The Tale of 2 Generic-Drug Makers

Teva Pharmaceutical (Nasdaq: TEVA) and Mylan (Nasdaq: MYL), two of the largest generic-drug makers, released solid earnings this week. But how they got there couldn't be more different.

Source: Company releases.
*Generic drugs only.

It's all about new U.S. products ...
Under U.S. generic-drug rules, the first generic-drug maker to challenge a patent on a brand-name drug gets a six-month exclusivity period. Without any other generic competition, the exclusivity holder can price its drug at close to the price of the brand-name drug, reaping major profits.

New generic-drug launches are fairly erratic, which can cause wild swings in revenues and profits. Teva's generic-drug sales were down 40% in the U.S. because the year-ago quarter benefited from the launch of quite a few generic drugs: Merck's (NYSE: MRK) Cozaar and Hyzaar, Bayer's Yaz, Sanofi's Eloxatin, Pfizer's (NYSE: PFE) Protonix, and others. Once those generic drugs cycle through their initial launch, sales usually slump off fairly rapidly. Without any substantial new product launches to counteract the lost sales, Teva was bound for a downturn.

Mylan, on the other hand, was on the upswing. Launches of generic versions of AstraZeneca's (Nasdaq: AZN) Entocort EC, Novartis'(NYSE: NVS) Femara, and Cephalon's (Nasdaq: CEPH) Amrix in the U.S. added to the substantial uptick in U.S. sales.

... and new companies in Europe
In the past year, Teva acquired ratiopharm, which accounted for most of that 82% increase in European sales. Extrinsic growth has become an important part of Teva's strategy, although organic generic-drug sales in Europe were up a solid 10%.

The cost of doing business
The somewhat convoluted Hatch-Waxman law allows generic-drug makers to gain approval and launch their copycat drug 30 months after making an application with the FDA. But if they launch before a court has decided on the validity of patents remaining on the drug, the generic-drug makers could be on the hook for damages.

Teva made at-risk launches of both Novartis' Lotrel and Pfizer's Neurontin. Rather than let a court decide its fate, Teva settled the suits and took legal charges of $221 million this quarter. The company would like you to ignore them as one-time charges and back them out of the GAAP earnings. But just like the ebbs and flows from new launches, legal charges for at-risk launches are just part of doing business as a generic-drug maker. Amortizing the charges over multiple quarters would be more appropriate than ignoring them.

Better buy?
I'm partial to the bigger-is-better strategy for generic-drug makers. If you're going to invest in a low-margin business, you might as well try to make up for some of that with larger volume. Plus the economies of scale can help push margins higher.

By that measure, Teva is the winner, with revenue more than 2.5 times that of Mylan. But that includes sales of branded drugs like Teva's multiple-sclerosis drug Copaxone, which is itself under attack from potential generic competition.

Until the Copaxone lawsuit works itself out -- or wouldn't it be ironic if there were an at-risk launch? -- Teva is a little risky. Copaxone is a nearly $4 billion drug that made up 23% of Teva's sales in the most recent quarter, and, we can assume, an even larger percentage of its earnings.

Mylan needs to continue growing to justify its higher P/E, but that doesn't seem too hard, since generic drugs will satisfy the nation's growing desire for lower health-care costs.

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