In the short term, this deal can hardly fail, as Cephalon’s strong cash flow and very high profitability will mean that it is earnings accretive from day one. Consolidating it will take Teva’s branded revenues to around $7bn ($2.8bn from Cephalon and the remainder from Teva) and make it a leading global specialty pharma company as well as the biggest generics company in the world. Teva also believes that it can achieve $500m of cost savings by the end of the third year, mostly coming from overlapping G&A costs but also from rationalising R&D and manufacturing. Historically, Teva has been very good at stripping out duplicated costs, so we consider this figure realistic, if not conservative, particularly as quite a lot of the savings will come from the Teva side of the combined operation.
The question marks, if any, hang over the longer term outlook. Teva’s management said repeatedly on the analysts’ call that this was a ‘game-changing’ deal and it appears to be in awe of the 30-plus products that the combined entity will have in late-stage development. However, quality counts for more than quantity and we are a bit sceptical about what Cephalon brings to this particular party. Cephalon had more money than it knew what to do with and an on-market portfolio that was approaching a patent cliff, so it had little to lose by buying up research compounds (as well as whole companies) and investing in them heavily in the hope of coming up with something that could replace its existing blockbusters. Teva, meanwhile, is also very cash-generative, but has been reluctant to spend too much of that cash on innovative R&D, forcing its branded business to take a cautious approach on clinical trials. As a result, Teva spends some 10% of its branded sales on innovative R&D annually, while Cephalon spends 25%.
We suspect that part of the synergy-generation exercise will be a consolidation of much of Teva’s branded R&D effort into Cephalon, in recognition of the latter’s strong track record of bringing products to market. But the cash coming out of the branded division will not necessarily be entirely available to be ploughed back into it, as it will be used to pay down debt and support whatever acquisitions Teva does next. This could make for some interesting discussions as the late-stage pipeline makes its way through what is also the most expensive phase of its development and we hope that Teva’s management is able to remove its rose-tinted spectacles and take an axe to the more dubious development compounds, enabling it to focus on the rather smaller number of drug candidates that actually have a viable commercial future.
Posted on 3rd May 2011