The past year has been a good one for investment bankers, lawyers and accountants, as companies have gone on a massive M&A binge fuelled by cheap debt and highly rated equity. It has also been a generally good year for shareholders, who are benefiting from share prices being pushed up on news of acquisitions, seemingly almost irrespective of what the target company actually is.
In these circumstances, as serial deal-makers see their stock power ahead, it can be hard for companies to avoid being swept up in the melee. Particularly as by standing still, they increase the risk that they will be the hunted rather than the hunter. Teva is in just such a situation at present, with rumours now circulating that it has received several approaches from potential bidders. Fortunately for Teva’s management, the company’s shareholder structure and Israeli HQ make it a tricky target for a hostile bid, but CEO Erez Vigodman must surely be under a certain amount of pressure from the Board to come up with a more proactive strategy. The question is: what should that strategy be?
Not that long ago, Teva dominated the global scene, with Mylan and Actavis vying for a fairly distant second place and Sandoz in an even more distant fourth, but all of them essentially focused on generic drugs, with just a few brands to pep up their portfolios. In the last two years, however, there have been radical changes. Actavis has transformed itself into an innovative speciality pharma company through the acquisitions of Forest and Allergan, such that generics now only account about a quarter of its sales and presumably rather less of its profits. Indeed, we would not be surprised to see Actavis spin off its generics business altogether, or at the least to dispose of Medis, its dossier developer. Meanwhile Mylan, while sticking a bit closer to its roots, has agreed to buy Abbott’s ex-US business (consisting of a portfolio of very old brands and a large sales force). As well as assets from the Indian company Famy Care, which specialises in women’s health products (Mylan already sells Famy’s products in the US). These deals will still leave it a much smaller company than Teva, but should at least perk up its EPS growth. As for Sandoz, which has the most constrained strategy due to being a subsidiary of Novartis, the next few years will nevertheless still be quite transformational, as the company finally starts to see the benefits of its huge investments in biosimilars. The FDA appears poised to approve its G-CSF as the first product to go down the new 351(k) pathway and while EP2006 (Zarxio) will not be substitutable initially, there is every reason to suppose that Sandoz will be able to produce the evidence necessary to make it so eventually. Even more crucially, Sandoz has a deep pipeline of projects behind this one, including multiple monoclonal antibodies, so even without buying anything, the company is set to shift its profile decisively towards brands.
In the meantime, Teva remains, at least on the surface, much as it was. Certainly, Erez has moved away from the ‘little big pharma’ strategy of his predecessor Jeremy Levin in order to focus only on two therapeutic areas, CNS and Respiratory, which will mean the disposal of a number of development programmes. He has also kicked off a cost-cutting programme aimed at improving internal efficiency and raising margins. The latter is particularly aimed at the generics division, which (naturally) is far less profitable than brands. In Europe – and presumably also in the US – this effort is manifesting itself in Teva walking away from low margin business, as well as closing factories. As a result, profitability is indeed improving, albeit at a cost to progress on the top line.
According to Teva’s recent presentations, the company is now focusing on four ‘levers of organic growth’. These are: generics (which are expected to increase their relative importance within the group); cost reduction (as noted above); lifecycle management for key specialty products (particularly Copaxone, where Teva has so far been remarkably successful in switching patients to the new 40mg formulation, assisted by the FDA’s refusal to date to approve any of the generic versions of the 20mg that are in registration); and, the launch of new specialty products. Of the four, the last is the most critical, as along with generics, it represents the key growth driver for the company. Teva is expecting some important milestones here in 2015, including approval for reslizumab, its biologic treatment for asthma and clinical data from pridopidine in Huntingdon’s Disease (currently in a sizeable phase II study covering both safety and efficacy) and LBR-101, which is in a phase IIb trial as a treatment for episodic and chronic migraine.
In our view, Teva’s management is right to focus on organic growth and on putting its house in order, at least for now. Rather than buying anything and everything, irrespective of fit or return considerations, Teva first needs to decide exactly what it wants to be and then do deals accordingly. And what Teva ought to be, we believe, is pretty much what it already is, i.e. primarily a generic company, even if many of the generics that it sells are brands. As it happens, Teva’s CEO has already laid out a few areas in which Teva would consider inorganic growth, most of which fit with this view. These include: emerging markets, complex generics and specialty pharma assets that fit within CNS or respiratory. In the case of emerging markets, there are one or two large targets that Teva might want to consider if its shareholders start getting really antsy. The most obvious of these is Abbott, particularly now that it has got rid of its developed markets business to Mylan. Buying Abbott would necessitate Teva re-selling the divisions that it didn’t want (diagnostics and devices – nutrition could probably stay), but that shouldn’t be a big problem and the deal would answer most of Teva’s emerging market needs in one go. If more were needed, Teva could add in Aspen, which would bulk it up in Africa and Australasia, as well as bringing some value-added products areas such as anti-coagulants. To a certain extent this deal would also cover complex generics, which would be useful because although there are plenty of smaller companies developing particular technologies, ‘hard to make’ products are a very competitive area these days, so returns may be lower than anticipated. In specialty pharma, there are plenty of smaller targets, but in our view Teva’s management should see how the internal pipeline comes on before doing big deals here – particularly given the less-than-spectacular success of its last one, Cephalon.
Unfortunately for Teva’s new CEO, pursuing a mainly organic growth strategy, despite this being probably the most sensible thing to do, is going to be increasingly difficult. Recent broker reports on Teva suggests that Erez has a challenge ahead if he is going to satisfy the ‘Street’ without at least one chunky deal. Most of the ‘Buy’ recommendations are based on the assumption that Teva will be able to increase its current earnings forecasts via acquisitions, so unless he feels that Teva can surprise on the upside through internal means (which perhaps it can), he can expect Teva’s share price (which has been performing well, as the prospect of Copaxone generics has receded) to start flatlining – and the bidders to start lining up.