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Ivax deal kick-starts Teva's growth
Teva's agreement to acquire Ivax makes it the top generic drug maker again just as the sector is set for improving profits.
By Robert Walberg
Generic drugs might come cheap, but generic drug makers do not.
Teva Pharmaceuticals (TEVA, news, msgs) announced Monday that it'll pay about $7.4 billion to acquire rival Ivax (IVX, news, msgs). The purchase price equates to about 22.5 times Ivax's annualized earnings before interest, taxes, deprecation and amortization of $330 million. According to Buckingham Research, Teva is paying well over the average generic acquisition price of about 13 to 14 times EBITDA. So what does Teva get for all that money?
For one thing it gets to reclaim its status as the No. 1 generic drug company, a position it relinquished to Novartis (NVS, news, msgs) last year when that company spent over $8 billion acquiring generic drug makers Hexal AG and Eon Labs.
However, this isn't just about the bragging rights of being No. 1. Teva will also end up with the broadest, deepest pipeline in the generic industry, with more than 300 generic drugs. By expanding its scale, Teva improves its negotiating leverage with drug wholesalers and drugstore chains, a key advantage in the increasingly competitive generic drug industry.
In Ivax, Teva also gets a partner with a similar mindset. Both companies have been working at building their branded drug pipelines. In fact, Teva's multiple sclerosis drug Copaxone generated sales of over $930 million last year, making it a virtual blockbuster, a rarity for generic drug companies. With drug candidates in development for the treatment of Alzheimer's and Parkinson's, among others, Teva was well positioned to grow this part of its business even before Monday's announcement.
A brighter picture
Now toss in Ivax's proprietary drugs, which accounted for a sizeable portion of the company's total revenues, and the picture looks even brighter. Most of Ivax's branded products deal with the treatment of asthma, though the company is also working on a oral therapy for multiple sclerosis with Teva rival Serano (SRA, news, msgs), as well as an oral therapy of the cancer drug Taxol, both of which could be considerable revenue producers.
The advantage of building a branded portfolio is obvious. Although the research and development and marketing costs are significant, profit margins on proprietary drugs are much higher than for generics. Management noted that after the deal, branded products would account for about 17% of the Teva's total revenues, up from 11%.
But while their branded portfolios make Teva and Ivax a natural fit, this deal is more about gaining scale in the generic drug industry, a strategy that's essential given the changing nature of the industry. In fact, the recent wave of consolidation in the generic drug sector is a direct result of the lower price structure and declining margins brought on by heightened competition from the big pharmaceutical companies.
Tired of losing profits to generics as drugs lost patent protection, Big Pharma companies have turned to "authorized" generics, or in-house generics. The way authorized generics work is that when a branded pharmaceutical company is about to lose patent protection of a key drug it'll license distribution of the drug to one or more generics, thereby maintaining some of the royalties. Or they can simply release their own generic version. Either approach cuts into the initial profitability traditionally received by the first generic company to get licensing rights to the original drug.
Better profits on the way
The trend of declining margins and slower profit growth is one reason generic drug makers struggled to keep pace with the market last year. But with consolidation altering the competitive landscape, and with the change in the Medicare drug benefit beginning in 2006, the profit picture for the industry is starting to improve. And with the Ivax deal the profit outlook for Teva is definitely going to improve. (The deal is expected to close late this year or early next.)
Investors should note that Teva's profit growth had been slowing and that the company recently issued a profit warning. While Monday's deal won't alter the short-term picture, it does put Teva in better position to reach its long-term goal of strong double-digit sales and earnings growth. Teva is currently projected to earn $1.57 per share this year and $1.87 per share in 2006. Look for the consensus estimates to move slightly higher in light of the Ivax acquisition. Management expects synergies alone to save the combined company close to $150 million next year.
Not all the news is good, however. Shortly after the deal was announced, Standard & Poor's announced that it might cut Teva's BBB corporate credit rating, a move that would raise the company's borrowing costs. Whether a downgrade occurs is tough to say at this point, though in Teva's defense is its strong track record of successfully integrating acquired operations and its sterling record of repaying debt. Nevertheless, the threat of a downgrade could weigh on the stock initially.
That said, the decision to pay up for Ivax wasn't made with the intent of bolstering near-term performance but with an eye on future growth. With the industry projected to nearly double over the next five years, having the broadest portfolio of generics by far and a growing pipeline of proprietary drugs puts Teva in position to continue dominating the generic industry for the foreseeable future. And that's very good news for shareholders.
Portfolio changes
As it so happens, both Teva and Ivax were part of my portfolio holdings. In light of Monday's news, I'll sell Ivax at the day's close and hold on to Teva for the long term. I will also continue to hold Barr Pharmaceuticals (BRL, news, msgs) because the trend toward consolidation and solid earnings prospects should enable the company to outperform the broad market.
At the time of publication, Robert Walberg neither owned nor controlled shares in any equities mentioned in this column.
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