Teva strives to pull out of a tailspin

Erez Vigodman photo: Eyal Yitzhar
Erez Vigodman photo: Eyal Yitzhar

CEO Erez Vigodman retains the board's support even though the company's share has lost half its value.

Teva Pharmaceutical Industries Ltd. (NYSE: TEVA; TASE: TEVA) is often regarded as the flagship of Israeli industry. Right now, however, to borrow a phrase from CEO Erez Vigodman, the company is more like a rollercoaster. "I heard the comparison to a rollercoaster more than once, and like a rollercoaster, sometimes it goes very high, with a good view of the promised land, and sometimes its finds itself plunging downward, where it can't always see the ground," says a close friend of Vigodman. "Vigodman has already been on a rollercoaster like this quite a few times in his career with Strauss Group Ltd. (TASE:STRS) and Adama (formerly Makhteshim Agan), and he led the rollercoaster back to the summit in all those cases. This experience is very important in the processes they're experiencing there."

Vigodman, who initially received support from every direction, is having sleepless nights, and feels less solid and confident in a position that is the culmination of his career. He has been hit by a streak of bad luck. A general slump in the pharma industry, coupled with bad news that the company has been forced to announce, have sent Teva and its investors scurrying for an urgent medicine for the company's migraine. "This is a very difficult year for him," his friend explains. "Things may look glittering from the outside, but when you are CEO of a company like Teva, you devote your life to the task even when things are normal, and even more so when the going gets tough. You don't sleep at night. But that's part of life in managing a company on that scale."

No one can accuse Vigodman of being too cautious since his appointment as CEO in 2014. He is certainly managing the process of emerging from the dependence on Copaxone with a range of unique drugs, and is also looking for solutions to the fall in prices and profit margins in the generic industry. "A lot of important things have happened in the company during these three years," says a senior pharma industry figure. "The most significant of them is the creation on an internal growth engine, reflected in Teva's current R&D capability and backlog of products in both the generic and ethical drug segments."

A capital market source says, however, "When sentiment is working in your favor, they overlook errors and missteps and all the bad things. When it's working against you, as is now happening to Teva, they don't see the good things. Even when Teva reports good things, such as a successful trial or interesting cooperation, almost nobody writes about it."

What are the 2017 forecasts worth?

What has happened to Teva? It opted for the biggest merger in its history: the acquisition of Actavis, Allergan's generic division, at a price that appears high in retrospect. Any assessment of this acquisition is premature, but Sigurdur (Siggi) Olafsson, the president of Teva's generic division and one of the acquisition's main architects and supporters, who was responsible for assimilating it, unexpectedly resigned two weeks ago, thereby upsetting investors, whose confidence in Teva's path was already waning.

Shortly after successfully completing the Actavis deal, Teva made a smaller acquisition - in retrospect an unsuccessful one. The object of the acquisition was Mexican company Rimsa. Teva had to declare this acquisition a failure after discovering an alleged double system of registration, i.e. fraud.

"This acquisition arouses great doubt about Teva's ability to make an acquisition with the right due diligence," says a pharma industry source. "This is something that Teva used to do very well. In recent years, however, its acquisitions have not been good. Just a few months, after this acquisition, $2.3 billion (the amount paid for Rimsa) went down the drain.

"This is not what people expect from a company like Teva," chimes in Leader Capital Markets research division manager Sabina Podval Levy. "They don't expect a company like Teva, with experienced management and a long record of mergers and acquisitions, to make this kind of mistake."

A capital market source came to Teva's defense, saying that the company had no way of knowing what was happening in Rimsa before seeing it at close range and discovering what it did, because it has always been customary to rely on the scrupulous and frequent checks made by food and drug administrations. At the same time, however, it was a harsh lesson for Teva, which is now changing its due diligence procedures for the future; if that is impossible, Teva will not make the acquisition.

Furthermore, Teva had to revise its forecasts for 2016 in November, which is very late in the year. The revision itself, as Chaim Hurvitz, one of Teva's owners and the son of Eli Hurvitz, Teva's legendary founder, put it was "an unpleasant surprise amounting to tens of millions of dollars, and in the sales line, not the profit line. It's not that I'm indifferent to it, but I'm also not too worried about it, considering the uncertain environment in which Teva operates."

The problem, however, was not "tens of millions of dollars"; it involved the way Teva makes its forecasts, and what that means for Teva's 2017 forecast - and that is a far more substantial concern.

"The targets that Teva published in July this year for the next three years are perceived by the market as very optimistic," says Levy. "The market has begun to be concerned that the company is overoptimistic. Teva held a day for analysts on generics in September, and was still expressing optimism. Several weeks later, however, when its third quarter results were published, we saw that its generic performance was not as good as they thought, and they lowered their forecast for 2016 at the same time. Investors wondered what this meant for the company's forecasts for 2017 and later."

To be fair, it was difficult to foresee that the drug industry would become part of the emotional presidential campaign in the US, or that the candidates would make promises about drug prices, both because of several scandals in the field that did not involve Teva, and because of drug prices - mainly of branded drugs, but also of generic ones. After the Democratic candidates jumped on the bandwagon, President-elect Trump announced in an interview that he would combat these prices. Changes in the industry also played a role in pushing down prices.

Was the deal too big?

Back in 2015, everything looked different. In July 2015, just weeks after the widely covered media exchange between Mylan N.V. (Nasdaq: MYL; TASE: MYL) chairman Robert Coury, who did not want his company to be acquired by Teva, and Vigodman, who wanted to acquire the company, Teva announced the biggest deal in its history and the history of the Israeli economy: the acquisition of Actavis, Allergan's generic division, for what eventually totaled $38 billion.

There were those who believed that the disappointment with the failure to acquire Mylan and the urgent need for a large-scale acquisition were what pushed Teva into such an ambitious measure. One capital market source thinks otherwise: "Teva's preferred target was Actavis from the first stage in the process. It sounds a little like science fiction, but you could say that Teva went after Mylan in order to get Actavis, because before that, Allergan refused to sell. Actavis was always the preferred deal for Teva, because it was a better complement to Teva's generic business."

Those were the days of the pharma boom in terms of market value, and the deal looked good "although there were some questions about the value," says Levy. Due to regulatory delays, however, the deal was completed only in August 2016, in the heat of the US election campaign, when the atmosphere in the market was completely different. That is when the questions emerged about the value. Teva's entire current value is actually close to the price it paid for the deal. In other words, as of now, at least, there is no reflection of the fact that Teva is now much bigger, and the company itself expects wonderful things from the acquisition, which has made Teva the world's largest generic company.

Before the discussion of the value, however, there were also some in the pharma industry who argued that the acquisition itself was a serious strategic mistake. "There are two growth engines in the generic market," explains a senior industry source. "One is the generic penetration rate, and the other is new products. The penetration rate in the West has already reached 90% - this is the impressive proportion supplied by generic drugs. The new products in the industry depend directly on the number of ethical drug patents that are expiring, mainly those with a big market - blockbusters - and there are few such drugs. Furthermore, biological products are penetrating the markets, and it is far more difficult to produce generic versions for them. It requires more difficult clinical trials and different pricing."

For these reasons, in addition to the 5% yearly fall in generic prices, some generic industry sources believe that Teva will find it difficult to generate enough growth to justify what it spent on acquiring Actavis. "I'm one of those," says Chaim Hurvitz, "who thinks that even if we paid a little more than we should have, what's important is that we ensured our leading position for many years." Another capital market source says that it is premature to determine whether or not the deal was too expensive. "It's such a big deal for Teva that a few years are needed in order to decide this question. The generic industry has at least proven, at least in the past 10 years, that deals that appeared to be expensive looked cheap after a few years, because the values rose over time.

"For the very reason that the blockbuster era has passed, the only way of achieving the same amount of development and growth is to have many more products. That's exactly what Teva was thinking about when it sought the merger with Actavis. It wanted to prepare itself for the changing market, and plans to launch no fewer than 80 new products in 2017: both generic and non-generic."

IBI investment house pharma analyst Steven Tepper agrees on the one hand saying, "The Allergan (Actavis) deal was very expensive for Teva, and saddled the company with a high degree of leverage. On the other hand, he adds, "Teva had no choice. It improved its profit margin in recent years, but could not generate revenue growth. The company did not launch a substantial quantity of new (generic) drugs in 2015; it lacked the growth needed for that. The acquisition strengthened its backlog of products for future launching, and also gave it an advantage of size with its biggest customers: health insurance companies and retail chains."

At the same time as it announced the Actavis deal, Teva announced that it would not consider another large-scale acquisition at the moment, and was now focusing on realizing the potential of what it had. Some interpreted this as a retreat from its old policy of growth through mergers, but Tepper praises the change. "For many years, Teva made a huge generic acquisition every two years. The company grew, and did not stop for a minute to absorb the acquired companies," he says.

Another capital market sources adds, "There is no retreat from anything here. The company has done very significant things, and it will take years to absorb the acquisitions. They also believe that they can create a lot of value with the assets they have, and don't need to continue gathering more, other than relatively small things to reinforce their ethical drug pipeline."

For now, Vigodman has backing

What progress is Teva making with the absorption of Actavis, and when will this be reflected in the company's results? Time will tell. What is clear is that Olafsson, the man regarded as the deal's architect, is gone. His resignation dealt a severe blow to Teva's image. The shock was so great that Teva hurriedly announced that it would bring forward its forecasts for 2017 from February to January.

Worthy of note is that Olafsson came to Teva from Allergan, and knows Actavis well, which should have helped in the merger processes. He was also Vigodman's personal choice, and is a very senior figure in the generic industry. One capital market source believes that Olafsson became weary, as stated in Teva's announcement: "2016 was a difficult year, the merger took longer than expected, and generated a lot of pressure, and he was in the forefront of the action in the US vis-a-vis the authorities, while it became necessary to adjust the forecasts, which attracted criticism in the capital market. He wound things up in good order, and the company quickly took action, because there was a designated successor (Teva Generics Europe CEO Dipankar Bhattacharjee), who was already ordered to report for the job."

Not everyone buys the official version, however. "It looks to me like the main whom Teva cited for his ability to lead the merger left at the peak of the tension, and at the worst possible time," Tepper says. "It's even worse from a public relations standpoint, because the market is saying that maybe we didn't hear the full story. It's not likely that he simply went into Vigodman's office and said, 'I'm exhausted - I've had it."

Was Olafsson forced to resign? Hurvitz believes he was not, but knows that Olafsson had disagreements with the board of directors. "He's a man my father would have said comes with his suitcase packed. He didn't come with the intention of staying for many years, and personally, I wasn't bowled over by him. He made a lot of mistakes. Maybe he was very sensitive, and was uncomfortable about what happened with Rimsa."

Benny Landa, an investor in Teva with a very active role in the company, is also glad that Olafsson left. "It's obvious that mistakes were made in Teva," he says. "It's good that Teva is making changes, because management has to bear responsibility. When a company loses half of its value, somebody has to take responsibility for it. This action was an excellent and necessary first step, but it's not enough."

"Globes": What about Vigodman? Should he take responsibility like that?

Landa: "As long as he's making changes in this kind of direction, it's very positive. Time will tell whether he's making enough changes, and quickly enough. It must be said, though, that in a situation like the company is in, it must be asked where the board of directors was. It's true that changes have been made in the board of directors, and I welcome the two relatively new faces on it, chairman Yitzhak Peterburg and Dr. Sol Barer. In general, however, the board of directors still has little experience in pharma, and the same is true about its judgment about whether to make an acquisition and what questions to ask when it's being discussed. A company can't lose half of its value without the board of directors taking responsibility. It has to reinvent itself."

A source associated with the board of directors says that the absence of public disputes should not be mistaken for weakness, and that Peterburg, "who is known as a very opinionated person, has taken upon himself to make sure that relations between the board of directors and management will not be like they were during the period of the preceding CEO, Jeremy Levin. The company is therefore making Vigodman its sole public face, and the arguments and disputes are staying behind closed doors. They sat for 12 days discussing the Actavis deal, and no question remained unanswered. The board of director's image has also changed, because Peterburg has reinforced it with super-professional people."

It must be stressed that as of now, Vigodman has the full backing of his board of directors. "Right now, the board thinks that Erez is part of the solution to the problem," a source associated with the board of directors told "Globes." Keep in mind that Vigodman is still highly valued outside the company, but "another two or three years of bad news, a further drop in the share price, are liable to generate public pressure for replacing him, whether or not it is justified," says a senior pharma industry source.

Another source very familiar with the industry believes that such pressure "will come only if the company disappoints the market for several more quarters, and company management is of course doing everything to change the rollercoaster's direction before that happens, so that it starts going upwards."

Dependence on Copaxone created a "cloud of uncertainty over the company"

Copaxone was a great blessing for Teva for many years, and even now accounts for half of its profit. Where hopes and concern for the future, even the near future, are concerned, however - and it is exactly these things that put shares into a tailspin - Copaxone is a big cloud darkening the horizon. "The connection between Teva and Copaxone," says a senior capital market source, "which for years was an asset, has become a burden, and is creating a cloud of uncertainty over the company." Whenever generic competition for this drug appears more imminent, the Teva share price suffers.

To summarize the matter very briefly, there are two versions of Copaxone. One of them, the older one, comes in a 20 mg dosage, and must be taken daily by injection. The patents on this version have already expired, and there is already one competitor, Momenta, producing a generic version. The second (newer) version comes in a 40 mg dosage, and is taken once every two days. Since most of the market has switched to the improved version, Momenta's market share is not large.

There are five patents on the newer version, and a war is taking place on two fronts. The first is in the US Patent and Trademark Office, which has already announced at the request of the competitors that three of the patents are no longer valid. Teva is expected to appeal this decision. The second front is in the District Court, which Teva has petitioned for protection; the Court has yet to rule on this petition. A sizeable number of analysts believe that it will not greatly deviate from the Patent Office's decision. Teva is battling against its future competitors in every possible way, even, according to Tepper, taking Momenta's product nto its laboratories to in order to detect irregularities, thereby preventing Momenta from obtaining approval for its 40 mg product.

There is a dispute between the analysts, and between them and Teva, when competition will arrive: in 2017, or not until 2018. Without discussing the details of the various arguments, this question has a great effect on the Teva share price. "Even if Copaxone is exposed to generic competition," says a senior pharma source, "Teva has several innovative drugs in its pipeline that can cause a real revolution."

This will take time, however. As of now, the revenue that Copaxone is providing is enough for Teva, but how long that will last is unpredictable.

Migraines, nerve diseases, chronic pain, and respiratory problems: Teva's new spheres of interest

Teva's answer for the day after Copaxone is no longer "to find a new Copaxone." Teva is seeking to build a range of products under the heading of "unique drugs," some of which are ethical drugs, while others involve a different way of using drugs, or a special way of administering them. "Because they are a relatively young player in the unique drug market," a capital market sources says, "they had to differentiate themselves from the others. They did this by focusing on areas in which they had know-how and capabilities on the one hand, and by finding areas in which they were trailblazers on the other - needs with no existing solution."

Teva's unique drugs department has four sections. The first is migraines and headaches, in which Teva acquired Labrys Biologics for $725 million in late 2014. Teva believes that the molecule it acquired with Labrys is the best of its kind. Development is slated for completion in late 2017 or early 2018. If this ethical drug succeeds, it will definitely fill at least part of the hole left by Copaxone.

The second section is diseases of the central nervous system and undesirable involuntary movements. Teva acquired a company named Auspex Pharmaceuticals for $3.2 billion in early 2015. Auspex has three immediate central nervous system drugs and several more in the pipeline for treatment of diseases like Huntington's Disease (HD). One of these drugs is already waiting for an answer from the US Food and Drug Administration (FDA) in April 2017. All of them treat only symptoms, but a small dream is also developing, in which one of these drugs will actually halt the disease's progress, which would be a real breakthrough. In this framework, they have brought back Laquinimod, the oral version of Copaxone for treating multiple sclerosis that failed its trial, have reinstituted a Phase III trial, and are anxiously awaiting the results.

Another section is chronic pain. In this context, Teva recently announced that it was cooperating with US company Regeneron in the development of a drug that will solve the problem of dependence on opioid materials.

The fourth section is respiratory products - various types of inhalers.

Published by Globes [online], Israel business news - - on January 1, 2017

© Copyright of Globes Publisher Itonut (1983) Ltd. 2016

Erez Vigodman photo: Eyal Yitzhar
Erez Vigodman photo: Eyal Yitzhar
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