California, for example."
Profitable from the first quarter
It turns out that Sicor was not easy to acquire. Both Novartis Pharmaceuticals (NYSE:NVS; LSE:NOV; SWX:NOVZ) and Barr Laboratories (NYSE:BRL) were casting their eyes at this attractive company, which could have expanded their positions in the US hospital market, which accounts for a fifth of the global pharmaceuticals market.
Since Sicor had many potential bidders, the price Teva paid was ultimately very high. It raised its offer for Sicor from $23 per share to $27.50 to close the deal. Teva took a lot of criticism for the $2 billion cash plus 7% of the company (another $1.4 billion) that it paid. The ratios also raised eyebrows: a p/e ratio of 30 and a sales multiple of 6 for Sicor. This criticism has already subsided as it had never existed.
"The question of price is not an easy one," says Makov. "I'd say that the test whether the price was high or low is ultimately determined by the results. When we announced the acquisition, we said we wanted a year of organization. In other words, Sicor would begin contributing to our net profit from the second year. We were surprised: Sicor began contributing to our profits from the first quarter of the merger. We haven’t yet made an acquisition with such an achievement from the first quarter.
"I believe that it's impossible to report good results if you pay too high a price. In addition, what we got from Sicor, and what we're doing with them now, not only provides us with financial advantages, but also strategic ones that an outside observer can't always examine. For instance, we now have global leadership in injectibles. We produced APIs for injectible drugs before, but our plans to enter the sector were for several years later. Thanks to Sicor, we brought our entry forward and brought an immediate advantage to the market. We're now adding injectible products to Sicor's systems, which greatly strengthens our position in the sector. The integration of our chemicals divisions was also very important, and we're now the largest company, with a huge number of products. Although ostensibly niche sectors, they have a large market. Thanks to the acquisition of Sicor's platform for the US market, we were able to base ourselves on them."
Sicor had annual revenue of $555 million when it was acquired, but it's not now possible to know how much it contributes to Teva. "We didn’t create a situation in which Teva compensates for Sicor, or vice versa," says Makov. "Everything we got was more than we planned."
It's a black box for investors, who don’t know how much Sicor contributes. "We have a lot of black boxes," says Makov. "All our acquisitions have been good ones. We've never had a major bad surprise. We make acquisitions responsibly, and it's worked so far."
Towards larger acquisitions
Sicor's largest product is Propofol, an intravenous local sedative-hypnotic anesthetic, which accounts for a fifth to a quarter of its revenue. This flagship drug has so far been able to fend off competition from generic versions, although these are on the way. Other important Sicor products are a drug for enhancing white blood cells in cancer patients, a drug for regulating the production of red blood cells, and interferons.
The market is waiting for you to make an acquisition in 2005. Did Sicor open the door to larger acquisitions?
"I don’t know if it opened a door, but it certainly doesn’t prevent large acquisitions. I assume we'll not only make smaller acquisitions than Sicor in the future, but larger ones too."
Waiting for biogeneric regulation; hoping to be the market leader
One of the most promising fields Teva wants to enter through its acquisition of Sicor is biogenerics - generic versions of biopharmaceuticals. Biogeneric regulation is only just beginning, and Makov has no doubt that Teva can become a leader in the field, even if it's a dream that will only be realized in another decade.
"Look at how much money biotechnology companies are investing," says Makov. "We acquired activities that include an interesting infrastructure with three plants that have sales. We're not selling a dollar or two worth of biogeneric products, but many millions of dollars worth in China, Eastern Europe, and Mexico. We're dynamically developing the field. It's true that regulation is far from complete, and we're talking with the US Food and Drug Administration (FDA) and European regulators. In our opinion, biogenerics will unquestionably be big.
"Today, 10% of global pharmaceutical sales are of biotechnology products, and 30% of products in R&D are from this direction. In the next decade, 30% to 50% of total pharmaceuticals turnover will come from biological pharmaceuticals. As Teva sees it, there is no way these drugs won't have generic versions. Today's society, and certainly tomorrow's, cannot pay the cost of drugs without generics. It's too expensive. That's why governments are involved. They know that they must bring down healthcare costs, including in biotechnology. I can already assert that Teva, as the generic industry leader, will lead the biogenerics subsector as well."
Leader DS analyst Uri Hershkovitz says, "Only at the end of the decade will we be able to look back and see whether the acquisition of Sicor was justified economically, in terms of biogenerics. At the moment, the battle for biogenerics has only just begun. To stay out altogether is a privilege that Teva cannot allow itself."
Not only generic drug makers are at the biogenerics starting line. Ethical drug makers, specialist companies, and start-ups are also there. At the moment, there is no FDA procedure for approving generic versions of biotechnology drugs, which are produced in far more complex ways than ordinary drugs. The production of proteins is far more complex than the production of chemical drugs.
Biotechnology is new, less than 30 years old, so it has not yet had to deal with generic giants and their generic versions of biotechnology drugs, in part because almost all biotechnology drugs are still patent protected.
Among the first candidates in the coming battle are simpler drugs, such as Eli Lilly & Co.'s (NYSE:LLY) humulin, an engineered insulin, and Genentech's (NYSE:DNA) growth hormone, Nutropin. Overseas, the ground is being prepared for biogenerics, a market worth tens of billions of dollars.
By the way, Teva's Copaxone, an innovative treatment for multiple sclerosis, will be an early victim of biogenerics. Copaxone is not a very complex drug; it's a sort of interim technology. Quite a few companies would be pleased to sell a generic version of this drug, in view of the immense market potential.
Companies are waiting for FDA guidelines. Hershkovitz believes that the FDA will toss this hot potato to Capitol Hill for Congress to decide. In September 2004, the FDA held a series of discussions about biogenerics. Teva representatives gave two lectures at this meeting. Representatives of many companies from both sides of the street participated in the discussions, including from Barr Laboratories, Johnson & Johnson (NYSE:JNJ), Pfizer (NYSE;PFE; LSE:PFZ), and Genentech. Naturally, no decision was reached.
A pointed political struggle
Judging by parties' polarized positions, this will probably be an intense political struggle. Generic drug makers point to their ability to make copies of ethical drugs without the need to repeat research conducted by the ethical drug makers. They also warn, certainly with some justification, that if generic drug makers do not enter the market, consumer prices will skyrocket. They claim that a situation in which developers of ethical drugs are given open-ended intellectual property rights with no expiry date is unacceptable, and assert that this will burden the basket of health services.
Biotechnology companies say that their drugs are complex and require clinical trials in order to know whether generic versions achieve the same results as their ethical counterparts. "Follow-on drugs are not equivalent," they asset. They claim that there is concern that if a drug is inaccurate, the human body will reject it, with devastating results. In other words, biotechnology companies claim that their production process is part of their intellectual property, not just the molecules.
Genentech told the FDA last September that its experience in drug development, the FDA approval process, and marketing cannot be duplicated. "We've learned about aspects of production that determine the characteristics of protein-based drugs," it says, adding that a large number of variables affect the final product, and that copycat companies would find it difficult to achieve its techniques.
The generic drug makers reply that Sicor and India's Ranbaxy Laboratories (LSE:RBXD) have been making biogeneric drugs in India and Eastern Europe for years without killing anyone.
No to clinical trials
Will the generic drug companies silence the doubt by carrying out their own clinical trials? Not easily, both because of the complexity of the research process, and because they would have to charge a premium for their drugs. It cannot be ruled out that a compromise will be reached that will require biogeneric companies to repeat some clinical trials already carried out by ethical drug companies. But, for now, that is still far off. "We believe that toward the end of the decade, or maybe soon afterwards, biogenerics will take off," says Makov.
The generic drug makers cite their ability to make copies of biological drugs without the need to repeat the research by the ethical drug companies. They warn that if generic drugs are not allowed onto the market, consumer prices will skyrocket. The biological drug companies say that the drugs are complex, and that clinical trials are essential. "Follow-on drugs are not equivalent," they argue.
Published by Globes [online], Israel business news - www.globes.co.il - on January 26, 2005