The generic/specialty pharma M&A frenzy appears to have reached its apogee in recent days, with Mylan making an unsolicited bid for the OTC specialist, Perrigo and Teva subsequently bidding for Mylan – conditional on the Perrigo bid being dropped. Share prices have risen all round, so these are happy days for investors, but it is hard to see how there can be a positive outcome for everyone. Nor whether the longer-term winners will be the companies that make successful bids or those that don’t. When transactions are being done mainly out of fear that the bidder could become the next target if it doesn’t stay one step ahead, the inevitable result is not just lots of deals, but lots of bad deals.
Mylan’s outraged response to Teva’s bid, while being hilarious to read, leaves little scope for the two companies every to come to an amicable settlement. It was never likely that Robert Coury would roll over without a fight, but he has chosen to leave himself no room at all for retreat, having poured scorn on Teva’s management team, Board, operations, strategy and stock quality, comparing Teva unfavourably to Mylan on all points. While his claim that Mylan is worth 20-25x EBITDA should be treated with extreme scepticism, it is impossible to disagree with all his reasons for rejecting a combination of Mylan and Teva. He is right that the two companies are almost totally overlapping geographically and that they make a lot of the same products, even if Mylan has some pipeline candidates – particularly its biosimilars – that would be very useful for Teva. Equally, it is inevitable that there will be a lot of regulatory scrutiny followed by significant forced disposals, not only in the US but also in France, the UK, Italy and possibly even Germany. Not to mention Japan, where both companies have significant operations. In the US, where a Teva/Mylan combo will have a very large market share, there may well be complaints from suppliers and/or customers, as well as the simple risk that clients will deliberately choose to put business elsewhere in order to reduce their exposure to a single company. Indeed, as Mylan points out, Teva has not really even tried to make a case for the combined company offering better things to patients, payers or employees. Teva’s argument is that similarities between the two entities will allow a lot of costs to be cut, which is true, but while this is certainly good for Teva’s management and shareholders, it is not clear that it is particularly positive for any other stakeholders. Of course, exactly the same could be said for Mylan’s historic deals (not to mention its pending one with Perrigo), but the scale here is rather larger.
The issue of a clash of cultures is an interesting one. Even before Teva made its bid public, Mylan had claimed that there was no ‘cultural fit’ between the two businesses. In his letter outlining the reasons why the Mylan Board was rejecting Teva’s offer, Mr Coury went further, saying that he hoped that Erez Vigodman, Teva’s CEO would ‘find a way to eventually change Teva’s culture and establish credibility in your business dealings’. As this remark followed straight after a paragraph complaining that Teva had not had the decency to inform Mylan in advance of its intention to make an offer, which Mr Coury claimed showed that ‘the old Teva is very much alive’, the strong implication is that Mylan believes Teva’s culture to be one of fundamental untrustworthiness and non-ethical behaviour. If so, this is quite a serious accusation. Later in his letter, Mr Coury contrasts Mylan’s ‘clear strategic plan’ with Teva’s ‘dysfunctional’ culture [with ‘dysfunctional’ in quotation marks, as Mylan is quoting from the remarks of an external commentator]. He concludes by stating that the ‘challenged’ culture at Teva is ‘a direct result of a Board of Directors that refuses to change, lacks adequate global pharmaceutical experience and consistently meddles in company operations’. Ouch!
In our view, Teva’s Board certainly isn’t its strongest asset, being (as Mylan says) rather short on pharma experience and (we would add) on non-Israelis. That said, there isn’t actually the massive cultural gap between Mylan and Teva that the former claims. Not below the C suite, at any rate. The two companies look different on the surface because Mylan is a form of dictatorship where all the bad news gets suppressed, while Teva has unfortunately been washing rather a lot of dirty linen in public. But at the level of individual business units, there is plenty of employee movement between the two. To make a geopolitical analogy, Mylan is China while Teva is Hong Kong – both very successful at doing business and both using the exact same type of people to achieve that success, but organised in fundamentally different ways. In our opinion, Teva is – or has been – a lot more entrepreneurial at the local level than Mylan, which explains why it has done much better in markets like the UK. But Mylan’s greater top-down discipline, while handicapping it in some locations, has produced a better result overall in terms of earnings growth in recent years.
Where Mylan really has scored over Teva is in not allowing itself (or having the chance, depending on how you look at it) to become dependent on a single product, or even a small number of products. Mylan chose years ago to focus on launching very large numbers of new products, some with technical challenges and many that have quite small sales, rather than relying on blockbuster 180-day exclusivities that inevitably create a ‘boom and bust’ effect on the P&L. This is not to say that Mylan doesn’t have a strong ANDA pipeline, with multiple FTFs, because it does; another reason why Teva wants to buy it. But the absence of many branded products outside the successful Epipen franchise has forced Mylan to focus hard on the profitability of its basic generics operation, whereas the very high margins generated by Copaxone allowed Teva to pursue a volume-based generic strategy that it is now struggling to reverse. And while Mylan’s claim that Teva has suffered from ‘flip-flopping’ strategy is exaggerated, it is not entirely untrue, as Teva has found it difficult to decide whether it should stick to generics or follow Actavis and move more decisively into branded drugs. We have always believed that Teva should mostly focus on generics, but buying Mylan wouldn’t stop it also pursuing branded opportunities later on, as its cash flow would be much improved.
All of which is not to say that we think that buying Mylan is actually a good idea for Teva: we don’t. It’s a handy quick fix for Teva’s currently dull EPS outlook thanks to the synergy benefits, but it doesn’t really take Teva anywhere much in terms of its overall development: a non-US deal would have been a lot better. Also, it is going to be a very time-consuming battle if Mylan’s Board really digs in, as all the indications are that it will. Robert Coury has already said that he would only consider a bid well in excess of $100/share, which anyone other than him knows perfectly well is so far above Mylan’s true value at present that no bidder is going to offer it. Consequently, Mylan’s Board is never going to negotiate, so Teva may have to go the slow route of trying to get its nominees on the Board, which could take years unless Mylan’s shareholders can be persuaded to ignore its management and take Teva’s cash and paper. Satisfying as it would be for Teva’s management to oust Mr Coury, particularly after all his rude remarks about them, a long drawn-out takeover battle probably isn’t really what Teva needs just now.
In contrast to the bombast of Mylan’s missive to Teva, Perrigo’s reply to Mylan was a lot politer and centred entirely on value. In our view, a Mylan/Perrigo tie-up doesn’t have a huge amount of logic other than that it takes Mylan into OTC medicines, which is an area where it is currently weak, but perhaps that is sufficient, particularly since this appears to be essentially a defensive move designed to make Mylan too big to be swallowed by Teva. There certainly wouldn’t be the regulatory headaches of a Teva/Mylan tie-up. Valution is a real issue, though. It is hard for Mylan to argue simultaneously that its own business is worth more than 20x EBITDA while paying less for Perrigo, and to criticise the stock component of Teva’s offer while offering Perrigo’s shareholders its own equity. Of course, Mylan argues that its shares are better quality, but they are also highly inflated by the Teva approach, which means that Perrigo’s shareholders should rightly be concerned about the implied value of Mylan’s bid if Teva walks away.
From the perspective of shareholders of either Mylan or Perrigo, we now have a form of Mexican stand-off. If Teva walks away from Mylan, leaving the latter free to buy Perrigo, Mylan’s share price will fall and so will the value of its Perrigo bid. But if Teva buys Mylan, Perrigo’s share price will fall (at least until the next bidder arrives). This being so, Joseph Papa, the CEO of Perrigo, would do well to hold out for an all-cash offer, the value of which would not be dependent on Mylan’s stock. Or at the very least – as he has already stressed in his rejection letter – one that looks attractive even using Mylan’s share price prior to the first rumours of Teva’s approach. As for Robert Coury (and we would note here that the fact that it was he who met with Erez Visgodman rather than Mylan’s CEO, Heather Bresch, tells you everything that you need to know about who actually runs Mylan), he had better hope that his stockholders share his confidence in the stand-alone future of Mylan, or he could ultimately be forced to eat humble pie.