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Why in the World Does Warren Buffett Like Teva Pharmaceutical?

By Keith Speights - Feb 16, 2018 at 6:04AM

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Some see a beaten-down drugmaker on the ropes. Buffett sees a bargain.

Say it ain't so, Warren.

Warren Buffett's Berkshire Hathaway (BRK.A 0.10%) (BRK.B -0.03%) filed an update of its investment holdings to the U.S. Securities and Exchange Commission (SEC) on Wednesday. There was one new investment this time around -- and it was quite a surprise. Berkshire bought over $357 million worth of Teva Pharmaceutical Industries (TEVA 1.93%) stock.

To put it bluntly, the Israel-based drugmaker is a hot mess right now. So why in the world does Warren Buffett like Teva? 

Warren Buffett

Image source: The Motley Fool.

Even Teva's problems have problems

It's a lot easier to identify why not to like Teva than it is to find reasons to like the stock. Teva lost nearly half of its market cap last year due to multiple factors. 

The company completed an acquisition of Allergan's Actavis Generics business in August 2016. Teva thought the deal would make it more competitive in the global generic-drug market and provide more diversified revenue sources. But there were two big problems with the acquisition of the Allergan unit.

First, Teva's timing was bad. The U.S. generic-drug market tanked in 2017, as prices for generic drugs fell faster than they have in a long time. One factor behind the price free fall: The U.S. Food and Drug Administration (FDA) approved more new generic drugs in 2017 than ever before -- twice as many as were approved in 2014.

The second problem with Teva's deal with Allergan was the cost of the transaction. Teva paid Allergan $33.43 billion in cash plus 100 million Teva shares. The issuance of new shares to give to Allergan diluted the value of existing Teva shares. However, the more serious issue was the added debt Teva took on to fund the acquisition.

One of the things that investors liked most about Teva was its high dividend yield. But when the increased debt from the Allergan deal combined with falling revenue, the company couldn't afford to keep paying out the dividend at the attractive levels of the past. Teva ultimately had to slash its dividend by 75%.

As if those problems weren't enough, Teva also lost patent exclusivity for its top-selling product, Copaxone. Sales for the multiple sclerosis drug fell 19% in 2017 from the previous year. With a generic version now on the market, Teva faces the prospect of further revenue declines in 2018. 

What Buffett probably likes

Warren Buffett, at heart, is a value investor. He likes bargains. Despite all of the dark clouds hanging over Teva, Buffett probably views the drugmaker as a pretty good deal at its beaten-down price.

Even after Teva's big jump following news that Berkshire Hathaway had bought a big stake in the company, the stock still only trades at a little over seven times expected earnings. If Teva can turn things around, there should be plenty of profits to be made by investing in the stock now.

But can the beleaguered drugmaker actually turn things around? Warren Buffett has a history of putting his faith and confidence in strong leaders of companies. Teva seems to have such a leader in new CEO Kare Schultz, who did a pretty good job righting the ship at Lundbeck. Schultz has already implemented a restructuring plan at Teva to help cut is debt.

Buffett also thinks long term. He knows that prices for generic drugs are likely to bounce back eventually, which would help Teva tremendously. And as an octogenarian himself, Buffett also realizes that there are increasingly more older Americans who will drive demand higher for generic drugs.

I suspect that Buffett listened to Teva's management about the prospects for the company's new products and others potentially on the way. During Teva's fourth-quarter conference call, executives pointed out three drugs that they hope will help Teva in its turnaround -- Austedo, which was approved in 2017 for treating tardive dyskinesia and Huntington's disease, migraine drug fremanezumab, which awaits FDA approval, and late-stage pain drug fasinumab.

Follow the leader?

It's hard to make a compelling argument that Warren Buffett doesn't know what he's doing. He's one of the greatest investors of all time. His nickname, the "Oracle of Omaha," is well deserved. So should other investors follow the leader and buy Teva stock? That's a different story altogether.

Teva has a long way to go before it can be viewed as a healthy company with a healthy stock. It could very well be a good long-term investment, but I think there are plenty of other choices that are just as good without the hurdles that Teva must jump to be successful again.

One of those other good long-term investment choices is Buffett's own Berkshire Hathaway. If you want an opportunity to profit from a potential turnaround for Teva, buying Berkshire could be the better way to go.

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Stocks Mentioned

Teva Pharmaceutical Industries Limited Stock Quote
Teva Pharmaceutical Industries Limited
TEVA
$8.47 (1.93%) $0.16
Berkshire Hathaway Inc. Stock Quote
Berkshire Hathaway Inc.
BRK.A
$456,500.00 (0.10%) $468.99
Berkshire Hathaway Inc. Stock Quote
Berkshire Hathaway Inc.
BRK.B
$304.05 (-0.03%) $0.10

*Average returns of all recommendations since inception. Cost basis and return based on previous market day close.

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