The Teva Pharmaceutical Industries Ltd. (NYSE: TEVA; TASE: TEVA) share price is still heading southward, falling 10% to below $40 last Thursday, its lowest point since November 2013. "Bloomberg" reported that a criminal investigation was being conducted in the US against 12 generic drug companies, including Teva, on suspicion of coordinating generic drug prices in violation of antitrust laws. Teva denies the allegations.
Teva's share recovered slightly last Friday in New York, rising 2.6% to $40.24 (reflecting a $36.8 billion market cap). This price is still 10% lower than the share price when Erez Vigodman replaced Jeremy Levin as CEO in February 2014. The Teva share was down 4.5% in TASE trading today, thereby closing the negative arbitrage gap with New York Stock Exchange.
There are a number of reasons for the share's decline in recent months. The most important of these are uncertainty regarding the US election results and the weakness of the generic sector, the second of which raises retrospective questions about whether Teva's $40 billion acquisition of Actavis, Allergan's generic division, was worthwhile.
The Teva share price has dropped 44% since its peak in mid-2015 (a peak attributed at the time to the report of the expected acquisition of Actavis, which then seemed to investors like a good idea). The cumulative decline in the share price reflects a loss of $15 billion for investors in Teva.
Teva said in a statement, "Teva is not aware of the existence of any facts that will cause exposure of the company in connection with subpoenas to give evidence that have been reported."
Mylan N.V.'s (Nasdaq: MYL; TASE: MYL) response was similar: "We have always been committed to cooperation with any investigation by the Federal Trade Commission. We have no evidence of participation by our company in price coordination."
Assessment: The Justice Department is aiming at a compromise
On Friday, Evercore Investment Banking analysts Umer Raffat and Akash Tewari published a detailed report in response to the event, in which they predicted on which drugs the investigation would focus, and on that basis tried to assess the maximum damage to the companies involved. They believe that Teva, which lost $1.6 billion in market cap in trading at the end of last week, is exposed to $700 million fine at most, while Mylan's exposure is $770 million. They say that Allergan is not exposed to the event, because it transferred all of its exposure to Teva through the sale of Actavis. This is a worst-case scenario in the event that the case culminates in either a compromise settlement or a trial lost by Teva, which according to the report is by no means certain.
The Evercore analysts are still recommending "Buy" for the Teva share, with a target price of $65, 61% above the share's closing price last Friday, when they wrote their review. "If Actavis Generics is really exposed to a claim," asks Bank Hapoalim (TASE: POLI) analyst Ron Friedman, "was this risk taken into account in the due diligence process conducted before Teva completed the deal, when a major failure occurred in this process when Teva acquired Rimsa?" Nevertheless, he believes that in the end, the Teva share price constitutes an attractive long-term buying opportunity, and recommends "Market perform" for the share, with a target price of $70. "In a 'normal situation', the Teva share would currently be substantially underpriced; at the same time, we think the share will have difficulty reaching our estimated economic value in the near future, before the picture becomes clear," Friedman writes.
Evercore's analysts also try to analyze whether the US Department of Justice really has a well-founded case against the generic companies. They note that the fact that an investigation is taking place against a number of generic companies (but not Teva) was known. What is new is that a criminal investigation is involved, and in order to prove that a crime has been committed, explicit price fixing must be shown. While they note that drug prices rose in tandem in 2014, it is more difficult to show that the companies' executives spoke with each other and reached agreement to act in this way. According to the analysts, since summons for specific people in a number of generic companies (not Teva or Mylan) were served in the past, it appears that the investigators are not simply shooting from the hip, and are not merely relying on graphs indicating simultaneous price rises by the drug companies. However, Raffat and Tewari say, the fact that the investigation took so long, the denials by Teva and Mylan, and the fact that the rumor of the investigations surfaced in the financial press in the current political climate (which is biased against Mylan and generic companies in general) is liable to indicate that the Department of Justice does not have much confidence in its case, and is inclined to compromise.
Note that the rise in generic product prices occurred at the same time as the government drug insurance reform. The companies can argue that an increase in all of their prices took place simultaneously because they were all responding to the reform, not because they were fixing prices.
Analysts: The responses are exaggerated
Those following the sector say that the heads of the generic companies had an opportunity to coordinate prices at the major industry conference that took place just before the prices started rising. Sanford C. Bernstein senior pharma analyst Aaron (Ronny) Gal expresses skepticism about a conspiracy on this scale. He notes that most of the trials in the sector end in fines of less than $1 billion for all the accused combined. Gal recommends "Buy" for Teva with a $52 target price, 30% higher than the Friday closing price for the share.
Gal addressed the general attitude towards the generic sector in the US, and says that in his opinion, the responses are exaggerated. "There is no substitute for generics in the US. Generic prices are not expensive. They constitute 90% of the US market, and the prices of all the drugs in the industry have fallen. Only in specific sub-categories have prices rise," he writes, adding, "Is it possible that the next administration will enact laws against generics? It is possible, but there is not much logic in it. How long will the fear in this sector continue? We do not know, but in the past, buying generics in a sharp decline proved to be a profitable strategy."
Poalim IBI Underwriting and Investments Ltd. (TASE:PIU) analyst Steven Tepper also recommended taking advantage of the crash. "It is almost impossible to prove that the crime of price fixing took place. In Israel, also, in the bank commission rate fixing affair, following years of investigation by the Antitrust Authority, the Antitrust Authority director general's ruling was there was an agreement in restraint of trade was reversed, and the banks reached a compromise with a miniscule NIS 70 million fine divided among the five largest banks.
"The degree of involvement by each of the companies (Teva, incidentally, has so far not been summoned for questioning), which products are involved, and the extent of damage caused are unknown, but in a nervous capital market, anything having to do with drug prices causes a crash. When the market is so hysterical, we become more confident in our belief that the Teva and Mylan shares are buying opportunities."
The Credit Suisse analysts also call the Teva share's response "exaggerated." In contrast, HSBC downgraded its recommendation for Teva to "Sell." "We have no idea whether the investigation is justified, but the claim is generating uncertainty, and investors are inclined to shoot first and ask questions later," the HSBC analyst wrote.
The sector is waiting for the elections
Along with the rest of the generic sector, the Teva share is way down, and it appears that any slight shock pushes it down further, with investors losing confidence in the company's policy. By the end of the week, however, a new US president will be elected, and the drug pricing issue, which the Democrats used as a campaign tool, is likely to disappear from the headlines after the next president is elected. As both Gal and Tepper have said in the past, no US president has any reason to hurt the generic industry.
Jonathan Kreizman, the analyst covering Teva for Bank of Jerusalem's (TASE: JBNK)( pharma department, also says the severity of the suspicions is unclear, noting, "The slide in Teva and the other generic shares is more anxiety about new legislation, as part of Hillary Clinton's planned reforms, that could significantly damage the industry. As of now, no such legislation is known. If indications of it do not emerge, we are likely to see these shares recover."
Substantial progress in Teva's innovative pipeline is also likely to change the picture. A new innovative drug in the market can generate billions of dollars in annual revenue for the company, and reduce its dependence on the state of generics. Teva's innovative pipeline has several prospects with a chance of achieving this result
Beyond Teva's exposure to a fine by the Department of Justice, proof of its guilt or a compromise by the company will expose it to derivative lawsuits. A number of such lawsuits have already begun to emerge in what is practically an automatic reflex when the shares of listed companies in the US drop sharply.
This time, the shaping of such a lawsuit has also begun in Israel. Adv. Jacob Sabo, from the Sabo and Co. law firm, has sent a letter to Teva chairman Yitzhak Peterburg on behalf of two shareholders in the company. The letter asks Teva to inform the shareholders within 45 days whether or not the claim by the US Department of Justice is justified, and if it is, it asks Teva to file suit against its officeholders involved in fixing prices.
Published by Globes [online], Israel business news - www.globes-online.com - on November 6, 2016
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