Teva and Proctor and Gamble (P&G) jointly announced today that they intend to create a joint venture in OTC. Owned 51% by P&G and 49% by Teva, the jv will encompass the whole of Teva’s global OTC business (which is split roughly 50:50 between Europe and ROW) and substantially all of P&G’s OTC activities outside North America. Marketing of OTC products will continue to be the responsibility of the two companies’ existing sales forces, but new product and brand development will be done by the jv, which will be headquartered in Geneva and have a CEO and CFO from P&G and a COO from Teva. Total sales of the jv in year one (effectively 2012, as closing of the deal is not expected until autumn this year) will be in excess of $1bn (closer to $1.3bn according to Teva) and the expectation is that this can be increased to $4bn within the coming years. This number is predicated on the jv as a whole achieving a market share equivalent to the one that it now has in Germany (which we estimate to be 5-6%), with Teva pushing P&G products in the pharmacy channel and P&G helping Teva to get its products into the retail chain. The companies will also sell/introduce each other’s products in territories where one is strong and the other weak – Teva’s CEO specifically highlighted Brazil and India as markets where Teva has almost no presence but P&G is well established. In addition, Teva will use its huge portfolio of prescription drugs to create Rx-to-OTC switches that can be sold by the jv.
From the perspective of Teva’s accounting, the deal is quite complicated. As the 49% owner, Teva will consolidate the jv using the equity method, which means that the profit or loss will come in to the P&L under a single line item. However, because the marketing is being done by Teva and not by the jv, current OTC sales ($650m in 2010) will not disappear but will actually be augmented by that portion of P&G’s sales that are made through the pharmacy channel. As a result, Teva’s OTC sales will rise to close to $1bn in 2012, although its EBIT will be little changed as the P&G sales will presumably just carry some kind of distribution margin. More relevant to profits in the short term will be the manufacturing side of the agreement, which involves Teva taking over production for the whole of P&G’s OTC operation. In the US, Teva will pay ‘a few tens of millions of dollars’ to buy two factories from P&G, while in Europe and ROW it will gradually transfer P&G’s products to its own sites. The North American products will be booked directly as sales made by Teva, while in Europe and ROW, revenues will be net of the final product sales that Teva is making itself.
Looking at this deal in the round, it can hardly be bad for Teva, but it’s also hard to believe that it is going to be quite as good as billed. Firstly, there could scarcely be two companies with more different cultures than Teva and P&G, so working together is going to be challenging, to say the least. Secondly, cross-selling sounds good on paper, but how will it work in practice? In markets where both companies are present, like Russia, it should be fairly straightforward, but what about in, say, India, where Teva has no OTC products on the market, as far as we are aware? OTC products are highly branded and as a consequence, very local. On the P&G conference call, P&G’s CFO was asked which were the most important brands that Teva was bringing to the partnership and he couldn’t name even one of them, which is a fair reflection of the situation on the ground. Whereas P&G has invested heavily in building global brands, Teva has inherited a mixed bag of local products from its multiple acquisitions, many of which probably have the same active ingredients, but with completely different brand names. Launching these brands into new markets makes no sense. Establishing a new OTC brand is both expensive and time-consuming, unless it is in a totally new category, so it hardly seems feasible that Teva would want to cover the cost of bringing many of its existing brands into a hyper-competitive market like India, even with P&G to provide distribution (who would cover launch costs is unclear, given that the jv has no capital of its own). Thus, while the jv should be able to boost sales of products that are already on the market, it’s hard to see how it can create a business for Teva where none existed before, other than by introducing new Rx-to-OTC switches, which is also a slow process in most places.
Which brings us back to the sales projections. While Teva didn’t say how long it expected it to take to get sales up to $4bn, P&G stated that the number should be reached at some point between the middle and the end of the decade. Taking 2017/18 as the target date and $1.3bn as the starting point for sales (although there seems to be a bit of confusion about what the total turnover of the jv actually is), we estimate that turnover will have to grow at 20-25% pa for this goal to be achieved. Given that the whole reason that P&G went into the jv is that the current growth rate of its non-US OTC business is unacceptably low and that Teva’s OTC sales growth, while better, is only expected to be around 10% this year, 20-25% pa appears highly ambitious. In fact, without acquisitions, we would go so far as to say that there is no hope at all of it being reached. It will therefore be interesting to see whether Teva is prepared to start splitting out its OTC sales on a quarterly basis, thus allowing progress to be monitored externally, or not. Our suspicion is that it won’t.
Posted on 24th March 2011