Teva: What's Next for the 'Generic Giant'?

TEVA, the “Generic Giant,” as I referred to it back in November when I recapped its quarterly earnings, continues to outshine and outclass its peers on pretty much every level. Since I have followed healthcare equities for quite some time now and kept my focus solely on this sector, it is easy for me to say that Teva (TEVA) is one of the best-managed companies out there, and I think you would agree based on its recent performance and strategic moves.

Earnings for the fourth quarter were highly scrutinized by all investors and Street analysts as our financial crisis continues onward, perhaps even getting worse. Many companies unloaded their books for fourth quarter earnings, marking down what is left. Others squeaked out positive gains but still were hesitant on guidance.

Well, I obviously do not blame Teva, but how can a company who provides guidance at the low-end of the Street and then misses on revenue have the Street ecstatic and excited about it going into the future? Why don’t we just take a closer look at Teva, and I will provide you those reasons.

Successful Acquisition Strategy

Teva’s acquisition strategy has brought tremendous growth to a once small wholesale drug business in Jerusalem that began distributing imported medicines to customers on the backs of camels and donkeys. So why does Teva have such a strong acquisition focus? Many investors often criticize firms with such a strategy, because they believe that acquisitions destroy shareholder value when companies continuously grow inorganically. In Teva’s case, that is simply not true. Since the focus and need for global expansion hit our economy in recent decades, Teva has been extremely proactive and has sought after micro to mid cap companies in the generic and pharmaceutical market in both developed and underdeveloped nations.

Why can’t its competitors do this? Some have tried, like Mylan (MYL). Mylan destroyed shareholder value for much of 2007 and 2008 because of its poor capital structure and lackluster management following the Merck (MRK) KGA acquisition. In simple terms, nobody amongst its peers has the flexibility and cash on hand to expand like Teva.

Most recent acquisition: Barr Pharmaceuticals

The price tag of the acquisition was $7.46 billion to take-over the fourth largest generic drug maker, with revenues behind Mylan and Novartis (NVS) (Sandoz). In terms of prescriptions per day within the United States, the now “generic behemoth” has 50% more than the #2 player, Mylan. Since Teva typically does not make large acquisitions, it is fully committed to digest Barr and will not really be on the prowl in the short term. Some key developments were released in the most recent earnings report:

• Cost synergies will be over $400 million versus the initial estimate of $300 million
• Accretion will be accretive to earnings in third quarter 2009 versus the initial estimate of fourth quarter 2009
• Leverage will return to the level it was before the Barr acquisition in 1 year (decrease from 34% to 24% by the end of 2009)

The Barr acquisition has expanded Teva’s global presence. It is now the number three player in the Poland generics market, and in Germany it will move to become a top five contender. In Russia, it sees huge growth potential and looks to expand rapidly focusing heavily on the new market. Its acquisition strategy has allowed Teva to create a global supply chain, unmatched across the sector.

Favorable Political Climate

So, now that Teva has the global footprint, what is in its favor within the United States where a majority of the revenue is derived? If you have ever heard President Obama speak regarding healthcare, one of his main points is his pledge to support generic products to help drive down increasing healthcare costs, which affects millions of Americans. Recently, Obama has gone public with his healthcare reform plans and has requested $20 million in 2013 to help speed up the development of generic drugs.

This will begin the process of allowing for FDA approval of generic versions of biologic drugs. The budget explains that this change would save the government about $9 billion over a 10-year period. Teva reports that the biologic market will exceed $200 billion by 2015. The “Big Pharma Effect” as I typically call it, directly relates to increased generic usage. Especially with the global footprint that Teva has, its reach is unmatched. Patent expiration will only open the doors for additional revenues from generic companies such as Teva, Mylan, Watson (WPI) and Novartis’ Sandoz division.

Teva is a firm that you could put in your portfolio to capture the growing worldwide generic market and still have some pharmaceutical exposure with some of its leading drugs like Copaxone and Azilect. Like management affirmed, I do not expect Teva to make any more large acquisitions until it can fully digest Barr, but do not put it past the company if it comes across a micro-cap firm that will allow it to continue to sweep up world market share.

-Ryan Savitz

Disclosure: The fund that the author manages is long TEVA.

Comments

[Chemist29:]

Great company, bought it last year, stock is breakeven and the s&p fell off a cliff, huge outperform.

Mar 23 09:44 AM

[Michael Eis...:]

This is an incredibly well run company. I know the CFO who just returned from a tour of duty at Checkpoint and he is a star. My grandfather bought some shares for my daughter when she was born almost 15 years ago and it has been a runaway success!

Mar 24 07:47 AM

[bbowen7:]

Acquisitions are complex, and require financial resources, a strategic perspective, and operational skills. It is rare that a company has it all - and the last is probably the most difficult. I preferred Walgreen's organic growth to CVS's acquisitions and likewise SAP to Oracle, but both were able to manage acquisitions very well. TEVA is in that league.

Mar 24 06:02 PM

[Chris B:]

So we should buy this company on the basis of how well they've done previous acquisitions? Because they're acquisition experts?

I'll stick with companies that grow organically. All the paper-pushing and rebranding in the the world doesn't do much for shareholder value. It's still true that 70% of mergers destroy shareholder value... so I would say it's an uphill battle for TEVA to create value this way even if they've been fortunate in the past.

Mar 25 11:51 AM

[Ryan Savitz:]

Well if you look at the history of Teva and how they have grown, it has been through small strategic acquisitions. The Barr acquisition was very large in relation to their historic purchases. If you examine TEVA versus the S&P 500 looking back through the last 5 years, Teva has increased about 46% while the S&P 500 has decreased about 27%. If you examine the bullet points about the acquisition you will notice they are managing it very well and have controlled their working capital:
* Cost synergies will be over $400 million versus the initial estimate of $300 million
* Accretion will be accretive to earnings in third quarter 2009 versus the initial estimate of fourth quarter 2009
* Leverage will return to the level it was before the Barr acquisition in 1 year (decrease from 34% to 24% by the end of 2009)

If you look at Teva during the last 6 months they are pretty much flat (decreased about 1%) while the S&P 500 decreased about 33%. So looking historically and more-so, during the recent economic downturn, Teva has performed extremely well.

You really cannot find any pure large cap companies that have grown organically.

On Mar 25 11:51 AM Chris B wrote:

> So we should buy this company on the basis of how well they've done
> previous acquisitions? Because they're acquisition experts? <br/>
>
> I'll stick with companies that grow organically. All the paper-pushing
> and rebranding in the the world doesn't do much for shareholder value.
> It's still true that 70% of mergers destroy shareholder value...
> so I would say it's an uphill battle for TEVA to create value this
> way even if they've been fortunate in the past.

Mar 25 04:13 PM

[stevenm1968:]

There is some noise on the internet about Teva buying Watson and I wanted to get some input on whether this is going to happen, or just rumor.

Apr 28 08:10 AM