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. (NYSE: TEVA; TASE: TEVA), one giant decision - to pay $30 billion (net) in cash for the acquisition of Actavis Generics, and to do it with an additional bond issue amounting to $20 billion - is what has brought the company to its sorry state.
Such a fateful decision, however - one that shatters a company - 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; it is a much deeper problem in how management and the board of directors make decisions. This problem will probably be solved only after a large proportion of the members of these two institutions is replaced.
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 the Teva over the past decade, while profit margins from generics were much lower. This generated two main attitudes in 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 that most of the company's investments should be directed towards ethical drugs - those developed by Teva itself, those obtained through acquisitions, and those obtained through investments in promising startups. Advocates of this view included Jeremy Levin, for example, CEO of Teva in 2012-2013. The decision to fire Levin and appoint Erez Vigodman in his place signaled to investors that the company board of directors had chosen to put generics back on center stage.
Under Vigodman's leadership, Teva invested over $40 billion in 2015-2016 in acquiring Actavis Generics and Rimsa. Teva's value has now sunk to only $21 billion, however, after losing 62% of its value over the past year (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 completely clear that the situation in which Teva is torn between two groups must end, and the company has to 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 out of the company, but Prof. Yitzhak Peterburg, who was chairman of the board of directors at the time, is still there, and is functioning as acting CEO.
What happened on Thursday?
Teva reported a $6 billion accounting loss in the second quarter of 2017, and downwardly revised its adjusted revenue and profit forecasts for the year as a whole. A more thorough look shows that the second quarter of the year was not much different than the first quarter. For example, Teva reported a 48% drop to $1.2 billion in cash flow from current activity in the second quarter, but reported an even steeper 66% plunge to $470 billion in its cash flow from current activity in the first quarter.
Revenue totaled $5.6 billion in the first quarter and $5.7 billion in the second quarter. The growth rate fell from 17% to 13%, but a lot more is needed in order to send the share 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 the entire market realized what was happening - that generics business was stagnating, and Teva's heavy debt could become a real threat to the shareholders. To this was added the decision by Moody's and Fitch to downgrade their rating for Teva's debt to one level above junk bonds (a negative outlook signals the possibility of a further downgrade in the near future), given the weakness in generics business and concern about generic competitive for 40-milligram Copaxone. 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 sure that this would have been a bad thing. Teva's acquisition saved it from a takeover, but in retrospect, it is clear that this was a Pyrrhic victory, especially when without any prospect of the 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 a $35 billion debt on its back, and any offer to acquire it will therefore reflect a value of at least $60 billion 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 will take such a debt upon itself. In general, it can be stated that major companies tend to avoid businesses in a crisis; they prefer to acquire prosperous companies. A takeover of Teva therefore sounds like wishful thinking. It would be nice if it happened, but the chances of it happening are very poor. It is more logical for leading companies in the industry to try to exploit Teva's weakness to buy activity from it that is profitable or potentially very profitable, and Teva's board of directors will have to deal with a choice between the present and the future.
In order to recover, Teva has to 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 of directors must take rapid action to find a prominent new CEO with substantial experience in operations, so that he will be able to 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 forego large acquisitions in the coming years, focusing instead on small and smart investments in the future products of the pharmaceutical industry.
Published by Globes [online], Israel Business News - www.globes-online.com - on August 6, 2017
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