Teva: Warren Buffet Is Barking Up The Wrong Tree

Teva (TEVA) reported more disappointing results for Q4. Revenue and EBITDA fell Y/Y by 16% and 29%, respectively. Somehow Berkshire Hathaway (BRK.B), (BRK.A) thought this was a good time to invest in the struggling generics drug giant:

After the market closed Wednesday, a filing from Buffett’s Berkshire Hathaway Inc. disclosed that it made only one new investment during the latest quarter … Teva’s ADRs had collapsed by 65 percent between last August and November, as its best-selling product — Copaxone, a medicine for multiple sclerosis — met with competition from copycat therapies. It doesn’t help that Teva, now a junk-grade issuer, is deep in debt after overpaying for Allergan Plc’s generic-drug business in a $40 billion deal that closed in August 2016. Most analysts aren’t confident that the business will make a substantial recovery this year after Teva’s own management — which has seen much turnover in recent years — gave a disappointing outlook.

Teva’s shares are up over 90% off there 52-week low that was reached shortly after Q3 2017 earnings were. Most of the rebound was due to exuberance over management’s restructuring plan that involved the lay off of 25% of its workforce and potentially $3 billion in cost savings. To be fair, dip buyers have been rewarded over the past decade. Whenever financial markets have faltered they have always miraculously bounced back. Maybe Berkshire expects global central bankers to save Teva and financial markets.

Despite the recent pullback the Dow Jones (DIA) is still up over 35% since President Trump took office. Berkshire’s play is mind-boggling until one adjusts for the melt up in financial markets over the past decade. Nonetheless, I believe Berkshire is barking up the wrong tree for the following reasons:

Teva’s Earnings Fundamentals Will Worsen

Teva’s share price might have bottomed but its earnings have not. I expect the company’s Q1 2018 revenue and earnings will fall – this is a near certainty. Mylan’s (MYL) generic Copaxone was approved in October 2017 and Mylan entered the market within weeks. The speed in which generic Copaxone was launched took Teva bulls unawares. The company quickly moved to match what was then believed to be Mylan’s 30% discounts on the drug.

Teva’s U.S. Copaxone market share fell from around 30% in Q3 2017 to 25% in Q4. Novartis (NVS) recently won FDA approval to offer a generic version of Copaxone 40 mg/mL. Since Mylan was the first generic to market Novartis may need to offer even steeper discounts in order to gain share. That means Teva might have to match steeper discounts or cede share to Mylan or Novartis. The cost of multiple sclerosis (“MS”) treatments had been out of control for years:

Runaway drug costs have vexed consumers and politicians. In particular, the average annual cost for an MS therapy increased from $16,000 to $60,000 from 2004 to 2015 – that equated to a 13% compound annual growth rate (“CAGR”).

Drug makers could cut the costs by over 70% just to bring the price down to 2004 levels. Copaxone has segment profit margins of over 80% and represents about 50% of Teva’s total EBITDA. Free falling prices at out-sized EBITDA margins portend a major hit to Teva’s EBITDA over the next few quarters. I do not expect cost cuts to fully offset the hit to Teva’s EBITDA. We will soon find out though.