Patent Cliffs Make Teva, Mylan, GSK All Undervalued

Includes: GSK, MYL, PBTH, TEVA
by: Takeover Analyst

As major pharmaceutical companies move towards patent cliffs, generics will start flooding in to foster more competition and innovation. Despite a challenging backdrop, I still find generic producers Teva Pharmaceutical (NASDAQ:TEVA) and Mylan (NASDAQ:MYL) substantially undervalued. At the same time, drug maker GlaxoSmithKline (NYSE:GSK) is also looking worthy of "buy" under low multiples. In this climate, investors are unreasonably staying on the sidelines and not fully factoring in future growth. Below, I review the fundamentals of the three companies recommended above.

Teva Pharmaceutical

Teva trades attractively at a respective 12.8x and 7.1x past and forward earnings with 8.7% annual EPS growth forecasted over the next half decade. The bar has been set low, since EPS growth over the past 5 years has been several folds higher. Complemented with a beta of 0.34 and a dividend yield of 2.4%, Teva is both a safe and a high reward investment.

Current supply chain issues and industry-wide exclusivity losses warrant dramatic cost-cutting measures. Management is expected to trim $150-$200M from branded R&D and improve manufacturing efficiency. Closing up to 40% of its 50 FDF facilities, Morgan Stanley argues it is theoretically possible to produce $20M in savings per site. With Jeremy Levin now at the helm from Bristol-Myers, I anticipate the company's focus shifting more towards acquisitions. Dropping an unprofitable line and acquiring local emerging businesses, like PROLOR Biotech (NYSEMKT:PBTH), will help re-excite investors. Pressures are likely to increase in 2015-2016 when Nuvigil, Treanda, and Copaxone go generic, but the integration of Cephalon and growth in women's health are major catalysts.

Going forward, Teva is likely to consolidate. Past acquisitions of Barr, Pliva, and Ivax, while value-creating at the time, have led to unnecessary FDF redundancies. Product recalls and supply chain problems have been so bad that at one time backlogs nearly approached $400M. Taking proactive steps to make sure this does not happen again and communicating this effort to shareholders would give the company a needed multiples expansion.


Mylan is another generic drug producer that trades at compelling multiples. With a valuation of 8.6x forward earnings and 11.7% annual EPS growth forecasted over the next 5 years, Mylan is much more positioned towards the upside than the downside. There are several factors that will drive value creation over the intermediate-term.

With an estimated $22B worth of drugs heading towards patent cliffs in 2012, Mylan will have several generic launches to cross-sell, including Actos, Diovan, Atacand, and Lexapro. While the expansion into Europe was poorly timed with worsening sovereign debt issues, Mylan has great global scale elsewhere that will hedge against macro certainty. The focus on US generics will help to communicate that European risk is not nearly as bad as what the market has assumed. Moreover, Mylan will be able to maintain high margins given the efficiency of manufacturing through subsidiary Matrix Laboratories. In fact, the company is able to run operations so efficiently that it is one of only a few that are manufacturing a generic version of Teva's Copaxone multiple sclerosis drug. This drug is hard to manufacture and illustrates the strengths of Mylan's facilities.

In terms of growth, Mylan is aiming to increase international scale where generic utilization is low. Future pricing pressure from sovereign debt woes should be overwhelmed by greater utilization. Lastly, I am optimistic about the company's interest in biosimilars, which was revealed by the JV with BIOCON. This is attractive, since biotech has difficult-to-replicate manufacturing processes and, accordingly, not very exposed to generic competition. Biosimilars are an alternative to existing drugs that can thus provide high margins.


GSK is one of the safest investments in the healthcare industry. It trades at a respective 14.2x and 10.3x past and forward earnings with a leading 5% dividend yield. Double-digit ROA, ROE, and ROI are complemented by 40% less volatility than the broader market and a powerful brand. If your goal is stability, I recommend buying a large stake in the British drug maker.

On an operational level, however, GSK has struggled. 2Q12 marked the third consecutive quarter where GSK missed expectations. Sales of 6.5M pounds were approximately 3% below expectations and largely were the result of a maturing pharmaceutical business. All in all, GSK, despite exiting patent cliffs ahead of competitors, has seen disappointingly flat sales of late.

Flush with $12B in cash, GSK has a major catalyst ahead to reign in investor fatigue: acquisitions and new drug development. Dolutegravir recently released Phase III data that showed non-inferiority and similar tolerability to daily raltegravir in treatment-naive adults suffering from HIV 1. These results are compelling and will help elevate multiples as more data is released.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

Additional disclosure: We seek IR business from all of the firms in our coverage, but research covered in this note is independent and for prospective clients. The distributor of this research report, Gould Partners, manages Takeover Analyst and is not a licensed investment adviser or broker dealer. Investors are cautioned to perform their own due diligence.