Teva Pharmaceutical

For every course that teaches Mergers and Acquisitions, the case study of Teva Pharmaceutical should be a mandatory part in the curriculum. It is a recent classic story of acquisitions gone bad, very bad. When Teva bought the generic drug business from Allergan, it would have been better off for investor to sell their stock rather than wait and see how the deal plays out. It played out horribly. Revenues that were anticipated haven’t materialized, and company has been charging impairments in billions of dollars to balance out the excess amount they paid to Allergan. The stock also went from trading in the high 60s in 2016, to under $10 in 2021. Teva has successfully managed to raise debt to destroy shareholder value.

For 2020, which was an unusual year for drug manufacturers, Teva’s revenue was $16.7 billion, which is down 25% from its 2017 revenue of $22.4 billion. The decline in revenue is due to the company selling off its business segment to pay off debt, and the decline in organic growth in sales. Teva’s Net Loss was $4 billion in 2020, and it has been reporting significant losses due to Goodwill impairment charges. If you look at operating income, in 2020, it was $3 billion compared to $4 billion in 2017. Compared to industry average of 25%, the operating margin for Teva is lower at 17%. While operating income has declined, the decline is likely proportional to the business segments that it sold off in the preceding years to pay off its debt. While there hasn’t been much difference in operating income, operating cash flow has been significantly impacted, going down from $3.5 billion (2017) to $1.2 billion (2020). 2020 was an unusual year as mentioned before, so I am not surprised of the lower cash generation, however that is not a forever to be used excuse. A better way to look at earnings is to add back the impairment charges to net income, then the adjusted earnings is $2.5 billion (2020) and $4.5 billion (2017), though this is not the most reliable method to calculate for every company. For 2019, the company only made $780 million in adjusted earnings.

Teva has two major business segments, the generic drug business and specialty drug unit. The generic drug unit is where the stable (likely) revenues come from, with low R&D and higher marketing costs, while the specialty drug business brings the profits, but with higher R&D costs. Teva used to report their segment earnings until 2017, and after it’s restructuring, the company reports based on location. I analyzed the segment reporting based on location, and did some analysis based on the drivers of sales (generic or specialty) and found that markets with higher generic sales had lower R&D expense and higher marketing expense. So even if the company does not report the unit profits separately, it is not that hard to understand the mix. The downside with specialty drug business is that once the patents expire, the margins and revenues are likely to go down due to competition. For example, COPAXONE drug, which Teva manufacturers has been decided by the courts that the patents have expired. And since the ruling, you can see the sales of this drug for Teva go down.

The company has managed to reduce its debt since 2017, but there is a federal lawsuit stemming from the opioid crisis, which might cost the company billions. For now there is high uncertainty on how the lawsuits will go, and Teva is not the only company involved, since majority of the drug manufacturers are involved in it. I expect that the lawsuits would play similar to the tobacco company lawsuits two decades ago. Even though the settlement involved considerable amount of money, it still was manageable for majority of the companies.

Teva’s market cap is currently at $10 billion, which is down significantly from $40 billion in 2016. Part of it is due to the higher interest payments puts a burden on the company’s earnings. While troubles in Teva have persisted for almost 5 years, I do expect the company to improve its business in the future, once everything sorts out. I expect the company to earn approximately $1.5–2.0 billion in adjusted earnings per year for 2022, as long as the company does not make any more value destruction decisions. Once the lawsuits are settled and debt is reduced, I do see the value of the company going up significantly.

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