At a hastily-arranged conference call a couple of weeks ago, the new CEO of Teva, Jeremy Levin, announced a downgrade of Teva’s forecast earnings for 2012 and talked a little about the business review that he is conducting and about his search for Teva’s soul (not found quite yet, it seems). At the top line, Teva now expects sales to be $1.5bn lower in 2012 than it was previously forecasting, at $20-21bn. Within this, European sales are expected to be $5.8bn, which is a full $1bn, or 15%, lower than expectations at the start of the year. According to Teva, around $600m of the reduction is accounted for by forex movements, but the remainder is a reflection of the tough time that Teva is having in many of its European markets. In response to a question, Rob Koremans, Teva’s new European head, said that while Teva’s OTC and branded businesses were doing well in Europe, it was the retail generic operation that was feeling the strain. He stated that Teva will have retail sales of some $1.9bn in Europe this year, which means that sales expectations in that part of the business (stripping out the forex effect) have fallen by around 17%. This is a massive downgrade, but Teva attributes almost half of it to destocking at wholesalers, with the remainder coming from reduced market growth expectations (4-6% at the start of the year, zero now). Our assumption is that the main problems are in Germany (where the market continues to shrink and where Teva is now the number two player thanks to ratiopharm) and in Hungary (where Teva has wholesaling as well as being the market leader in retail and where there have been swingeing price cuts this year). France, where Teva is the number three, has also been a particularly tough market recently, with little sign of short-term improvement. Destocking should be a one-off, but prices are continuing to fall and with relatively few major patent expiries in the next couple of years. It is hard to see Europe growing more than low single digits at best.
Although it will be some months before Jeremy Levin announces Teva’s new strategic direction, some elements of his plan can be clearly seen in the remarks that he made on the conference call and at the Sanford Bernstein Strategic Decisions conference later the same week. Firstly, as befits someone with a big pharma background, he intends to take a much more focused approach to R&D, with the emphasis put on developing a portfolio of products in specific therapeutic areas (to paraphrase: ‘a single product isn’t a franchise; it’s a patent cliff waiting to happen’). Non-core projects will either be partnered or – presumably – dropped. He didn’t say this, but we assume that he will also try to ensure that the surviving programmes are properly funded. Teva has historically spread itself fairly thin on the branded development side, taking a very parsimonious approach to funding clinical trials. Under the new regime, we would expect more funding to be channelled to fewer projects, probably in the oncology and CNS areas. By the sound of it, Dr Levin will also try centralise generics development a bit more. He commented that he had discovered ‘portions of a set of platforms’ in various Teva locations, with the implication being that these could benefit the company a lot more if they were brought more closely together. Any gaps in R&D will be filled by in-licensing or co-development, while Teva will also look at striking marketing deals that leverage its sales assets outside the US, in therapeutic areas where it would be too expensive to create a US sales force.
Manufacturing is another priority area. Teva has 74 plants spread across the world, which Dr Levin characterised as having ‘built-in redundancy’, partly for security reasons (if one plant has problems, another can step in) and partly due to the need for the aggressive stock-building implicit in a US strategy based around launches of products with exclusivity. As the number of exclusive Para IV opportunities declines, the latter function becomes less relevant and we would therefore expect to see Teva’s manufacturing footprint shrink and possibly also move eastwards. Dr Levin noted that Teva had an impressively broad geographic reach but with one major gap in its coverage, which is obviously Asia. Insofar as Teva makes acquisitions aimed at expanding its reach, therefore, we would see this region as a prime target.
Teva’s Board is clearly not happy with the company’s recent performance in the US and the fact that Dr Levin has shunted Alan Oberman, who at one time ran Teva’s Canadian operation, back from EMEA to take charge of the US, is evidence of this. Alan will report to Bill Marth, who remains in charge of the North American region overall, but it’s hard to interpret Alan’s appointment as entirely supportive of Bill’s handling of the situation. To a certain extent, Teva has been unlucky, insofar as it had a massive bolus of 180-day exclusivities in 2010, which fell away in 2011 and couldn’t be replaced. However, it has also contributed to its own problems by failing to get its generic version of Lovenox past the FDA when both Sandoz and Watson were able to do so and by concentrating very much on mainstream generics (albeit with the potential for exclusivity) rather than the niche products with better margins and a longer lifecycle that have become a mainstay for Mylan and Watson. As a first step, apart from appointing Alan, Teva has struck a new deal with its wholesalers to prevent them from over-stocking its products. The aim of this is to make sure that any price increases are immediately felt by the company and not simply soaked up in the distribution chain, but also to tie supply much more closely to demand, something that will feed back into the slimmed-down manufacturing. Dr Levin emphasised that it was a mistake to look at the US one product at a time (a legacy of Para IV thinking), since it is the reliable provision of a broad range of high-quality products that is key to Teva’s relationship with its big customers. This may be true, but the more fundamental question is whether he is happy to accept low growth and declining margins in the US retail generics business, which is likely to be the consequence of a mainly volume-based approach. If not, then Teva is going to have to work a bit harder on some of its more value-added franchise areas, such as respiratory drugs.
To summarise, the obvious parts of Dr Levin’s strategy are a slimmed-down and focused R&D effort (probably with less distinction between brands and generics), a smaller manufacturing footprint and a bigger emphasis on exploiting Teva’s global(ish) presence to distribute more products, be they generic, innovative or OTC. The less obvious ones concern the overall balance between generics and brands, what he will do to mitigate the impact of Teva’s own patent cliff (which has, if anything, been compounded by the Cephalon acquisition) and of the economic woes in Europe, and how exactly (apart from the items already mentioned) he will create the ‘differentiated’ strategy that will allow Teva to return to a growth track.
On the generics vs brands argument, Dr Levin appears to consider this to be a false distinction. To quote him: “a medicine is a medicine and the question is, how do you get it into the marketplace…”. This is also the view of big pharma companies buying emerging market generic assets, but in our view, it is both wrong and dangerous. In markets where generics are brands, there may not appear to be any meaningful difference between a generic and an innovative product, but it takes very little to shift to a purchasing model that forces identical products to compete on price. Hungary, where Teva (as mentioned previously) is the generic market leader, is an excellent example of this. And Russia, where Teva has a large and rapidly-expanding presence, could easily turn out to be another one. Therefore, instead of celebrating generics that are brands, Teva should – in our view – be worrying a bit more about brands that could turn out to be generics. From this perspective, using Teva’s global network to sell innovative drugs sounds like an excellent idea and one that should also be at the heart of any acquisitions that the company makes to expand its presence into Asia. Differentiation also needs to be the core focus in Europe. While it is undeniable that generic penetration is low in many European countries, implying the potential for volume growth, the reality is that most of the biggest markets already have high generic use and those that don’t – Spain and Italy – are seeing higher volumes largely offset by lower prices. The long-awaited volume boom in European generics is a mirage, in our view, and Teva should assume that things will continue to get worse and plan its future portfolio accordingly.
As for the patent cliff, there isn’t that much to be done. Copaxone will probably sustain a lot longer than many people think, provided that no generics that are actually substitutable are approved in the US (if they are, then it is clearly doomed, as the vast majority of Copaxone’s profits, if not its sales, come from the US market), but products such as Provigil are certainly on their way out. What Dr Levin doesn’t seem likely to do is pay large sums of money for existing, on-market products (or for whole companies, for that matter) to make up the difference, although he might try to mitigate the damage (and simultaneously shift Teva’s geographic balance further away from the US) by co-marketing products outside North America. Other than that, it will be down to the pipeline to deliver replacement products, which is presumably why Teva has just hired a high calibre new head of R&D.
For the sake of Teva’s stock price and shareholders, the differentiated growth strategy is the most important piece of the jigsaw. Under the previous regime, growth projections were high but lacked credibility as they were based on as-yet unknown future acquisitions. An organic growth strategy will clearly have to be rooted in Teva’s own pipeline (albeit probably beefed up with some additional in-licensed products) and will thus require Teva to be much more open about what it is developing and when it can expect its new products to launch. Greater transparency has already been promised by Dr Levin and our guess is that he will dump some pipeline products, accelerate the development of others and try to fill in Teva’s biggest geographic gaps so that he can sell globally. ‘Supergenerics’ are also likely to play a prominent part: Teva is already developing both biosimilars and respiratory drugs and is likely to do more to come up with differentiated generics that can be developed relatively cheaply but have some protection against substitution. Dr Levin frequently praised Teva’s local country managers around the world and we suspect that they will be leading the charge, something that really would make a refreshing change.
In our view, the big picture is simple: the industry that Teva was largely responsible for creating has changed, but Teva itself has failed to change with it. Dr Levin’s job now is to identify where a company with Teva’s strengths should be heading next and to make sure that it gets there. Our own belief is that it should be out of the US and away from substitutable products. By the end of the year, we’ll find out whether he agrees.