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Analysis

Legal Troubles Could Weigh Down Teva’s Ability to Carry its Debt Covenants

On one hand, Teva is facing lawsuits that could end up costing it hundreds of millions of dollars; on the other hand, new profitable drugs and a cost-cutting reorganization program. Is it enough to keep its head above water?

Uri Tal-Tenne 12:5616.05.19
Almost four years ago, on July 30 2015, Teva published its second quarter reports to a background of celebrating shareholders. The company reported exceptionally high profitability for the quarter: a non-GAAP operating income of $1.6 billion, and a quarterly non-GAAP EPS of $1.43.

 

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Three days prior, the company announced the acquisition of one of its three main generic rivals, Allergan’s generic business Actavis, for $33.75 billion in cash and $6.75 billion-worth of Teva securities. Teva’s stock reached an all-time trading peak of $72, and Teva’s capital listed for trading was 850 million, giving the company a market capitalization of $61.2 billion. The day the quarterly reports were published, Teva’s stock closed at $69.

Teva CEO Kåre Schultz. Photo: Sivan Farage Teva CEO Kåre Schultz. Photo: Sivan Farage

 

But amid the euphoria, Teva’s reports also highlighted its weak points. Copaxone, Teva’s blockbuster multiple sclerosis drug, contributed half of the quarter’s operating profit but was already seeing generic competition in its near future due to patent expiration. Some of Teva’s other brand drugs, such as Azilcet for Parkinson’s disease and Nuvigil for excessive sleepiness, were also facing generic competition. In addition, much of Teva’s operating profit in its generics business came from a few specific drugs it launched with the time-limited first-to-file exclusivity in the U.S. in the first half of 2015.

 

The company realized it was facing a future slump, and the Actavis acquisition was meant to prepare for that future. But the deal would turn out to be the company’s biggest mistake, turning what should have been a slow decline into an avalanche.

 

Teva received Actavis’ bread, but not its butter

 

A little more than 13 months passed between the announcement of the deal and its competition. In the meantime, Teva was forced to sell off overlapping assets as part of the European Commission's conditions for approving the deal, due to concerns that the "merged entity would have faced insufficient competition from the remaining players." When the transaction closed, many of those generic drugs, whose price remained stable due to low competition, were no longer under Teva’s ownership. Furthermore, Actavis’ profitability mainly relied on a limited group of low-competition generics, chief among them a generic version of ADHD medication Concerta. Soon after the acquisition, increased competition slashed profits sharply.

 

At the same time, the U.S. market began experiencing increased downward pressure on generic drug prices, meaning Teva’s generic business began seeing its profit decline from one quarter to the next. Teva acquired Actavis mainly for its generic pipeline—which at the time was the largest in the industry—but its first-to-file generic drug release rate fell steeply after the first half of 2015.

 

While Teva managed to keep the profitability of Copaxone for a while by launching a 40 mg version, the launch of generics for that version as well in 2017 meant Teva’s grace period was over, and the company was left with a huge debt, an unsure future, and as of February 2017, no CEO.

 

Enter Kåre Schultz in November 2017

 

As Teva’s new CEO, Schultz’s first step was to launch an aggressive reorganization plan intended to cut the company’s total base cost by $3 billion by the end of 2019. So far, he managed to slash it by $2.5 billion, making the target an achievable one. The cost-cutting, which included a streamlining of Teva’s portfolio, managed to significantly boost the profitability of Teva’s generic business and Europe and, over the past two quarters, stop the slide in the profitability of Teva’s generic business in the U.S.

 

But harsh generic competition for Copaxone, increased competition for Teva’s respiratory products, and the sale of its profitable women’s health business in 2017 to cover its debt, all mean the company’s profitability is still declining, and the company still has a net debt of $26.7 billion to contend with. Add to the that the company’s recent opioid-related legal troubles and price-fixing accusations in the U.S., and Teva’s financial future is under a heavy shadow.

 

Not all is lost

 

On Monday, Teva’s stock closed at $12.23, its lowest point in the last decade barring a brief record low in November 2017. As Teva has 1.09 billion shares listed for trading, this gave the company a market capitalization of $13.3 billion. Teva forecasted an annual non-GAAP operating profit of $3.8 billion to $4 billion for 2019, and global Copaxone sales of $1.3 billion. Both are reasonable estimates, though Teva will probably end in the lower range of its profit forecast: Teva’s Copaxone sales dropped to $335 million in the first quarter of 2019, and the next two quarters are expected to see similar sales. The drug’s operating profit margins are 75%-80%.

 

That means that excluding Copaxone, Teva is expected to see an operating profit of $2.8 billion to $3 billion for 2019—enough to keep its head above water but not much more.

 

Teva has two additional cards up its sleeve: brand drug Ajovy, a preventive migraine treatment, and brand drug Austedo for Huntington's disease and tardive dyskinesia. Conservative estimates place their maximum sales at $500 million to $1 billion a year, while less conservative estimates predict they could become blockbuster drugs with annual sales of over $1 billion. Regardless, they are expected to continue to grow in sales and mitigate some of Copaxone’s continued decline. Teva also has some biosimilar launches planned further ahead in its future.

 

Teva’s decline in profitability is expected to cease this year, with the competition of its reorganization plan and the expected increase in Ajovy and Austedo sales.

 

Teva’s great challenge now will be carrying its debt covenants. Teva’s leveraged debt means any refinancing carries high interest rates, and Teva’s cash flow in the next two years is not expected to be able to cover its covenants. Current lawsuits against the company could end up costing Teva hundreds of millions of dollars, making refinancing even harder and adding to Teva’s shaky position. Risks could force the company to raise capital at high interest rates.

 

A clearer picture of Teva’s legal situation and a small increase in profitability could better Teva’s standing, but for the short future at least, Teva’s stock is expected to stay in the $10-$20 range.

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