Teva's collapse could happen to Israeli economy

Avi Tiomkin  photo: Einat Levron

Israel is putting too many eggs in the startup basket, warns Avi Tiomkin.

The thundering crash of Teva Pharmaceutical Industries Ltd.'s (NYSE: TEVA; TASE: TEVA) share last week gives rise to many questions, above all why it happened. Teva, which had a $60 million market cap in 1986, reached $70 billion in 2015. The company value then collapsed, and only two years later, is now less than $18 billion. The main reason, of course, is the acquisition of Actavis Generics, the generics division of US company Allergan, for $40 billion, which was completed last year (immediately after the failure to acquire Mylan N.V. (Nasdaq: MYL; TASE: MYL) for the same price). The company went into debt to pay for this acquisition, which is seriously restricting the ability of Teva's management to function and maneuver.

Without wasting words on the faulty outlook of the company's managers, bordering on arrogance and a feeling that they knew everything, it should be mentioned that Erez Vigodman, CEO of Teva until recently, previously showed superb ability as CEO of Strauss Group Ltd. (TASE:STRS) and Makhteshim-Agan, was a Teva director for five years, and is an accountant by profession, so there can be no question about his personal or professional suitability for the CEO position at Teva. Vigodman's main problem was the reason that he was made CEO of Teva, and what was expected from him. Here it is necessary to mention Teva's success as a drug company and its metamorphosis from a company based on a single customer (Clalit Health Services) to a worldwide manufacturing and sales system with an almost complete focus on generic drugs. This direction, under the brilliant direction of Eli Hurvitz, including the consistent but gradual acquisition of companies in stages, enabled Teva to develop very positively and gradually.

Calamity began with the success of Copaxone

The event that both sparked Teva's meteoric rise and constituted the source of its downfall was the development of the Copaxone drug for treatment of multiple sclerosis by scientists at the Weizmann Institute of Science. The company's business breakthrough began when the drug was approved in the US and the UK in 1997-2000, with Teva's share price zooming from $6 to a peak of $72 in late 2015. Starting in 1986, the company's market cap multiplied itself by more than 1,000 (this is not an error). Thanks to Copaxone, almost overnight, an extremely successful company built over a period of years became an international giant with an almost unlimited ability to expand and obtain credit.

This also, however, paved the way for the calamity that brought Teva to its current predicament. The knowledge that Copaxone's exclusivity must end within a few years, with sales, and especially Teva's unbelievable profit margins on Copaxone sales, declining as a result, should have been the basis of a strategy for continuing the gradual building of the company. That, however, is not what happened.

The biggest mistake was the attitude of managers and investors in Teva to Copaxone. Instead of regarding this drug as a one-time bonanza to be enjoyed and utilized for the gradual building of the company, the managers and shareholders became prisoners of the unique position in which the company found itself.

It is important to emphasize that the generic drug sector, which was Teva's forte, is completely different from the branded (original) drug industry. It is like a company investing in real estate that suddenly discovers a gigantic oil field that enriches its shareholders and makes it a huge source of income. The oil field, however, is obviously limited in size, and will eventually be used up and go dry. If the company's owners regard themselves as a giant in the energy field with a long lifespan, they will have to make massive investments, while going deeply into debt, in order to maintain the company's size. Instead of acting wisely and gradually in the company's basic specialty, the owners will have to take enormous risks, while an important mistake in judgment or performance is liable to cause the company's collapse.

When Vigodman became CEO of Teva, he had only one goal, which was dictated by the company board of directors, with the support of its shareholders: maintaining Teva's standing as a leading company, despite (and perhaps because of) the knowledge that the Copaxone effect was about to fade dramatically. I will not discuss or analyze the decisions, how they were made, the choice of target, and the global conditions, which contributed to the fall of Teva and the biggest fall in value in Israel's history. One thing, however, is clear: strategic thinking and risk management were left out of the equation completely; the sole aim was to preserve the company's size and status.

Israeli high tech is losing its advantages

The startup industry is the Copaxone of Israel's economy. The stunning success of Israeli technology companies such as Waze, Check Point Software Technologies Ltd. (Nasdaq: CHKP), and Mobileye have attracted a substantial proportion of Israel's enormous store of talent to this industry. For years, decision-makers in Israel have put all their eggs in the basket of the high-tech industry's success as a basis for growth in the local economy.

At the macro level, the contribution of high tech was extremely significant for Israel's growth, exports, and foreign currency reserves. In recent years, however, the important advantages of the local high-tech industry have been rapidly dwindling. Just as the period of exclusivity for Copaxone neared its end, together with its contribution to a substantial growth in sales but mainly to disproportionate profits, the high-tech industry is now losing the advantages it enjoyed as one of the first in the world.

The level of competition is increasing. The need for larger investments and follow-up financing rounds is increasing the risk. The willingness to pay enormous sums for successful companies is on the wane, and the willingness to invest in venture capital funds is declining.

The figures published in the media prove it. Most startups in Israel fail; 600 of them close down every year. Nearly half of these companies discontinue their activity in the first three or four years. Only half of those that are eventually sold earn back the investment in them. All of this is accompanied by a clear decrease in follow-up financing rounds and in the value of exits - the average exit value has fallen by 30% in recent years.

While the spotlight has been turned almost exclusively on this industry, the bread and butter of the Israeli economy has been neglected: small and medium-sized industries in all the basic economic sectors. We frequently hear about factories closing around the country, but because attention is paid almost exclusively to exits, the cumulative damage of this process - the loss of a real basis for the domestic economy - passes almost without comment. The scale of the damage is reflected in a survey for 2015 by the Association of Craft and Industry, which found that 40,000 small and medium-sized businesses close down every year in Israel, and over half of all such businesses are in danger of closing down. It is no wonder that the middle class in Israel is being continually eroded.

The analogy with Teva and Copaxone is clear. Just as the expiry of patent protection for Copaxone led to a series of major errors in decision-making by Teva's management, which embarked upon catastrophic adventures, instead of gradually and judiciously building broad infrastructure for business activity, the end of the "protection" period for the Israeli startup industry's exceptional contribution, which has reached the advanced stages, will cause the downfall of the Israeli economy. This will have enormous social effects that will make the 2011 social protests look like a children's game.

Warren Buffet said, "Only when the tide goes out (the boom ends) do you discover who's been swimming naked." The nakedness of Teva has now been completely uncovered, and I fear that the same fate lies in store for the Israeli economy.

The author is a consultant to international hedge funds. In February 2016 (when Teva's share price was $65) he warned students at the Tiomkin School of Economics at the Intedisciplinary Center Herzliya of the dangers inherent in the Teva's acquisition of Actavis.

Published by Globes [online], Israel Business News - www.globes-online.com - on August 10, 2017

© Copyright of Globes Publisher Itonut (1983) Ltd. 2017

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Avi Tiomkin  photo: Einat Levron
Avi Tiomkin photo: Einat Levron
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