The news earlier this week that Siggi Olafsson is leaving Teva, to be succeeded by Dipankar Bhattacharjee (currently head of Teva Generics Europe) comes as something of a surprise, to say the least. As the architect of Teva’s long drawn-out purchase of Allergan’s generics business, Actavis, we would have expected him at least to oversee the integration of the two businesses. And the timing of the announcement is odd, given that Mr Olafsson hosted an investor day on New York in September at which he laid out the growth plan for the expanded Teva generics division, which he will now not be staying around to deliver. But of course, the deliverability of the plan may be precisely why he is going.
The Teva press release says that Siggi will remain with the business until the end of Q1 2017 to ensure an orderly transition, which has been interpreted by some as meaning that the decision to leave has come from him rather than from Teva. In our view, this is unlikely to be the whole story. It is rather more probable that Teva’s board feels that someone should carry the can for the company’s recent underperformance and that Siggi is the obvious candidate. Teva’s share price has been nosediving in recent months, due to investor unhappiness about the price that Teva was forced to pay for Actavis (which looked a bit toppy on the day that the deal was announced and sheer madness by the time that it completed, a full year later) and the disappointing earnings that have resulted to date (culminating in a profit warning alongside the Q3 numbers). Whether there was also a more proximate cause, such as the discovery of something nasty in Actavis that has only been revealed now that Teva has full control of the business, is as yet unknown. Teva reconfirmed its 2016 guidance at the same time as announcing Siggi’s departure, but since it is already December, that doesn’t really prove anything about the longer-term prospects of the business. The outlook for 2017 and beyond is expected to be revealed in February.
At its recent investor day, Teva laid a lot of emphasis on the growth prospects for its generic division, reiterating its previous expectation of mid single digit growth annually. The company also made much of its genuinely impressive pipeline of first to file opportunities in the US, where it is responsible for around half of all the filings with this status. What the company failed to mention, even though it is obvious, is that FTF opportunities and steady growth are mutually incompatible. The super-normal sales and profits that come from six months of exclusivity are great for cash flow but inevitably create volatility in earnings as the collapse in price on day 181, or whenever additional competitors enter the market, cannot always be compensated for by other FTF launches of equivalent size at exactly the right moment. In addition, the expected rate of decline of prices in the base business, which Teva also expects to be around 5%pa, does not apply to FTF products where the decline in revenue between the situation with and without exclusive status is likely to be closer to 80%. Consequently, Siggi’s assertion on the Q3 earnings call that he needs $500-600m pa in new FTF launches in the US each year in order to be able to deliver 5% top line growth is mathematically wrong. Assuming a $8bn base business (it is actually a bit larger than this), 5% pa price erosion in the base and 80% price erosion in the FTF products in the first year that exclusivity is lost, $550m in new FTF products is only sufficient in year one – and even then if you assume around $300m of non-FTF launches on top of the FTF ones. By year three, you need roughly $1.4bn in FTF opportunities and the figure grows annually, making it completely unsustainable to achieve over the long term, even for Teva, unless it can come up with new launches that have a much lower level of price erosion.
Teva demonstrated this point neatly in Q2, ahead of the investor day, when its US generics business shrank thanks to the loss of exclusivity on aripiprazole, budesonide and esomeprazole. Results for the quarter as a whole remained flat, however, as European and ROW generics, plus Copaxone and the specialty business increased to compensate. By the time that the Q3 results were announced, after the investor day and contrary both to analysts’ expectations and to the impression given when the business was presented to investors, the situation had worsened to the point at which overall EPS fell and Teva was compelled to cut its earnings guidance for the year as a whole.
Time and time again, analysts came back to the question of why, only two months after painting such a positive picture of the generic outlook, Teva appeared to be so far adrift from its own earnings projections. And time and time again, management said that it was due to expected product launches not materialising (due to regulatory delays and problems with third party suppliers), plus some additional problems caused by unexpected price declines in the high-margin products that Teva was forced to divest in the US to get the Actavis deal past the FTC. This price hit (caused by buyers putting pressure on the companies that bought the overlapping assets and hence driving Teva’s prices down too) meant that the total average price decline in the base business was 7% in Q3 vs only 4% in Q2, a situation that will presumably sustain until mid-2017, when the base effect wears off.
The fact that the question got asked so often tells you that the analysts didn’t really believe the answer. Or at least, they didn’t believe that the answer was sufficient to account for the difference between their expectations and the reality. What they presumably suspected was that a) prices generally are under more pressure than Teva is ready to admit – which would fit with the experience of other generic players – and, b) that the Actavis side of the business failed to deliver as much sales as had previously been anticipated. After all, the delay in the major new launches – which are now not anticipated before some point in 2017 – should surely have been apparent even in September. Since Teva declined to provide a precise bridge between where it thought its generics business was a few months ago and where it finds itself now, concerns will linger that there is more bad news to come. Hence, perhaps, the mutual decision to make a change at the top, albeit of an orderly kind, as a prelude to the introduction of a more restrained short-term growth target.
So, what of Mr Bhattacharjee, Siggi’s successor? As UK MD, he was an entirely invisible presence in the market and as head of Europe he also appears to have kept his head down and focused on the job in hand, which was to get profits and margins up after years in which Teva Europe appeared to pay rather limited attention to the bottom line. His success in this area was lauded on the Q3 call, along with the way in which Teva Europe had smoothly integrated the Actavis business, although the latter is less of an achievement when you consider that Actavis divested most of its European operations to Aurobindo at the start of 2014 and that Teva was forced to sell off Actavis UK (to Intas, as it turned out) to satisfy the EU competition commission. The ability to impose order on chaos will certainly come in handy when integrating Actavis and Teva and Dipankar’s track record to date and good relationship with the board made him an obvious choice for Siggi’s job, particularly if we assume that the choice had to be made in something of a hurry. But nevertheless, such a big job perhaps requires a big personality, even if Teva is hardly short of opinionated people at all levels of the business.
In our view, the person in charge of generics at Teva once the integration is done needs to be much more than a master of the detail and a good operations man. They need a have a vision, the ability to articulate it and the stamina, power of persuasion and determination to implement it. Being successful in generics means being able to spot opportunities and seize chances as well as keeping a close eye on the dull but vital stuff like the supply chain. With the price of generics currently high on the political agenda in both the US and the UK, Mr Bhattacharjee will also need to deal with politicians and law-makers as well as driving the biggest possible synergies out of the Actavis deal and – most importantly – coming up with a growth strategy for the business overall that is both feasible and credible. This is a lot to ask of anyone and there is no evidence that Dipankar will do any better at it than Siggi would have. The only hope is that changing the person at the top may break the vicious cycle whereby the realisation that a company has severely overpaid for an asset (Actavis, in this case) leads to increasing pressure on line management to delivery synergies that can justify the inflated price. This, in turn, leads to performance expectations that are impossible to fulfil and hence, inevitably, to disappointment. Since the Actavis deal only closed in August, this cycle has been surprisingly rapid, but nevertheless we appear to have reached the disappointment stage already and Siggi’s departure is the result.