Teva (TEVA) needs to cut costs amid generic competition for its blockbuster multiple sclerosis drug Copaxone faces generic competition from Mylan (MYL). CEO Kare Schultz decided to delay some layoffs at its Jerusalem plant amid social unrest in Israel:
In what was hailed as a victory for Israel’s labor unions, Teva’s management on Sunday decided to delay the layoff of some of the workers at its Jerusalem plant, even while saying the plant would be closed down in 2019 as planned. Some 340 workers were scheduled to have been fired in the first wave of layoffs at the start of 2018, ahead of the closure of Teva’s pill-manufacturing Jerusalem plant.
After workers barricaded themselves into the building, management reached a compromise with the workers union and agreed that in the first stage of layoffs only some 200 workers would lose their jobs at the Jerusalem plant. The final count of layoffs will be unchanged, however, and the plant is still scheduled to close as planned in 2019, Teva said.
TEVA spiked after management announced after the company announced it would lay off about 25% of its workforce and suspend its dividend. I always thought the plan was ambitious; 14,000 employees is the size of a small town. Local Israeli employees will also bear the brunt of the company’s austerity measures. Over 1,500 employees in Israel are expected to lose their jobs. That could be problematic after Teva received billions in tax benefits from Israel.
In mid-December labor union Histadrut hit back at Teva in the form of a major strike at Ben Gurion airport in Tel Aviv. The airport, government offices, banks and the stock market were idled for half a day. I also understand Histadrut was calling a general strike in order to send a “clear message” that the layoff of Israeli workers was not acceptable. A few hundred Teva employees barricaded themselves inside a plant in Jerusalem, preventing managers from leaving.
Teva can ill-afford a work stoppage or to have any of its plants shut down. The company has over $13 billion in debt due by 2020, of which $5 billion is due this year. Fitch recently downgraded Teva to junk status amid the loss of Copaxone sales and pricing pressure in its North America generics business. The company needs all the cash flow it can get. Teva may have been forced to make concessions to employees in order to avoid an unexpected shut down.
Impact On Sentiment
Teva reported disappointing Q3 results. The stock is still up over 30% compared to its price just before earnings were announced. Broader financial markets are also reaching record highs on a weekly basis, but in no way did I foresee TEVA spiking in the face of headwinds from generic Copaxone. Part of the spike in shares was due to $3 billion in expected savings from planned layoffs by the end of 2019:
“The cuts are larger and more rapid than what had been anticipated,” Vamil Divan, a New York-based analyst at Credit Suisse Group AG, wrote in a note to clients. Given Schultz’s track record, “investors will also be willing to give him the benefit of the doubt that he will be able to successfully execute on this.”
The cuts were larger than expected and investors have given Teva the benefit of the doubt. In my opinion, the stock trades more on sentiment than on earnings fundamentals. One hundred and forty fewer layoffs than expected in 2018 might not sound like a big deal. However, given the political pressures in Israel who is to say management will not back track on other planned layoffs? Could delays in cost cuts impact the positive sentiment the company has built up among analysts and investors over the past month?
Impact On Cash Flow
Schultz, effectively known as “Kare The Terrible” by Teva employees, has put the $3 billion figure out there, but can he deliver? What are the schedule of layoffs and plant closings and how will they impact costs and cash flow on a go-forward basis? During Teva’s Q4 earnings report I believe it is important for Schultz to lay out (1) which quarter plant closings and layoffs are expected to occur and (2) how much of the $3 billion savings will be phased in on a quarterly basis for 2018 and 2019.
While the stock has spiked I do not believe there has been any meaningful improvement in Teva’s fundamentals. Generic Copaxone is here and it should partially impact Q4 earnings and have a full impact beginning in Q1 2018. I estimate Copaxone has quarterly revenue and EBITDA of about $987 million and $799 million, respectively. A potential loss of 70% of Copaxone sales due to generic competition could cut quarterly EBITDA by approximately $560 million, which would equate to $2.2 billion annually. Teva would have to cut annual costs by over $2 billion simply to mute the potential diminution in Copaxone earnings.
The company will also have to restructure $5 billion in debt that comes due next year. This will likely result in tens of millions of debt fees and advisory fees. Fitch recently downgraded Teva’s debt to junk status. New debt could come at much higher interest rates than it currently pays on its $35 billion debt load. Teva has also engaged in asset sales that will result in lower EBITDA going forward. Debt restructuring costs, rising interest rates and lower EBITDA will impact the company in real time. However, the full amount of cost cuts and the timing of those cuts are less certain.
I believe management will deliver on the lion’s share of announced cost cuts, yet there could also be more pain ahead for the company. Any hiccups in cash flow or delays in expense cuts could hurt Teva’s credit metrics and/or cause Moody’s or S&P to also downgrade the company’s debt. This could create another chain of events – higher interest expense, less cash flow, etc.
Deteriorating credit metrics and declining EBITDA could warrant an equity raise, yet Teva’s management would rather workout its problems without going that route. Until the company demonstrates a sustained improvement in revenue and EBITDA the stock remains a sell.
On Trump And The Global Economy
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?