We have found that there is a measurable and consistent "Israel Discount" in the biotech and pharmaceutical industry. The market seems to punish Israel-based companies by marking them at lower valuations as compared to US-based company valuations. Diversifying into Israeli companies in this industry is an excellent way to add alpha to the pharmaceutical segment of an equity portfolio in anticipation of a market correction towards equilibrium.
Teva Pharmaceuticals (NYSE:TEVA) is a prime example of this discrepancy. Teva has far outpaced its competitors as the biggest generic drug maker in the world with a market capital of $42 billion and 2011 sales of $18.3 billion. It is larger than the next four competitors combined on both market capital and revenue. Teva's market leading status provides a wide array of advantages in the pharmaceutical industry as their economies of scale allow them to report margins that are around 1,000bps higher than their competitors (on a gross, operating, and net basis).
Size does not come at the expense of growth, as one would normally expect. Teva has been in business since 1944 and is one of the largest companies trading on the NYSE, yet they are still able to achieve 20+% top-line compounded annual growth rates. Despite all of these clear advantages, the stock is trading at less than half of Watson Pharmaceuticals (WPI) on a P/E basis. Over the past two years, based on our calculations, Teva's average P/E has been 16% lower than Watson's and their EV/EBITDA multiple has traded at a similar 14% discount.
Looking at the other end of the pharmaceutical spectrum, we shine the spotlight on Israeli Prolor Biotech (NYSEMKT:PBTH) as compared to US-based Idenix Pharmaceuticals (NASDAQ:IDIX). While working in different fields, these two development stage companies are both in phase two of the FDA approval process with a pot of gold at the end of the rainbow in the form of revenues from their respective experimental drugs. To-date, there are no meaningful earnings from the product so standard valuation metrics such as price-to-earnings, price-to-book, or EV/EBITDA are not meaningful. We therefore turn to Wall Street models based on discounted future cash flows for guidance on the "true value" of the stock.
Prolor Biotech is an Israel-based company that has products that are going through the FDA approval process that aim to provide a more user-friendly version of existing Human Growth Hormone treatment. The main axe on this name is Summer Street Research Partners. Their latest DCF model points to a price target of $8 per share. The current stock price reflects a 32% discount from the true equity value.
Idenix Pharmaceuticals Inc. is a biopharmaceutical company that discovers and develops drugs that focus on the treatment of infections caused by hepatitis B virus, hepatitis C virus, and human immunodeficiency virus (HIV). This company enjoys a much wider coverage base of 13 analysts with an average analyst price valuation of $10. The current price reflects 24% discount from the true equity value. The "Israel Discount" is alive and well in the development stage as well.
We see that whether it is the more mature and diversified pharmaceutical giants like Teva and Watson or the development stage companies like Prolor and Idenix, the "Israel Discount" is apparent and significant. It is difficult to say how long this trend will continue, but the patient investor who holds on for the medium-term should be rewarded as the valuations metrics correct. This "Israel Discount" seems to be an issue that is local to the pharmaceutical and biotech industry. A comparison of the main country indices of these two countries (see chart) shows little discrepancy in valuation metrics. This tends to indicate that the trend in the pharmaceutical industry has a limited lifespan.
P/E Ratios of the TA 100 and the S&P 500