Teva: Is This What A Bloodbath Looks Like?

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Teva CEO Kare Schultz

Teva (TEVA) needs to cut costs to compensate for the loss of its top-selling multiple sclerosis drug Copaxone. Per Bloomberg the company is considering cutting up to 10,000 jobs:

Teva Pharmaceutical Industries Ltd., the debt-ridden Israeli drugmaker, is considering cutting as many as 10,000 jobs as new Chief Executive Officer Kare Schultz seeks to pare costs, according to people with knowledge of the matter.

The company aims to reduce expenses by $1.5 billion to $2 billion over the next two years, with a little less than half of the cuts linked to research and development spending, the people said, asking not to be identified as the discussions are confidential. The drugmaker also doesn’t plan to proceed with an equity offering in the near term, they said. The stock jumped to its highest in almost two months.

10,000 people is the size of a small town; such bloodletting equates to about 15% of Teva’s employee base. The company could always decide to cut less than 10,000, but the announcement likely put investors and employees on notice. Politically, if Teva makes a sizeable cut to its local employee base in Israel it could create a backlash from the Israeli government. It will be interesting to see the mix of U.S. and local employees that get downsized.

Mylan’s (MYL) generic Copaxone was approved in October. The drug represents over 45% of the company’s EBITDA, so head count reductions to compensate for the loss of revenue and earnings were to be expected. TEVA bounced over 7% on Friday’s news, which I was surprised by. My question was “Why the spike in the stock for layoffs we knew had to happen anyway?” Bloomberg’s Abigail Doolittle explained that the stock was indeed up on the possibility of cost cuts. Investors were expecting cuts between $1.5 billion and $2.0 billion and the potential for sizeable job cuts in addition to an expected reduction in R&D was a step in the right direction.

Teva’s run-rate operating expenses are around $16 billion annually. The expected cost cuts would equate to about 9% to 13% of total operating costs. On the face of it the cost cuts appear reasonable. However, the hit to efficiency and employee morale has yet to be discussed. Below are other issues I believe led to the spike in TEVA and/or could impact the stock longer term.

No Plans For An Equity Offering

Another key part of the Bloomberg article is that Teva apparently has no plans for an equity offering. That likely spurred the stock as well. My previous article highlighted how generic Copaxone could render Teva insolvent:

I also estimate that generic Copaxone could cut Teva’s EBITDA by about 34%, making it difficult to cover its $34 billion in net debt. Said another way, generic Copaxone could cause the company to become insolvent … At run rate EBITDA of $4.3 billion and a median multiple of 7.7x, Teva’s enterprise value of $32.9 billion would be less than its net debt of $34 billion.

Generic Copaxone will likely take a sizeable bite out of Teva’s EBITDA. However, its $34 billion debt load will not fall in-kind. Once generic Copaxone fully kicks in I believe Teva’s debt will exceed its enterprise value. The company would be functionally insolvent, which is not positive.

However, it still should have ample liquidity to remain in business. At Q3 the company had $680 million in cash on hand. Through the first nine months of the year it generated $2.3 billion in cash from operations, 40% below the $3.8 billion in generated in the year earlier period. I expect generic Copaxone to further crimp cash flow, yet Teva should still remain cash flow positive.

Strong Interest Coverage

Despite its $34 billion debt load Teva’s interest expense is paltry. In Q3 the company had $259 million in what it described as “financial expenses.” The weighted average interest rate on its debt appears to be as low as 2%. Its EBITDA-to-interest coverage is currently exceeds 6.0x. Even after pricing in a 51% decline in Copaxone sales the company’s interest coverage would exceed 4.0x. This still would be considered stellar. If the company’s debt gets downgraded further or if it has to restructure certain principal payments its interest expense will likely increase. For now, its interest coverage is strong which could allow it to forgo an equity raise in the near term.

Can Teva Bulls Stomach More Ratings Downgrades?

Teva’s Q3 results were a disaster. The company missed on revenue and gave  weak guidance for Q4. The stock sold off 20% shortly after earnings. The company acknowledged a loss of pricing power in generics and that Copaxone would take a hit in Q4. What happens when generic Copaxone fully kicks in next year. Can TEVA bulls stomach a decline in EBITDA of around 30% to 35%? Then there are fees and costs from potential debt restructurings. Management could kick the can down the road for years but bankers will want their pound of flesh if management has to push back near term principal payments or re-negotiate debt covenants due to EBITDA short falls. In forgoing an equity raise management also potentially exposes the company to debt-related fees while it rights the ship.

Fitch recently sacked Teva due to operating stress amid a high debt load, and continued pricing pressure in generics. The company’s debt/run-rate EBITDA currently exceeds 5x. Once generic Copaxone kicks it the metric could easily deteriorate to 6x or 7x. That portends further downgrades from Fitch or even Moody’s and Standard and Poor’s. Debt downgrades could create negative sentiment and pressure the stock.

Allergan Might Have To Unload Teva Shares

Teva acquired Allergan’s (AGN) generics business for over $30 billion in 2016. As part of the deal Allergan also received 100 million TEVA shares (approximately 10% stake) it agreed to hold for at least a year. Allergan has intimated it will sell 25 millions shares in Q1 2018, which could pressure the stock. I believe Allergan might have to dispose of more than 25 million shares to help shore up its own balance sheet, which could further pressure TEVA.

Allergan has a $30 billion debt load at 4x run-rate EBITDA. Its organic revenue growth is dead; it kept the rating agencies at bay in Q3 by cutting R&D to 11% of revenue from 17% in the year earlier period. Its patents for dry eye drug Restasis were recently invalidated by Judge William Bryson. Restasis represents 12% of Allergan’s income. If it loses a pending inter partes review for the drug then generic Restasis could arrive some time next year, pressuring Allergan’s cash flow and jeopardizing its debt rating.

Restasis buyers recently hit Allergan with an antitrust lawsuit for blocking low-cost generics from entering the market at customers’ expense. I believe the lawsuit is credible and Judge Bryson’s ruling could buttress these customers’ claims. Allergan’s patent ploys could prompt similar antitrust lawsuits. While its organic growth is dead, generic competition and legal exposures are rising. Allergan has $5.4 billion of cash and securities. I believe it could be forced to dump its TEVA shares if generic competition and/or lawsuits hurt liquidity next year.

Conclusion

Market chatter suggesting Teva will not dilute its stock could allow equity analysts to speculate on a turnaround and allow day traders to profit from sharp movements in the shares. However, ratings downgrades and selling pressure from a sale of Allergan’s stake could be on the horizon. TEVA is a sell.

 

On Trump And The Global Economy

Wuyi, Coconut Rob, Shock Exchange, Professor Brogman stunt for the ‘gram

The second installment of Trump And The Global Economy Town Hall took place October 24th in Fort Greene. It Featured Professor Lance Brofman, Coconut Rob (Coconut Rob Smoothies), Wuyi Jacobs (AfroBeats Radio) and Ralph Baker, author of Shock Exchange: How Inner-City Kids From Brooklyn Predicted the Great Recession and the Pain Ahead.

The event was well-received by the community. We parsed through President Trump’s proposed tax plan and [i] how it was pure economic folly and [ii] high net worth individuals could potentially game the system by shifting income around. Apparently, Kansas Coach Bill Self did this when the state of Kansas cut taxes in the past. We discussed the pros and cons of technology on workers and the economy. How will the economy and country prosper under Trump’s leadership vis-a-vis Obama? What’s behind the verbal sparring with black athletes, ESPN’s Jemele Hill and North Korea’s Kim Jong Un?

 

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