Teva sacrifices long-term growth for stability

Kare Schultz Photo: PR

One year into the job, Teva CEO Kare Schultz has halted the plunge in the company's share price and restored investor confidence, but what of the future?

"The question is whether or not you're in." This is what Teva Pharmaceutical Industries Ltd. (NYSE: TEVA; TASE: TEVA) Kare Schultz, now finishing his first year at the helm, said less than a month after entering his position to those of the company's management he wanted to retain. In that talk, he explained that he was going to make cuts, and "if that suits you, I'll be glad if you'll stay, but you have to realize that this is the job you are going to carry out in the next two years."

In his first year as Teva's CEO, Schultz took the company, which looked like it was on the edge of the abyss, with a huge debt and facing a crisis in the generics industry, the loss of exclusivity for Copaxone, its flagship product, and above an absolute loss of investors' confidence, to another place. Teva's debt was reduced and rescheduled. Its organizational structure was made flatter, leaner, and more efficient. Its share price resumed its upward path from a low of $11 to over $22 (and a market cap of NIS 85 billion) followingthe positive results earlier this month, which were better than expected - among other things, due to the fact that doom-laden predictions of a steep drop in Copaxone sales did not materialize. The company, however, was also forced to make painful cuts. No fewer that 9,100 of its employees worldwide, including 1,700 in Israel, were sent home. 12 plants were closed or will be closed later, including at least three in Israel, despite the prime minister's attempts to intervene.

There was another difficult concession: a complete abandonment in the coming years of what had characterized Teva in the past - the creation of new growth engines. Teva has a new and recently launched innovative drug for treatment of migraines, and several other things in the pipeline, but all of them are the results of previous investments, mainly during the term of former CEO Erez Vigodman. There are no significant new investments. "Among us analysts," says Leader Capital Markets Ltd. (TASE:LDRC) research department manager Sabina Levy, "you won't see an assumption of growth in Teva in the coming years. For me personally, this raises questions. I do believe that the company will succeed in reducing its leverage, and assuming there are no earthquakes in the market, within two or three years, its market value will rise because of the reduction in debt."

"He's doing all of the right things in the short term," says an industry source. "It's obvious that in the short term, you have to first put out the fires. The big question is whether Teva will ever be what it was before. For the longer term, Teva needs growth engines. The money it saved, the good people it dismissed, put this in doubt. It sold many units with good sales, meaning that it cut its ability to grow. Especially now, when profit margins in the generics industry are falling year-by-year and the penetration rate in the US is already 91%, generating additional value has to be in the innovative sector, and this is something that is not happening now."

Other industry sources say that there is a right time for everything, and it is impossible to both rescue the company from its dire straits and invest in growth at the same time. When the time comes, they hope, Schultz will be able to invest in Teva's future. "It is premature to interpret what he is doing and say that he is only cutting, not building," they argue.

Former Teva CFO Dan Suesskind, who was a company director in the first nine months of Schultz's term as CEO, is convinced that "Schultz is the right man in the right place at the right time, because he came with a single clear goal and no commitments to the past. That enables him to took at things the way they are. He does not back down. This characteristic first stood out when he met with Benjamin Netanyahu last December. Netanyahu apparently thought that their meeting would change things in Teva's streamlining plan, but Schultz decided on the plan and will carry it out, without giving in to pressure or cutting corners."

"Globes": As far as you can judge, won't this cost-cutting plan, especially shutting down part of production, harm Teva in the long term?

Suesskind: "When it's essential to act quickly, sometimes the baby is thrown out with the bathwater. There's no doubt that closing down a large number of plants was logical, but not all of the decisions are 100% right, and it's not definite that shutting down all of those plants was necessary. There are plants that could have been shut down, but were not. When you need an emergency plan, however, you can't spend a year on putting it together. It's like war; when they attack you, there's not time to sit around comfortably and devise a plan."

Sources associated with Teva said that the company "explicitly stated that it would make no more acquisitions, because its debt was still large. The company will be busy reducing its debt until late 2019. There will be no non-organic expansion until Teva attains a level of debt that is normal for a company its size, which is expected to occur in 2020. There will be no more of the buying and selling that were not always precisely calculated that occurred in the past. At the same time, there is a strong system of generic products and every shekel is being invested in biosimilars (copies of biological drugs that are more complex than ordinary generics). The company is launching a drug for migraines in the US and hopes to expand to Europe next year, and there are more drugs in the pipeline. In the near future, there is room for growth."

"The rules of the game are very clear"

Schultz, who made his mark in the Danish pharmaceutical industry, first in Novo Nordisk and later as the CEO responsible for the turnaround in Lundbeck, is focused, consistent, and demanding. His former employees in Denmark used to call him "hardcore" (the name "Kare" is pronounced "core") because he was so demanding in achieving targets. People around him say, "As long as you supply the goods, everything is fine, but the rules of the game are very clear."

He is also something different in the local management landscape. "He's a Dane in the full sense of the word," says someone who knows him well. "He has none of the manners or papers of the typical CEO. He has no entourage. He brought only his personal assistant with him. He sits in open space, eats in the cafeteria (in Teva's Petah Tikva offices), and is likely to go up to employees and sit at their table. But he's a shark in navigating this ship in very stormy waters."

He may be informal, but he is certainly not modest in his salary demands. The moment of desperation at which the board of directors contacted him yielded a remuneration package that includes a $20 million signing bonus (in two payments); a $2 million regular annual salary, not including expenses; a performance-linked bonus amounting to 140-200% of his regular salary which he will most likely receive, given the streamlining plan's success; an allocation of options with $6 million on the allocation date at a strike price of $11.40 per share, which puts these options in the money, and a further allocation of $20 million in vested options that he can exercise later in installments over the next five years.

It can be assumed that all of this is likely to make him not only highest paid executive at the time, but also the highest paid CEO ever in Israel. The company Jaguar he was given at the beginning aroused social protest, so he was given the Lexus used by his predecessor, acting CEO Yitzhak Peterburg.

"He keeps his cool, and like most Europeans, he has a certain gentleness and charm," says former Teva executive Chaim Hurvitz, son of the late Eli Hurvitz, former Teva founder, CEO, and chairperson, who still keep in close touch with Schultz. "He has a good combination of determination and emotional sensitivity. His style is suitable for getting along with Israelis. He also fell in love with Israel, likes to travel, and enjoys the Tel Aviv scene.

"I feel that with him, Teva has returned to a working mood. Before, everyone was in shock at how a strong company, the pride of the industry, all of sudden fell so hard. It wasn't easy recovering and getting back to normal. I think he succeeded in calming the company, setting new targets, and also rebuilding the people, who were rather depressed: both the management and the board of directors."

Such cool is un-Israeli, and perhaps the effort to make objective decisions that are not affected by excessively emotional meetings is also reflected in Schultz's refraining from visits to Teva's plants in Israel - both those that were closed down and those that remained, such as Teva Kfar Saba. "Other than Petah Tikva, he didn't visit Teva's sites even once," says Teva Kfar Saba union chief Eliran Kozlik. "I corresponded with him several times, but I never saw him. I don't judge him; he received a bad inheritance, and I know he's doing everything to raise this company. But maybe it's right for a new CEO to do a tour of the plants to see what we're doing and talk with the workers."

Kozlik is leading the struggle of Teva workers against Schultz's decision to cancel the bonuses that the workers regard as part of their salary and working conditions. "When it's raining, everybody gets wet," says Kozlik, "but I don't see that the people above are getting so wet. When Eli Hurvitz came in tough times and said that he had no money to pay, we said all right, because we knew he didn't pay anyone. Now they're saying, "Tough, tough," but the cream is too sweet for those still eating it."

Meir Ben Elul, chairperson of the workers at Migada, Teva's plant in Kiryat Shmona, now up for sale, who is currently in the midst of a tumultuous workers' struggle against Teva, has never met Schultz. The Migada employees are not fighting for the laid off workers, who will receive the retirement packages achieved in previous struggles at Teva Jerusalem (10-12 monthly salaries); they are fighting for those will remain and work under the news owners to whom the plant is sold. The argument is over the amount they will receive in order to give up the retirement terms and remain.

"Now they're throwing us to another company," Ben Elul says, "when no one knows whether they take the machines away and go after two years. They know that we are in an outlying area, and there isn't much employment here. Let them leave us a bit of dignity." Teva says that there was already an agreement with the workers, who retracted it. In any case, however, Schultz, who has already closed 12 plants and will close more, has never been seen in Kiryat Shmona.

"Why doesn't anyone ask whether Schultz went to see the plant that Teva closed in India, or in the US?", sources close to Teva ask. "Teva is a global company serving 200 million people all over the world, with its headquarters in Israel, but with 46,000 employees throughout the world. He doesn't manage Israel; he manages global Teva, which competes against companies from India, Eastern Europe, and China that produce the same quality at much lower cost. The provincial attitude in Israel prevents people from understanding that one of the biggest dangers is not that they will close some sites; it's that they will move Teva away completely."

"A share like any other share"

Teva is not being removed completely from Israel, at least not now, but many believe that the Teva's severe crisis was an opportunity for Schultz to greatly reduce its activity here, under the assumption that "there is no choice." The words "exit from Israel" in production were not pronounced for the first time when Schultz joined the company. The subject has been on the agenda of all the CEOs since Eli Hurvitz. Company sources, mainly on the operation side, thought that there was no justification for leaving the plants in Israel. Some thought that this was true of all of Teva's plants; others thought it about only some of them. There was, however, agreement on the substance, but it was very hard to do when the company was in a good situation.

The crisis, however, which may have been blown up out of proportion, and the fact that Schultz is not from Israel, has no emotional attachments, and especially has no local connections and commitments have created "a rare opportunity to do things that would have been considered extreme and impossible in a different context," a market sources says. In his renowned letter to the prime minister explaining why he had to made such painful cuts and layoffs, Schultz wrote, "I want to sincerely and personally apologize in the name of Teva's previous management for the situation that the company is now facing," both explaining that there was no choice and also announcing, "It's not my fault; I'm here to save the situation."

In a competitive world, amidst continually eroding profits in the generics sector and cheap labor in certain places around the world, it is obvious that it is impossible to arbitrarily decide ideologically that production will take place here and nothing else is important. Focused steps can, however, be taken to improve the Israeli plants and decide what is suitable for them to manufacture and what is now. Such a plan began when Vigodman was CEO, but the crisis naturally also took precedence over that.

A good question is whether Schultz will bother doing this work. Otherwise, if manufacturing vanishes from Israel, R&D will also gradually vanish. At the same time, it must be kept in mind that while there really is no reason to manufacture tablets in Israel, there are more complex products made by Teva, such as biosimilars - almost exact copies of original biological drugs - that can be manufactured in neither China nor India, but only in Israel, and also in Australia and Germany.

This is the place to ask the question about Teva's Israeli identity. This question did not start with Schultz, of course. For many years, most of Teva's shareholders and market have not been here. Teva's activity in Israel accounts for maybe 2-3% of the total. Although the company is also listed on the Tel Aviv Stock Exchange (TASE), most trading in the share is on Nasdaq. Teva's previous management included four Israelis, including the CEO himself. Only two are left now: group EVP and chief human resources officer Mark Sabag and group EVP for corporate marketing excellence Iris Beck-Codner. Of the 11 members of Teva's board of directors, there are only three "veteran" Israelis (Amir Elstein, Nechemia Peres, and Prof. Ronit Satchi-Fainaro) and a few more "new" Israeli residents.

"When Teva stopped being an Israeli company, I lost interest in it," one investor says. "Now it's a foreign company for all intents and purposes, with a CEO who is present in Israel symbolically because of the articles of incorporation. What is surprising is that the country continues to follow Teva as if it were still the country's share. There's no basis for it. I'm still a shareholder, but no longer for patriotic reasons. It's a share like any other share in my portfolio."

Suesskind, on the other hand, is convinced of Schultz's commitment to the company's Israeli character. "He bought an apartment in Israel, and recently took up residence there with his wife. His commitment (according to Teva's articles of incorporation) to being a resident of Israel didn't require him to do this. But he nevertheless moved the center of his life here, and also brought the (non-Israeli) members of senior management to live here."

In addition to Schultz, EVP and CFO Michael McClellan, EVP international commercial markets Gianfranco Nazzi, both senior executives, and Teva Active Pharmaceutical Ingredients (TAPI) and biologics operations president John Nason moved to Israel. "It's important for him," Suesskind adds, "to soothe the fear that Teva will no longer be Israeli. He spoke to the workers in Petah Tikva at the traditional pre-Rosh Hashana toast and definitely said things along those lines - that it's true that the management is not all Israeli, but the company will remain Israeli and its management will be from Israel, and will also keep R&D and manufacturing activity in Israel as much as possible."

Schultz did buy an apartment here in a luxury project above a hotel in Jaffa. As he usually does, he conducted tough negotiations for it and got a 10% discount, paying $6 million. The project has a swimming pool, fitness club, laundry, room service, and so on. Note that buying an apartment here is not something that foreign CEOs of companies with headquarters in Israel usually do. Neither former Teva CEO Jeremy Levin nor former Israel Chemicals (TASE: ICL: NYSE: ICL) CEO Stefan Borgas did it.

"He is giving everyone a lesson about what an Israeli company is," Schultz's associates say. "He comes from Novo Nordisk, the Danish equivalent of Teva, a local company that grew into a global one and in contrast to Teva, applied mechanisms that left the company's center of gravity in Denmark, although there are both Danes and non-Danes in the company's management. After all, a multinational company also needs managers who understand other cultures and other markets. In the Kare era, more functions are moving to Israel, and in his vision, all the managers who are not geographic marketing managers who require proximity to the target market will be located here. This is the opposite of the trend that gained momentum under the previous CEOs. Teva today is far more Israeli than ever."

An unclear future

Exactly one year ago, when Schultz first strode into the Teva building in Petah Tikva, the impression of sources close to the company was that "his record of someone able to turn things around was completely appropriate for what the company's management had experienced. It was completely despondent after the share price plummeted, and the feeling was that the situation was no longer sustainable."

He arrived following several meetings with chairperson Sol Barer and members of the board of directors' appointment committee. He already read all the material - published material, since the company was a public one - and prepared an analysis and mapping for himself. He immediately held meetings with all of the company's management and decided who would be allowed to stay, if they wanted, and who would be asked to leave. He promoted people from inside to fill the vacant positions. "This is one of the things he believes in," says a person who knows him well. Schultz took up his position in early November. Only November 27, Teva already announced that it was restructuring. "Simpler, more accurate, and limited, with fewer intermediate levels," was the impression of someone close to the company. The new team was summoned immediately to deal with the most urgent problems: a debt of almost $35 billion, an almost total collapse of the generics market and the beginning of generic competition for Copaxone, Teva's flagship drug. In the restructuring plan, all management members were asked to show how they would make cuts averaging 25%.

As of now, there is no doubt that Schultz has fulfilled expectations, and even exceeded them. The plans for reducing and arranging the debt are working according to plan, due among other things to a successful bond issue, while the plans for reducing the spending base by $3 billion by the end of 2019 (in comparison with 2017) are going even faster than expected: at this stage, the spending reduction, which should have been $1.5 billion according to the plan, has already reached $1.8 billion. "There is no doubt that the enterprise has undergone an earthquake," says someone well acquainted with Teva, "and another year of restructuring is in store. But there is a different spirit in the corridors, and the masses of employees all over the world who left the company have created an extraordinary opportunity for people from inside. There is an outbreak of energy."

In September, following some delay, Teva received approval from the US Food and Drug Administration (FDA) for Ajovy, its original drug for treatment of migraines. In April 2017, Teva launched Austedo, a drug for treatment of movement disorders and Huntington's Disease that already has $200 million in sales, and there are other things in the pipeline, such as a biological pain reliever named Fasinumab, which is still in the testing stages. All of these things are encouraging, but predicting how much they will grow is difficult. Teva notes with pride the entry of long-term investors, such as Capital Research Global Investors and Warren Buffett's Berkshire Hathaway. "Not the short players, but those who understand that despite everything, the generics industry is sustainable, even if the prices from four years ago do not return."

"There is no doubt that Schultz entered during a storm and immediately embarked on a very comprehensive cost-cutting program," says IBI Investments pharma and medical analyst Steven Tepper. "He did very well at cutting the debt and convincing the market of his commitment to cutting the debt, and it appears that he will succeed in meeting payments on the principal spread over the coming years. The market greatly appreciates this.

"It is true that it is unclear what will be in the future pipeline, but Schultz is giving the market a clear indication that this is a period in which the situation has to be stabilized and the debt reduced. He says that as of now, the products he has will provide growth in the short term. The focus right now is not on R&D, and the market is not pestering them about R&D, because the debt has to be taken care of and the existing products must be promoted." Just how patient the market will about Teva's lack of investment in the future? Schultz will have to deal with this question in his second year at Teva that is now beginning.

Published by Globes, Israel business news - en.globes.co.il - on November 11, 2018

© Copyright of Globes Publisher Itonut (1983) Ltd. 2018

5 Comments
View comments in rows
Update by email about comments talkback
POST
Comments
Kare Schultz Photo: PR
Kare Schultz Photo: PR
Twitter Facebook Linkedin RSS Newsletters גלובס Israel Business Conference 2018