California and Vermont have been in the forefront of the drug price debate. They have both attempted to shine a light on drug companies with out-sized increases in drug prices. Teva (TEVA) and Valeant (VRX) are now on California’s radar pursuant to recent price hikes:

Documents obtained by Politico show that Valeant Pharmaceuticals plans a 63% price hike on a generic glaucoma drug, while Teva Pharmaceutical Industries plans a 49% price increase for an inhaled asthma drug at the start of May. While it’s unclear whether the warnings will do much to control overall drug costs, state officials hope pricing disclosures can stir up pressure against big hikes.

Certain pricing information could be disclosed on the the government’s website. This is likely the first step to getting drugmakers to acknowledge such price hikes and explaining the rationale behind them.

The Situation

Certain goods and services like prescription drugs and a college education are inelastic – demand doesn’t necessarily decline amid price hikes. It’s no wonder both are rising at multiples of the rate of inflation. Lawmakers and politicians like Hillary Clinton, Bernie Sanders and President Trump have brought attention to price-gouging by drug makers like Turing Pharmaceuticals and Valeant. California passed a law requiring health insurers to disclose certain costs and forcing them to let the public know about price hikes in advance.

It is difficult to pin drug makers down on how they set prices. One would think they would price in [i] a cost for R&D and marketing and [ii] some mark-up above their “cost of goods sold.” In reality they seem to charge whatever they think they can get away with, regardless of their cost basis. Valeant and Teva are in such dire straits they may be forced to hike prices.

About Valeant

Valeant built its operations via a pharma roll-up strategy – rapidly acquiring other drug companies, cutting R&D and hiking prices. After being called out by lawmakers in 2015 the company vowed to stop price gouging and repair its image. It also put a moratorium on acquisitions and focused on cash flow management. However, developing new drugs was never part of Valeant’s DNA. Without new drug launches its new strategy appeared doomed.

Valeant has announced about $4 billion in asset sales over the past two years, which has helped reduce debt by $6 billion. The company’s credit metrics have not improved but asset sales did spike gyrate the stock higher; VRX is up over 90% versus its Q1 2017 lows. Asset sales appear to have subsided and now double-digit revenue declines await VRX bulls. In January the company hiked prices on certain key drugs by around 9 percent. The price hike for its generic glaucoma drug implies desperation, in my opinion. New drug launches have not been material enough to offset loss of exclusivity (“LOE”) for its pipeline. Sans acquisitions, Valeant practically has to hike prices in order to stem its top line erosion and justify its $30 billion enterprise value.

About Teva

Teva has also been hiving off assets to pare its $32 billion debt load. Things took a turn for the worse when Mylan’s (MYL) generic Copaxone was approved in Q4 2017. The multiple sclerosis drug accounted for 18% of Teva’s revenue and over 40% of EBITDA. Teva’s new CEO Kare Schultz announced the company would close plants and lay off about 10,000 employees; the restructuring efforts were designed to offset the blow to Copaxone. Nonetheless, Teva’s debt has been downgraded to non-investment grade status. Once generic Copaxone fully kicks in during the first half of 2018 I believe more downgrades lie ahead.

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