Is Teva’s $1 Billion Paragard Sale Much Ado About Nothing?

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Teva (TEVA) has had some exciting news to present over the past week. It hired 30-year industry veteran Kare Schultz as its full-time CEO. He will be charged with rightsizing the business while simultaneously paring debt. To that end the company completed the $1.1 billion sale of its Paragard intrauterine copper contraceptive to CooperSurgical:

The embattled Israeli drugmaker said it had struck a pact with CooperSurgical to unload its Paragard intrauterine copper contraceptive for $1.1 billion in cash. Along with it will go a manufacturing facility that produces the product exclusively …

Paragard generated revenues of about $168 million between June 30, 2016 and June 30, 2017, Teva said—but the company is much more in need of the cash. Thanks to last year’s ill-fated, $40.5 billion purchase of Allergan’s generics unit, Teva expressed doubts earlier this year about meeting its debt agreements.

Teva is actively pursuing divestitures and expects to garner at least $2 billion in total asset sales for year. Every little bit helps when it comes to paring Teva’s $35 billion debt load. It could be much ado about nothing, however. I explain below.

Teva Will Still Be Highly-Indebted

Teva has been a serial acquirer of pharmaceutical brands in the same vein as Valeant (VRX) and Allergan (AGN). Its $40 billion acquisition of Allergan’s generics business is beginning to haunt the company. Teva’s debt/run-rate EBITDA (Q2 EBITDA annualized) is at 5.0x – junk levels. Valeant has also engaged in asset sales to pare debt. While it is well on its way paring debt by $5 billion, and after every announced asset sale the VRX tends to gyrate upwards. The stock is up over 71% since its 51-week low heading into Q2 earnings, yet its EBITDA has declined faster than debt reduction. Valeant has what some would call “optionality” – its small sliver of equity gives it the volatility of a stock option.

Teva’s announced asset sales appears to be a copycat of Valeant’s strategy. The problem is that selling asset also means the company has to forgo future revenue and EBITDA. Even if there was no loss of EBITDA with the Paragard deal Teva’s debt would only decline to around $34 billion. Debt/EBITDA would be about 4.9x, and the company would still be highly-indebted. The market knows the company is in dire straits so potential buyers might not be eager to pay up for assets. The stock spiked about 25% on reports of the new CEO hire and asset sale. However, Teva does not appear to have the same optionality as VRX.

I would rather see the company raise equity in order to pare debt. Negative sentiment from an equity raise could sink the stock, but at least the company would not have to worry about a slow wind down in earnings and potentially, the share price, over time.

Teva’s Remaining Operations Are A Question Mark

Teva’s Q2 revenue of $5.9 billion was up 13% Y/Y, yet EBITDA only grew by 4%. Gross margins from 57% in Q2 206 to 50% this quarter; margins for its generics business have been hard-hit as customers begin to push back in pricing. Headwinds for the generics business is expected to spill over into 2018. Gross profit margin for generics peaked at 49% in Q4 2016, and was 42% in Q2.

Source: Shock Exchange

 

Teva has been experiencing price erosion and lower volume in the sector. The continued slide in margins was likely one of the reasons the company reduced its full-year earnings guidance. The acceleration in generic drug approval by the FDA has also increased competition and is expected to persist.

In my opinion, over 70% of Teva’s revenue stream remains challenged. Generics represents 54% of revenue, while MS specialty – mainly its Copaxone drug used to treat multiple schlerosis – makes up another 18%. Revenue for this segment was off 10% Y/Y on lower volumes in the U.S. and a loss of pricing power elsewhere. Generic Copaxone is also on the way, and when it arrives it could cut punish Teva’s Copaxone sales. I would expect a generic version to hit the market by Q4 2017 or Q1 2018.

Conclusion

After the Paragard sale Teva will remain highly-indebted and over 70% of its operations will face sizeable headwinds. The asset sale might might be much ado about nothing. TEVA is a sell.

 

On Shock Exchange

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