Could Teva Merge With Mylan or Valeant?

Teva Pharmaceutical (TEVA 0.69%), a major manufacturer of generic and specialty pharmaceuticals, has seen better days.

The stock has gone nowhere over the past 12 months, its top-selling multiple sclerosis treatment is in serious peril, it plans to slash 5,000 jobs to cut costs, and CEO Jeremy Levin stepped down after only 18 months on the job after a dispute with the board of directors.

All of these problems have led to speculation that Teva might eventually merge with either Mylan (MYL) or Valeant Pharmaceuticals (BHC -0.92%) to stay afloat, according to a recent Bloomberg article. Let's take a deeper look at the facts and figures behind Teva to see if such a deal is possible.

Is Teva ripe for a takeover?
First and foremost, we should take a look at how Teva measures up fundamentally to its comparable peers, Actavis (AGN) and Mylan.

Source: Yahoo! Finance as of Nov. 27. TTM = trailing 12 months. MRQ = most recent quarter.

Although Teva is larger than Actavis or Mylan, it is the cheapest based on P/E, P/S, and P/B valuations. Teva also has much more cash and much lower debt than its peers. In addition, based on its P/S ratio, the stock is actually at its cheapest point in over a decade.

Uneven growth in generic pharmaceuticals
However, Teva's trailing valuations tell only half the story. To get a better idea of where Teva stands, we should take a closer look at its two primary businesses -- generic and specialty pharmaceuticals.

Teva's generics business, which accounts for 56% of its revenue, has posted unimpressive growth. Last quarter, generic sales rose in the U.S. but slid across the rest of the world.

Source: Company earnings reports.

By comparison, Actavis' revenue growth is skewed by its $5.8 billion acquisition of Actavis Group, which turned Actavis into a major threat in generic pharmaceuticals.

Teva's U.S. generics business is the company's bright spot, fueled by fresh demand for new generic products, such as generic Niaspan ER (cholesterol) and Temodar (brain cancer), and boosted by strong sales of generic Adderall (ADHD) and TriCor (cholesterol).

In addition, a U.S. court recently upheld a prior decision that AstraZeneca's patent for Pulmicort Respules was invalid -- granting Teva three to 12 more months of generic exclusivity.

Flat growth in specialty pharmaceuticals
Teva's specialty business, however, is what most investors are worried about.

Source: Company earnings reports

Although Actavis' presence in specialty pharmaceuticals appears small, the company recently acquired Warner Chilcott for $8.5 billion. That acquisition makes Actavis the third largest specialty pharmaceuticals company in America, and strategically reduces its corporate tax rate by relocating its operations to Ireland.

By comparison, Teva's growth in specialty pharmaceuticals appears to have peaked, and one drug -- the MS treatment Copaxone, which accounts for half of the specialty segment's revenue -- is the biggest problem of them all.

The Copaxone conundrum
Sales of Copaxone inched up 1% last quarter to $1.05 billion, accounting for 21% of Teva's total revenue. Copaxone faces two major problems -- generic competition and a superior competitor.

In May, a U.S. court ruling invalidated Teva's key patent on Copaxone, which opened the door to generic competitors like Mylan and Momenta Pharmaceuticals, which is developing a generic version with Novartis' Sandoz.

To make matters worse, Biogen Idec's (BIIB -1.53%) new drug Tecfidera, the third approved orally administered MS treatment, is widely considered to be a disruptive threat to Copaxone, which is injected. Tecfidera also has a better safety profile than previous oral MS drugs like Novartis' Gilenya and Sanofi's Aubagio -- a fact that analysts believe will propel the drug to annual peak sales of $3.3 billion by 2017.

Last week, a leaked report acquired by the Israeli financial publication The Marker claimed that Teva was expecting a 42% reduction to its bottom line next year due to the Copaxone conundrum. However, Teva quickly denied that alarming figure, claiming that the article was based on an outdated presentation and did not accurately reflect the company's growth forecasts.

Is Teva an attractive target for a merger?
Therefore, Teva is fundamentally cheap, but its generic and specialty businesses simply aren't that attractive. Yet there is still a chance that Mylan and Valeant could step up.

Since it's becoming clear that Actavis is evolving into an 800-pound gorilla in both generic and specialty pharmaceuticals, a merger between Teva and Mylan could benefit both companies with cost-saving synergies. A combined Teva and Mylan could go toe-to-toe against Actavis, and also decrease Copaxone's relevance to the combined company's top line growth. In addition, Mylan needs better sales growth -- its revenue declined 2% year-over-year last quarter, so seeking inorganic growth could be a sound idea. Moreover, Teva recently settled patent litigation over Copaxone with Mylan in the U.K., France, and the Netherlands -- indicating that there could be opportunities for the companies to cooperate in the future. 

Valeant is a company that has been repeatedly using acquisitions to fuel its top line growth, making an average of 25 deals per year. Its $8.7 billion acquisition of eye care company Bausch & Lomb earlier this year boosted its revenue by 74% last quarter, helping it compete with Novartis' Alcon unit and Johnson & Johnson's Acuvue business.

Merging with Teva, which generated $20.3 billion in revenue last year, would substantially boost Valeant's top line and offset bottom line losses caused by generic competition of products such as Zovirax, BenzaClin, and Retin-A Micro.

The Foolish takeaway
Teva faces some major headwinds going into next year -- it lacks a permanent leader as the company faces a crucial crossroads.

In my opinion, Teva desperately needs to merge with another company to reduce costs and the significance of Copaxone, which is about to take a bite out of the company's top line. If Teva decides to go at it alone, then its shareholders could have a lot to lose over the next few quarters.