Chaim Hurvitz: Teva has no problem as a company

Erez Vigodman  photo: Tamar Matsafi

Some analysts see distress signals in Teva's 2017 outlook, but most still recommend "Buy".

Teva Pharmaceutical Industries Ltd.'s (NYSE: TEVA; TASE: TEVA) business difficulties and a loss of confidence in the company among investors have caused a 45% fall in its share price over the past year. The company revised its 2017 forecasts this week, leading to a further slide in the share.

When Teva published its third quarter results and downwardly revised its forecasts for 2016, the market wondered what would happen in 2017. Teva, however, did not change its 2017 forecasts. The company's current revision is even worse than the market expected. The Teva share price plunged 7.7% in New York following the revision, pushing the company's market cap down to $35.6 billion.

Teva now projects $23.8-24.5 billion in revenue, down 4-6%, compared with its most recent forecasts from July 2016. Its new earnings per share forecast is $4.90-5.30, compared with a previous forecast of $6-6.50 in July.

Under CEO Erez Vigodman, Teva has experienced several negative events recently. The generics sector is suffering from a substantial drop in prices. The market is now criticizing Teva's acquisition of Actavis, Allergan's generics division, for $40 billion in cash and shares. Teva's acquisition of Mexican company Rimsa proved to be a fiasco; Rimsa's plants are now shut down. There have also been two legal imbroglios. One was a case of bribery in developing countries, in which Teva reached a compromise settlement with the relevant US authorities, but is now subject to a derivative lawsuit by an Israeli shareholder. The other is a US investigation of suspicions that leading generics companies fixed prices. More important than any of these factors is the Copaxone trial. This trial could end in the coming months with approval of a generic version of Teva's flagship product, which currently accounts for 35% of Teva's profits. These are definitely tough times for Teva, and the latest forecasts published by the company have not improved the situation.

Leader Capital Markets analyst Sabina Levy writes, "Teva's downward revision of its forecasts was more aggressive than the market consensus, even though it did not take into account generics competition for 40-mg Copaxone, while a considerable proportion of the analysts did include this in their calculations. In other words, the situation according to the revised forecasts is significantly worse than what the market previously thought. The market was not surprised by the forecast, but was somewhat embittered."

Teva stated that if generics competition emerges for Copaxone, it will cost the company $1-1.2 billion in revenue and $0.65-0.80 per share in profit. Bernstein Research analyst Ronny Gal believes that the damage to Teva's profit from generics competition will be much greater - $1 per share. He adds, "For Teva, we are mainly awaiting the true results, because its record of meeting its forecasts is not so good."

"Globes": Could Teva simply have published excessively low forecasts in order to make sure that it meets them this time?

Levy: "Teva did say in its conference call that these forecasts were conservative. During this conference call, however, I felt that the analysts were still not sure about these targets. Vigodman did very good work at first in gaining the market's trust, but investors have lost a great deal of faith in recent months."

Is Vigodman's job in jeopardy? Teva shareholder and former senior executive and director Chaim Hurvitz says, "Vigodman is really having a hard time, but his basic character hasn't changed. He's an honest and smart man - an achiever. Some of the problems have nothing to do with him. He'll get through it. That's the advantage of Israeli managers."

In the conference call, Vigodman himself said, "2016 was a transitional year. 2017 is a performance year. It's important to realize that the forecast we presented was based on the information we had at the time."

Was Actavis worth the price?

If Teva does meet its forecasts, its profit in 2017, the first full year in which Actavis's results are consolidated, will be 5% higher than in 2016 (assuming that the company also meets its forecasts for the fourth quarter of 2016). Teva's EBITDA is also projected to grow 11%, with most of the increase coming towards the end of 2017. Actavis will contribute $2.1 billion, 25% of profit, to EBITDA. Teva also said that synergy would save it $1.3 billion (the company previously said that it would post a $1.4 billion gain for synergy in 2019, and is now reaffirming that forecast).

Evercore ISI senior marketing director and analyst Umer Raffat says that the forecast means a 4-10% drop in generics business. Levy adds, "Most of the damage to revenue comes from the generics sector, which means that as of now, the acquisition of Actavis was not worth the price, as the market feared."

In the conference call following the publication of the forecasts, Vigodman said, "Today's forecasts are substantially lower than those we published last July, mainly due to the generics business in the US and the generic launches that did not take place. These affected 2016, and will continue to have an effect in 2017."

Levy asserts, "Some of the delays are due to Teva's partners, not to Teva. In some cases, the problem is with the US Food and Drug Administration (FDA), which has stepped up the pace of its approval for generic products, but is prioritizing the smaller products." Hurvitz notes that there are a variety of reasons, some of them legal, such as a delay in at risk launches and products waiting for legal approval.

Vigodman himself says, "We will have many small launches that will add up to large sums, and will probably be more stable than the big wins we had in the past." He added that the merger with Actavis would boost the generic division's profit margins, despite the drop in generics prices in the US.

In the innovative sector, Teva hopes to launch the SD809 product for Huntington's Disease in the first half of the year and its dyskinesia product late in the second half. According to the analysts, peak revenue from this product could amount to billions of dollars, and to tens or hundreds of millions of dollars in the first year after the launch, depending on the launch date. Teva also expects results from its Phase III trial of a product for treatment of migraines during the year. Good results are likely to boost Teva's market cap even before the product is launched. At the same time, Teva expects to lose its exclusivity for other innovative products, such as Azilect, ProAir RespiClick, and Fentora.

Selling real estate and reducing debt

In the conference call, Vigodman said that Teva would make no substantial acquisition deals before its ratio of debt to EBITDA is reduced to 3.5 (compared with 3.6-3.8 at the end of 2017, according to the forecast). Bank of Jerusalem (TASE: JBNK)( senior analyst Jonathan Kreizman writes, "The restriction on acquisitions because of debt contradicts the original plan to acquire a company in biosimilars, in which Teva trails behind its competitors."

Levy writes, "In the conference call, Vigodman said that the company would sell various assets, including real estate properties, intellectual property, and products being sold by Actavis in Europe, in order to increase its free cash flow in servicing its debt. This message could disturb the market. It says that the company is in distress." Levy, on the other hand, believes that the debt is not currently putting the company at risk. "In principle, the cash flow challenges are liable to affect Teva's dividend at a later stage," she writes. Vigodman stated in the conference call that as of now, no such development is expected, but investors could find this point troubling.

Meitav DS Brokerage analyst Ziv Narkis writes, "Teva is assuming that its debt will total $30.5 billion at the end of 2017, compared with $27.2 billion in its previous forecast. This difference jeopardizes its prediction that its debt will fall to $12.7 billion. Teva is counting on a substantial improvement in its operating profit from general business and a successful sale of assets, which will help it repay its debt." Narkis adds, "Teva has recently had trouble in gauging the situation, and its forecasts are far from the actual results."

Most analysts recommend "Buy"

According to Vigodman, Teva is developing in international generics, following the acquisition of Actavis, and is reducing its dependence on Copaxone in favor of generic activity (because Copaxone sales are falling). Vigodoman says, "Today, only 50% of Teva's profit comes from its innovative activity, and the rest from generics. Only 35% of profit comes from Copaxone."

At a time when the generics market is in trouble, Teva is thus fortifying its standing as a generics company. As of now, it has no cash available to acquire substantial innovative business. In effect, it has locked itself into this position for the coming years. This was a deliberate decision by Vigodman, who sought to deal first with generics, and only later to develop in the innovative segment.

In private conversation, several analysts are raising the question of whether the way to rescue Teva's value is by splitting it into two companies: one innovative and one generics. Such a split has become an acceptable measure in recent years among pharmaceutical companies.

This would leave Teva's generics business as the world's largest. If half of Teva's current market cap is attributed to generics, it is worth $20 billion. If priced at the market's currently prevailing multiples for this type of activity, Teva's innovative business could be worth double this, meaning that its total value will rise by 50%. In this plan, Teva will no longer be an everyman's share incorporating both dreams and industry; the industry and the risky dreams will be separate, and each investor will have to choose which version he prefers.

Levy comments, "Teva often says that the analysts are not pricing its products pipeline properly. Separating the companies can enhance its pricing, but with a higher pricing also comes risk."

Hurvitz says in response, "Teva's power lies in the combination of generics and innovation, and there's a great deal of synergy between these fields. The analysts should stop telling us what to do. Teva has no problem as a company; it has a problem with its share price."

In view of all these negative views, it is interesting that most analysts still recommend "Buy" for the share, feeling that the market response has been too extreme. 14 of the 25 analysts covering the company recommend "Buy," while the other 11 recommend, "Hold."

Published by Globes [online], Israel Business News - www.globes-online.com - on January 9, 2017

© Copyright of Globes Publisher Itonut (1983) Ltd. 2017

Erez Vigodman  photo: Tamar Matsafi
Erez Vigodman photo: Tamar Matsafi
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