Teva debt to keep buyers away

It’s said that what was built over many years can be destroyed in a few months. It’s also said that one bad decision is enough to destroy what was built with thousands of good decisions. In the case of Teva Pharmaceutical Industries Ltd., one giant decision – to pay $30 billion (net) in cash to buy Actavis Generics, and to do it with an additional bond issue amounting to $20b. – has brought the company to its sorry state.

However, such a fateful decision, should not happen in a company with checks and balances. A strong company with functioning institutions should not decide to acquire a competitor in a deal that threatens its very existence. The very fact that a decision was made to acquire Actavis at an excessive price and excessive leverage indicates that Teva’s current situation is not the result of an individual decision but a much deeper problem of how management and the board make decisions.

Eli Hurvitz, Teva’s legendary founder and CEO (and later chairman) made Teva a global leader in generic drugs and put the DNA of a generics company into its bloodstream. At the same time, however, over the past two decades, Teva has made enormous profits on the success of Copaxone, a branded drug it developed for the treatment of multiple sclerosis.

This single drug was responsible for half of the net profit reported by Teva over the past decade, while profit margins from generics were much lower. This generated two main attitudes at Teva. The first, advocated by former Teva executive Chaim Hurvitz, was that generics should be left as Teva’s main business. Other executives, on the other hand, took the opposite line, saying most of the company’s investments should be directed toward ethical drugs – those developed by Teva itself, those obtained through acquisitions, and those obtained through investments in promising start-ups.

Advocates of this view included Jeremy Levin, for example, CEO of Teva from 2012-2013. The decision to fire Levin and appoint Erez Vigodman in his place signaled to investors that the board had chosen to put generics back on center stage.

Under Vigodman’s leadership, Teva invested more than $40 billion in 2015-2016 in acquiring Actavis Generics and Rimsa. Teva’s value has now sunk to only $21b., however, after losing 62% of its value over the past year and 70% since its peak two years ago.

Judging by results, it appears that, at least for now, this strategy has been a dismal failure. Beyond that, however, it is clear that the situation in which Teva is torn between two groups must end, and the company must choose what it wants to be.

It was obvious that the person who led these unsuccessful deals had to go. Vigodman, who led the two acquisitions, is already gone, but Prof. Yitzhak Peterburg, who was chairman at the time, is still there and functioning as acting CEO.

Teva on Thursday reported a $6b. accounting loss for the second quarter and downwardly revised its adjusted revenue and profit forecasts for the year. A more thorough look shows that the second quarter was not much different than the first quarter. For example, Teva reported a 48% drop to $1.2b. in cash flow from current activity, but reported an even steeper 66% plunge to $470b. in cash flow from current activity in the first quarter.

Revenue totaled $5.6b. in the first quarter and $5.7b. in the second quarter. The growth rate fell from 17% to 13%, but a lot more is needed to send the stock of a large company tumbling 34% in two days. Even falling prices of generics product in the US and the troubles in Venezuela are not enough to cause such a result by themselves.

So why did the share price collapse? Probably because, this time, the analysts and entire market realized what was happening – that the generics business was stagnating and Teva’s heavy debt could become a real threat. To this was added the decision by Moody’s and Fitch to downgrade their rating for Teva’s debt to one level above junk, while a negative outlook signals the possibility of a further downgrade in the near future. When the rating companies talk about concern with respect to the financial ratios, the market is reminded of Teva’s debt burden.

When Vigodman led the acquisition of Actavis Generics, he argued that without a measure of this type, Teva would have been swallowed up by a larger company. That was probably true, but in retrospect, it is not at all certain that this would have been a bad thing.

While Teva’s acquisition saved it from a takeover, in retrospect, it is clear that this was a Pyrrhic victory, especially when without any prospect of shareholders getting a large premium on the market price, the media started again to deal with the possibility of a takeover of Teva. Ostensibly, Teva is now a much cheaper company in an extremely vulnerable position, and taking it over is, therefore, much easier and cheaper. This, however, is an illusion. Teva has $35b. of debt, and any offer to acquire it, therefore, will reflect a value of at least $60b. for its business – a price that is not cheap even for major companies. It is hard to think of any drug company in the world that would take such a debt upon itself.

A takeover of Teva, therefore, sounds like wishful thinking. It would be nice if it happened, but the chances are very poor.

More logical would be for leading companies in the industry to try to exploit Teva’s weakness to buy activities from it that is profitable or potentially very profitable, and Teva’s board will have to deal with a choice between the present and the future.

To recover, Teva must sell products that are not part of its core business, take quick action to reduce its debt, and hope that no generic competition for 40-milligram Copaxone emerges in the near future.

Beyond this, however, it is important to make sure that the layoffs do not detract from the excellence of the company’s operations, without which Teva has no future.

The board must take rapid action to find a prominent new CEO with substantial experience in operations, so that he can rebuild Teva and encourage motivation among its employees while maintaining its operational efficiency and reducing its debt. At the same time, the new CEO will have to forgo large acquisitions, focusing instead on small and smart investments in the future products of the pharmaceutical industry.