Teva - What a difference a year makes

Shiri Habib-Valdhorn

Tough streamlining, a stablization in generics prices, better than expected performance by Copaxone, and most of all Kare Schultz's leadership, have transformed Teva.

The day in 2017 on which Teva Pharmaceutical Industries Ltd. (NYSE: TEVA; TASE: TEVA) published its financial statements for the second quarter was a black one for the company's shareholders. Teva's share price plummeted 24%, cutting no less than $7.6 billion off the company's market cap. After having previously escalated, the crisis of confidence between the market and Teva's management reached a peak on that day. Under the temporary management of Yitzhak Peterburg, Teva took investors unaware by reporting a huge loss caused by a $6 billion write-down of goodwill, downwardly revising its guidance, and warning of a possible failure to meet the finance criteria to which it had committed.

A year has passed since then and in many respects, Teva today is a completely different company. In retrospect, that black day in August 2017 was not the low point for Teva - not for its share price or for the financial surprises supplied by Teva to its investors.

In those days, prominent shareholders in Teva raised their voices and demanded a real change. In September, Teva appointed Kare Schultz as CEO, drawing positive responses in the market. Schultz, who had experience in managing austerity programs at other pharma companies, was regarded as someone able to steer Teva's ship away from the iceberg it was heading for.

He took up his position in November. The day after entering office in Petah Tikva, the company published more weak results and again lowered its guidance for the year. The company's share sank again, reaching a 15-year low. Since then, despite ups and downs, the general direction has shifted. Schultz presented a new organizational structure almost immediately and published a detailed and painful streamlining plan in December. During the months since then, Teva has carried out the plan and slowly regained investors' confidence.

Teva's current market cap is $24.1 billion, following a 112% increase in its share price since the nadir in November, but still 23% short of the price before the great crash a year ago and 65% less than the price at which it was traded at its peak in the summer of 2015.

Teva's share price reached that peak after it announced the acquisition of Actavis, the generic division of Allergan, the biggest acquisition in Teva's history. The acquisition was completed a year later when the US generic market underwent a sea change, leaving companies to deal with price erosion and intensifying competition.

Teva took on large debts to finance the acquisition. The debt was at relatively low interest, but the company's difficulties aroused real concern about its ability to service the debts, which amounted to $35 billion a year ago and sent the share tumbling. The company embarked upon a massive streamlining plan aimed at cutting $3 billion off its cost base by 2019.

"The main change in Teva over the past year was the new CEO. He gave its investors confidence in his ability to lead Teva to a better place - lower expenses, better financial ratios, dealing with the balance sheet, and decreasing leverage," says Leader Capital Markets Ltd. (TASE:LDRC) research department manager Sabina Levy. "What really burdened Teva was its enormous debt. It is not the only generics company affected by what happened in the US market; all of them suffered. But Teva also had high leverage caused by the acquisition of Actavis. The market is now more confident in Teva's ability to cut its expenses base and people are even talking about a higher rate of streamlining than they previously considered."

Teva is planning 14,000 layoffs worldwide in its streamlining plan, including 1,750 in Israel. As of the end of the first quarter, 6,000 employees had already left the company, and a revision of this figure is expected when the company publishes its second quarter financial statements next week.

Schultz came to his position with an idea of how to manage a company in crisis. It was clear to everyone that harsh measures were in store. Nevertheless, publication of the plan caused shock waves among the company's employees. Concern was raised in Israel about Teva's Israeli identity being lost. The prime minister and other ministers met with Schultz in an attempt to avoid the closure of the company's plant in Jerusalem.

The fact that Schultz did not cave under pressure signaled the direction of Teva's management: there was no choice - the company had to make cutbacks or it would go under and be sold at a fire sale price by a financial institution or an activist shareholder in an attempted takeover.

As of now, agreements have been signed with representatives of the workers and the Histadrut (General Federation of Labor in Israel) and many workers have left the company under voluntary retirement plans. Together with the layoffs, Teva's sites in Israel are being closed, development projects canceled, and the company is negotiating with its customers in the US and is halting its sales of unprofitable generic products.

Even before the streamlining program, Schultz changed Teva's organization structure in order to simplify and consolidate it. He eliminated the previous separation between generics and branded drug activity. Senior executives left the company as a result, including Michael Hayden, who managed R&D under the two preceding CEOs. Schultz, however, did not bring his own associates with him into management. The only one to join Teva together with him was his personal assistant, who has accompanied him for many years.

Teva's debt totaled $30.8 billion at the end of the first quarter. Teva hopes to reduce its ratio of debt to EBITDA to under 4 by 2020, "compared with 5 or more in 2018," Levy says. "We see progress in the streamlining plan and a higher level of confidence that the company will solve its debt problem and lower its leverage by 2020."

Four months ago, Teva successfully completed a debt issue to replace existing debt. Demand was strong, with the company raising $4.5 billion at interest rates ranging from 3.25% on euro-denominated bonds to 6.75% on dollar-denominated bonds. Teva repaid its bank debt, which had a junk bond rating, after the rating agencies lowered the rating because of the company's high leverage.

Mylan, which launched its generic version of 40-milligram Copaxone, Teva's flagship branded drug for treatment of multiple sclerosis, in October 2017, achieved a market share of less than 20%. Despite great fears and negative expectations, Copaxone is maintaining its ground fairly well. Mylan recently slashed the price of its drug, which is likely to affect Teva later.

It appears that Teva's luck has been holding recently. In addition to slower-than-expected competition for Copaxone, it is winning another few months of grace in the market for its other branded drug, the ProAir inhaler. Perrigo Company (NYSE:PRGO; TASE:PRGO) was scheduled to launch a generic version of this product, but it has been delayed, leaving Teva more room to breathe.

On the other hand, Teva has had less luck with the launching of its drug for migraine headaches, which was supposed to be one of the most important original drugs in the coming years, after marketing approval for it was put back from June because of problems with the manufacturer of the active ingredient. This approval is now expected in September.

"The rate of erosion in generic drug prices in the US has now stabilized. Penetration of generic Copaxone has been slow, and assessments of Teva's ability to launch its drug for treatment of migraine have improved," Levy writes. "Amgen has already launched a product at a price lower than the market expected, but a very rapid penetration rate has been reported, which gives confidence about Teva's drug. Teva has not reached the market first, but the market may be larger than expected, which is generating a positive buzz for Teva."

Berkshire Hathaway, the holding company of legendary investor Warren Buffett, holds 3.9% of Teva's shares. Buffet has boosted Teva's share price twice this year. The first time was in February, when Berkshire Hathaway reported a 1.8% holding in Teva, which Buffett bought when the share was at its nadir. His investment made many investors optimistic about Teva.

Buffett shortly afterwards poured cold water on the enthusiasm, saying that his deputy, not he, was the one who decided on the investment. Three months later, however, it was learned that Berkshire Hathaway had doubled its holdings in Teva, propelling the share upwards again. The current value of Berkshire Hathaway's holdings in Teva (assuming that it did not buy or sell shares during the second quarter) is nearly $960 million.

Berkshire Hathaway is not the only one to give Teva's share a vote of confidence. Capital Research, Teva's largest shareholder, increased its position in Teva and had a 15.9% stake in the company as of April, compared with 10.7% in February.

One shareholder that reduced its holdings in Teva during the period was Allergan, which, as expected, sold shares that it had received as part of the deal for the sale of Actavis to Teva. Allergan had to recognize a decrease in value amounting to billions of dollars on its holding in Teva because of the fall in the share price.

Seven institutions are currently making a negative recommendation for Teva's share ("Underweight" or "Sell"). The other 15 are all neutral at this stage.

Leader Capital Markets is one of those now making a neutral recommendation ("Market perform"). Levy writes, "I do not think that many things have changed in the past year. To put it simply, if the company does not change its guidance too much, the market will feel comfortable giving a higher multiple for the company, because the level of confidence has risen, there is stability in the management backbone, and there is a feeling that there is a CEO doing the right things from a long-term perspective."

Despite the improvement, Teva has not regained its former value and does not expect growth in the near future. When will that happen? Probably not before 2020. Schultz himself said that Teva had already made enough acquisitions and its cash flow in the coming years would be used for debt repayment.

"In the past, in the generics field, Teva focused on maximizing revenue under the assumption that everything would come together and profits would be made. This does not work. Operating profit has to be maximized," Schultz said in January. 2018-2019 are years of focusing on meeting existing obligations. Only after stability has been achieved will it be possible to talk about expansion.

Levy says, "Teva has an excellent platform for production and geographic deployment. It may sound like a slogan, but it cannot be ignored - it is a giant company - a well-oiled machine. There are more things here that can be done for development and growth, but for that, the company has to be healthy and financially prepared. If there are no more shocks and they succeed in implementing the program, they will be able to resume business development and acquiring companies, activities, or technologies, but as of now, that is not its focus."

Published by Globes [online], Israel business news - - on July 26, 2018

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