Once a darling of the health care space (and a frequent member of "buy and hold forever" lists), Teva Pharmaceuticals (NYSE:TEVA) spent about three and a half years in the market's doghouse. Investors bailed out due to worries about competition in the company's lucrative MS franchise, the perception of a dwindling pipeline for major generics, and turmoil in executive leadership. Now it looks as though the company has shored up its MS franchise, rejuvenated its R&D efforts, and become more serious about driving better value in/from the business.
A new formulation is extending the value of Copaxone
Teva's Copaxone has been a significant value driver for some time, as this multibillion-dollar MS drug still generates around 20% of the company's revenue. The value of this MS franchise has been tarnished, at least in the eyes of Wall Street, by Teva's inability to develop a compelling next-gen oral MS drug to compete with Biogen Idec's Tecfidera and the threat on oncoming competition.
Generic rivals for Copaxone are a potential threat, as Mylan (NASDAQ:MYL), Momenta, and Synthon are among those hoping to launch relatively soon. Teva has argued that Copaxone is a complex drug and that doctors and patients should not trust that generics are truly equivalent (suggesting a different activated immune profile), but Synthon has now presented data from its Phase III GATE study showing that at least its generic version is equivalent in terms of efficacy and safety. This study was done for the purposes of EU approval, and it is unclear how the FDA will respond, but it does at least suggest that generic versions of Copaxone could be valid alternatives.
Teva has already been taking steps to preserve its Copaxone franchise. The company's "Shared Solutions Support" program has proven to be a strong factor in patient retention. More significantly, the company has launched a 3x/week Copaxone formulation that has been quickly gaining share. Teva management believes that it could convert 50% of Copaxone users to this new formulation, and that could significantly extend the value of the franchise, particularly as doctors and patients are often reluctant to switch medications that appear to be working.
Rebuilding momentum in generics
At about half of the company's revenue, generics are still a key business for Teva, and the company enjoys roughly 15% to 20% share of the U.S. market – putting it well ahead of Mylan and Actavis which are each around 10% of the market. Although anlaysts have fretted that the pipeline of major branded drugs going off-patent has meaningfully narrowed, Teva has been building up its capabilities and targeting new opportunities that could add billions to its long-term revenue.
Teva has been bulking up its respiratory franchise, developing the DuoResp inhaler and looking to make over a dozen regulatory submissions over the next five years, including a generic form of the $5 billion drug Advair. Respiratory drugs are more difficult than average and require specialized delivery systems, so this could be a significant revenue driver with comparatively less competition.
Teva is also looking at New Therapeutic Entities (NTEs) as a major opportunity. NTEs are drugs where a previously known/approved compound is reformulated and/or administered in a new way. While the sales potential on an individual drug is modest (Teva estimates an average peak of $250 million each), the development risk is lower. Teva has at least 50 NTEs planned, with as many as 30 potentially reaching the market before 2020.
Self-improvement and M&A could build value
Teva has joined in with its larger pharma peers and embraced cost-cutting and restructuring as a necessary means of offsetting flagging revenue momentum. Management has identified and targeted up to $2 billion in savings by the end of 2017, though about three-quarters of that will be reinvested in areas like R&D. Given that Teva's new CEO Eroz Vigodman led a turnaround at a large Israeli generic agrochemical company, the odds of success here should be above average.
Teva is also apparently embracing the potential for transformative M&A. With its strong existing presence in CNS and respiratory, Teva could be a consolidator in either of those spaces.
A target like Receptos (UNKNOWN:RCPT.DL) could improve the company's MS franchise. Receptos is developing RPC1063, an S1P1 modulator similar to Novartis's oral MS drug Gilenya. It is still early in development, but '1063 appears to have a much better tolerability and safety profile, while showing efficacy faster than Gilenya. Other companies (including Novartis, Actelion, and Ono Pharmaceuticals) have S1P1 modulators in development, but the Receptos drug could still capture enough share from patients who haven't responded well to other drugs to generate a $1 billion in revenue, and the sales synergies with Teva's existing platform could lead to meaningful profits.
Receptos could make sense, but Teva but management may want a larger target. Teva could likely spend as much as $10 billion on a deal and at recent multiples for deals that could bring as much as $2 billion in incremental revenue.
The bottom line
Without a large deal or a major pipeline development, Teva will probably find it challenging to grow revenue at a long-term rate much above the low single digits. Closer attention to costs, more cost-effective product development (like NTEs), and leveraging past R&D investments into new products (like the money spent in developing its respiratory technologies) should allow FCF margins to move back into the high teens and then the low 20%'s, but it's challenging to find much value into the $50's.
Teva is making a lot of moves that the Street has long wanted, and the shares are reaping the rewards. Should the company reach for its checkbook and execute a meaningful deal that promises substantial revenue and/or margin synergies, the market would likely respond quite favorably. Even better adoption of 3x/week Copaxone would offer some upside, but investors considering Teva today shouldn't expect the stock to continue the incredible momentum of the past few months.