The capital market will not give incoming Teva Pharmaceutical Industries Ltd. (NYSE: TEVA; TASE: TEVA) CEO Kare Schultz 100 days of grace. Schultz began his job last week in the middle of a storm. The negative momentum in the US generics market, the company's main market, has picked up speed, pushing Teva's financial results downward, while earlier than expected competition for Copaxone, the company's flagship product, is having a greater than expected impact. The result was that two days before Schultz's taking up his post, Teva lowered its guidance for the second straight quarter.
Looming in the background is Teva's enormous $34.7 billion debt, which dropped only slightly in the third quarter. Combined with the anticipated erosion in the company's cash flow, It is no surprise that Fitch has already downgraded Teva's debt rating to junk bond level.
International rating agency S&P downgraded Teva's rating outlook to "Negative," signaling the possibility of an impending debt downgrade. S&P cites the increased uncertainty about Teva's business positioning. Its current debt rating is BBB minus, one level above junk bonds. In a conference call following the publishing of its third quarter results, Teva acting CFO Michael McClellan was asked about the significance of the company's rating. He stated that loans totaling $6 billion would be immediately affected, with the interest on them rising by 25 base points. Yesterday Fitch Ratings downgraded Teva's debt from BBB minus to BB - a junk bond rating.
What scenarios does Teva currently face? Poalim IBI Underwriting and Investments Ltd. (TASE:PIU) analyst Steven Tepper maps the possibilities.
Rolling over the debt
"Right now, Schultz has assets in hand, but very little financial flexibility, and the debt burden will make it very difficult for him to handle Teva's current business activity, especially cutting costs on the one hand and planning long-term strategic activity on the other," Tepper says.
"Teva can say, 'We'll get along and roll the debt forward. But this is a tough measure, because a downgrade to high yield (junk bonds), for which there is a high degree of certainty, will make the interest rate jump. Obviously, the further forward the debt is rolled, the higher the interest rate will be. In such a scenario, if Schultz want's to carry out a process for the sake of future growth - it may sound very distant now, but for example, if Teva wants to acquire some neurological products that will yield results in the short term for $1 billion - he will be unable to do it. It is possible, however, that Teva will decide that rolling over its debts is a possibility to be considered, in the hope of increasing its profitability in the future."
A share offering
"In my opinion, an attempt to raise share capital is the preferred option," Tepper says. "Teva needs to raise several billion dollars, so that together with its cash flow, it will be able to move its debt from levels of $30 billion to levels nearing $20 billion. In the end, debt at a certain level is a burden, but it can turn into an asset at a certain point, when it is in the right proportion to the market cap."
Tepper says that as of now, all the cash flow that Teva can generate is being used to reduce its debt, and if it raises capital and reduces its debt, it will be able to use its cash flow for acquisitions or increasing its dividend.
"Globes": Raising several billions at the current low share price means a substantial dilution for the shareholders.
Tepper: "There is dilution but according to my calculations, the company's share is currently traded at a 3.8 multiple on its profit for 2018. Even if there is a substantial dilution, the multiple will rise to 6, and that's still a very low multiple. Teva is already not being priced according to its multiple. Dilution is obviously painful, but the question is what you prefer. Is it preferable for the company to be unable to service its debt, with the shareholders losing everything? Today, control of Teva is effectively in the hands of its debtors, and as long as the balance with the shareholders remains unchanged, the shareholders will be unable to provide its real economic price."
Tepper emphasizes that if Teva wants to continue existing as an independent company, it has to raise capital; otherwise, it will be exposed to a takeover.
At Teva's current share price, 83% less than its peak in July 2015, Teva could be considered an interesting target for a takeover. Tepper says that there are two main obstacles to a takeover of Teva: its huge debt and the fact that the company's shares are widely distributed among the public, with no one outstanding shareholder (with a 9.9% holding obtained in the sale of Actavis to Teva in 2016, Allergan is the largest shareholder in Teva. Allergan announced last week that it intends to begin selling these share, S. H.-V.). "The fact that Teva has a huge debt is an obstacle, because even if an investor eventually takes it over, what will he do with the debt? There is a problem facing all those private equity funds that love to do such things (acquiring a company and enhancing its value through streamlining, S.H.-V.). They will find it difficult to do this with such a heavy debt," Tepper explains. One of the major pharma companies is likely to show interest in a takeover. "A pharma company can tell itself that Teva is interesting at the current price," Tepper notes. "Such a company knows what to do with the assets and knows the right way to examine them, and can swallow up Teva's debt."
What is the likelihood of this scenario?
"The problem with this scenario is that there are not many players capable of doing it. You can count the relevant companies on the fingers of one hand, so it is hard to predict. There could also be a more complicated constellation of an acquisition including a spinoff of Teva's generics activity. If as Teva's share price continues its slide, a buyer may tell himself that it is hard to say no to the opportunity at this price."
What about the possibility of bringing in an investor like Len Blavatnik to buy a stake in the company, perhaps even Allergan's holding?
"There is still no verification of this story, but such a possibility is good news. I think that it's worthwhile for him to invest within the company (meaning that Teva will issue shares to him, and the money will go to the company itself, S.H.-V.), rather than buying from Allergan. Teva's share is a hot potato going from one investor to another right now, but if the money goes into the company and reduces its debt, it creates more value. Teva might be able to take advantage of a good wind in this measure by expanding such an offering to another group of investors, thereby raising a more substantial sum in order to reduce its debt.
"Incidentally, if Blavatnik enters the company, he will be a substantial party at interest. That is likely to change the dynamics in Teva, because he will exercise control and keep a closer watch over the board of directors. A large party at interest can also lead to an option to acquire the company, because it is easier to acquire a company when the shares are not dispersed among many investors."
In 2008, shortly after Teva acquired US company Barr for $7.46 billion, including all of Barr's $1.5 billion debt, then Teva CFO Eyal Deshe (who resigned this year) said in an interview, "We won't be in a situation of being unable to repay debt. We read about such cases in the newspapers, and this will never happen at Teva, even under the most extreme scenario." Is this extreme scenario about to occur now? Tepper believes that it will not. "I don't think that we're in a situation that where a debt settlement is needed. For the foreseeable future, keep in mind that $30 billion of the debt is spread over a prolonged period. Teva must repay a few billion each year, not everything in one year. Teva can maneuver, raise more expensive debt, and buy time. It's not a healthy process, but Teva has already vastly improved the covenants (the financial terms for its bank debt, S.H.-V.), and in the debt payments it makes, the first thing is to reduce the bank loans for which there are covenants. There is no commitment to specific debt ratios for the bonds."
On the other hand, Tepper adds, "If Teva has difficulty handling its debt and has to roll it over, it will affect its rating. The main problem is that if the rating falls, the interest rate on the debt will be higher. There is no immediately threat of bankruptcy, but the problem is that this is a continuing process that no one knows how it will end." For example, Tepper sketches a scenario in which Teva's two new ethical drugs, for movement disorders and migraine headaches, are unsuccessful, in contrast to current expectations. In such a case, Teva is liable to reach a situation in which its cash flow is unable to reduce its existing debt. "There is no problem right now with the interest payments, because these are very low, so there is no immediate threat. In such a negative scenario, however, the risk can become more concrete."
Sale of assets
In any case and under any scenario, Teva is likely to decide to sell more assets in addition to the women's health assets recently sold for $2.3 billion. "Teva has already sold its substantial assets that were not part of its core business. It may have a plant here or there that it can sell, but the only significant assets that it can sell now are its respiratory products," Tepper says.
Teva's respiratory products were one of the bright spots in its third quarter results, with $351 million in revenue, 30% more than in the corresponding quarter last year. Tepper says, "This business could theoretically be sold, but Teva has to get a very high price for it in order to sell it. When you sell such activity, no one gets a price that matches the potential growth. If Teva manages to sell at a very high EBITDA multiple, it could be worthwhile, but right now, this activity is important for Teva's growth from a long-term perspective."
Eliminating the dividend
At the same time, Teva may reconsider cutting its dividend, or even eliminating it entirely (which is liable to lead investors who hold the share because of the dividend being distributed to sell their holdings). Teva slashed its dividend by 75% in the preceding quarter and distributed $0.085 per share, and in its recent reports announced that it would again distribute $0.085 per share - a total of $86 million. This rate amounts to $345 million a year that Teva could save by eliminating its dividend, and analysts are wondering whether Teva needs to do this.
Layoffs are obviously another option. Teva announced in the past its plan to reduce the number of its employees by 7,000 by the end of the year, compared with the number of its employees when it acquired Actavis in July 2016. Everyone remembers the battle and fuss created when Teva announced hundreds of layoffs in Israel (Teva eventually reduced the number of layoffs), but will it have to cut its labor force again? Schultz is known for having led Lundbeck, the company he previously managed, through a successful streamlining process.
Billionaire on a white horse
Billionaire Len Blavatnik, controlling shareholder of Clal Industries and a major shareholder in Channel 10, is considering the purchase of a substantial stake in Teva. The talks are in the initial stage, and it is unclear right now whether they will lead to a deal, mainly because of Teva's situation.
Teva's current market cap is $11.5 billion, the lowest it has been since 2000, after the share plummeted again when the company again reduced its guidance, following Schultz's entering the CEO post. Teva's $35 billion debt is over double its market cap. Allergan, which owns 10% of Teva's shares, recently announced that it would sell its stake gradually, a policy that is likely to generate additional downward pressure on the share. One possibility under consideration is a purchase of the shares directly from Allergan. Teva stated, "The company does not comment on rumors."
Len (Leonard) Blavatnik made his money by buying assets when the Soviet Union was dismantled, and used the money to also develop substantial business outside Russia. He is in 40th place on the list of wealthy people in Forbes Magazine, which estimated his wealth at $20 billion, so the acquisition of Teva is a possibility for him.
Blavatnik is already active in the pharma industry through Clal Biotechnology Industries Ltd. (TASE: CBI), controlled by Clal Industries. At his instruction, Clal Biotechnology acquired the biotechnology activity of Access Industries, Blavatnik's holding company, and made it the center for Clal Biotechnology's activity in the US. Teva currently owns 15% of Clal Biotechnology, and recently increased its stake, so the parties have a pharma interface through this channel.
There is also logic in the synergy between Teva and Blavatnik's existing business and activity in Israel. Blavatnik manages his activity outside Russia through Access. Among other things, he acquired holdings in Western chemical companies (regarded as close and synergetic in the type of their business with pharmaceutical companies, main generics ones). His portfolio includes the Lyondell Chemical, for example, which was merged with another chemical company he owned; the two companies currently make up LynondellBasell, which has a $41 billion market cap.
Blavatnik invested in the company just before it went bankrupt last in the preceding decade. Although he lost billions of dollars in the bankruptcy because of leveraged debt, he continued investing afterwards, and made back more than he lost. Blavatnik was recently acquitted on charges of fraud relating to this process, and still holds 16% of the company.
Blavatnik, considered an associate of Prime Minister Benjamin Netanyahu, was questioned on suspicion of trying to mediate between Netanyahu and "Yedioth Aharonoth " daily newspaper owner Arnon Mozes in a sale of the newspaper.
Published by Globes [online], Israel Business News - www.globes-online.com - on November 7, 2017
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