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Posted on 26th August 2018

The changing of the guard: New CEOs move in

Recent months have seen a slew of management changes at major generics companies. Some of this has been driven by shareholder dissatisfaction with poor performance (Teva being the obvious example here), but there have also been generational and other shifts that offer interesting pointers to what owners (or boards) see as the important attributes needed for leadership in the current challenging market conditions.

First up is Gedeon Richter, where Erik Bogsch, who has been CEO since 1992, recently stepped back from running the company to become Chairman. Into his place comes the former COO, Gabor Orban, who came to Richter from a career in the financial sector in September 2016. In line with Richter’s tradition of cautious progress, Mr Bogsch will be an Executive Chairman and will retain responsibility for commercial strategy and for international and governmental relations, leaving Mr Orban to deal with the perennial challenge of price pressure on standard generics. Consequently, Richter is very unlikely to change its current strategy of slowly transitioning into a speciality pharma company focused mainly on women’s health, particularly as it has specifically identified a shift to innovative products as the best way to escape from the relentless competitive pressure in the generics market. Nor is it likely to alter its vehement opposition to the sale of the government’s 25% stake, which effectively protects it from a hostile takeover. Given that Richter’s strategic plan, while so far proving pretty effective, is nevertheless being pursued more slowly than some shareholders might like (as well as resulting in significantly diminished operating margins as the company invests heavily in R&D), a patient controlling shareholder will continue to be important. However, should Mr Orban ever assume control over M&A, we might expect to see a slightly more aggressive policy here, since he is unlikely to share Mr Bogsch’s total aversion to taking on debt, something that stems from Richter’s near-bankruptcy in 1991, when the break-up of the USSR in 1991 left it with unsustainable levels of hard currency obligations.

Meanwhile, over at Hikma, there has superficially more of a break with the past. Here, Said Darwazah, son of the company’s founder, has also moved to the position of Chairman, with Siggi Olafsson, formerly of Teva (and prior to that, Actavis) taking the helm as CEO. In Siggi’s time at Teva, the company was at the tail end of a debt-fuelled acquisition spree, the final element of which was the catastrophically over-priced purchase of Allergan’s generic business (which Siggi used to run). In Siggi’s first appearance on a results conference call, he commented that it was good to be at a company with a strong balance sheet, and we assume that this time around, Said Darwazah will keep it that way, although we would still expect acquisitions to form an important part of the growth plan. That said, Siggi’s first task has been to look for efficiency savings and to improve service levels, since Hikma, too, has been suffering from the tough US pricing situation. Said is presumably also be hoping that Siggi can help Hikma to come up with some new ideas for creating a sustainable strategy for its non-MENA operations. In the MENA region, the company’s strength is unrivalled, allowing it to expand not only via new product launches and natural population growth but also through in-licensing deals with innovator companies that want access to the region. Outside MENA, the path to growth is less clear. The US operation has tended to be opportunistic, selling niche molecules and putting up prices whenever possible. The purchase of Baxter’s injectables business followed by Boehringer Ingelheim’s Roxane subsidiary has brought substantially greater scale and a much bigger focus on parenteral forms – a traditional Hikma speciality – but not really a strategy as such. Driving up the profitability of the acquired businesses has also taken longer than anticipated – another point for Siggi’s ‘to do’ list. As for Europe and Asia, these remain very much work in progress.

In India, companies are generally dealing rather better with the turmoil in the US thanks to faster new launches helping to offset the falling prices of existing drugs. This is more of a benefit for newcomers than for the older-established companies, though, and it is against this backdrop that Dr Reddy’s, one of the most globalised Indian pharma concerns, has decided to replace retiring COO Abhijit Mukherjee with Teva’s Erez Israeli, who now reports to Dr Reddy’s veteran CEO G V Prasad. Not entirely unlike Gedeon Richter, Dr Reddy’s is currently engaged in switching away from basic generics and towards niche and proprietary products, but across a far broader front than Richter is attempting. Having been one of the pioneers of Indian involvement in the US generics market, Dr Reddy’s was also one of the first to start diverting its R&D towards complex generics – injectables, dermatology products, sustained-release products and biosimilars. It has also – like many Indian companies – invested heavily in completely innovative products and has additionally tried to develop some OTC brands.

Bearing in mind that Dr Reddy’s only has turnover of about $2.2bn and generated free cash flow of not even $100m in FY 2018, having spent $280m on R&D, the most obvious task for Mr Israeli would seem to be to impose some order on this sprawling mass of ‘priority’ areas. Biosimilars is probably a good place to start, as the biosimilar market is already becoming extremely crowded in Europe, albeit with rapidly growing revenues, while simultaneously proving hard to get off the ground at all in the US. Unfortunately, though, having biosimilars and innovative drugs in the portfolio is a matter of personal pride in Indian pharma circles, so Mr Prasad is unlikely to be keen to kill many of these developments off, no matter how low the likely return on investment. Hence Erez may have to content himself with fixing DRL’s manufacturing problems (which have been delaying some US approvals) and looking for M&A targets that rebalance the portfolio more quickly than internal development alone. Acquisitions have not been Dr Reddy’s’ strong point, with the disastrous 2006 purchase of Betapharm in Germany lingering long in the minds of management and shareholders alike, but the company has a strong balance sheet and a number of its local competitors have been very active on the deal-making front, so we would expect this to change.

Back in Europe, Stada’s new CEO starts work at the beginning of September. Here, interim CEO Claudio Albrecht (ex of Actavis and ratiopharm) has already kicked off the task of reorganising Stada for its new controlling shareholders, Cinven and Bain, but will be replaced by Peter Goldschmidt, who has come from running Sandoz’s North American business. Most of Peter’s former fiefdom – which has been hit hard by a combination of declining prices and slow new product approvals – is now up for sale, so the move is timely. In contrast to Sandoz US, Stada is currently growing, but its new CEO nevertheless has a long and urgent list of tasks, since patience is not usually the strong suit of PE owners. The most important item on this list is the overdue full integration of the many historic acquisitions made by Stada, which effectively means taking much more centralised control of the subsidiaries outside Germany and removing a big layer of duplicated costs and functions. A second priority is a dramatic improvement in efficiency in areas such as sourcing, where the previous decentralised structure has allowed every country manager to sign their own agreements. Mr Goldschmidt is also expected to continue Stada’s shift towards branded and OTC drugs, an area where Claudio Albrecht has already been making progress via a combination of acquisitions and the termination of existing third-party distribution agreements in favour of in-house arrangements. Cinven and Bain still have capital to deploy but at Stada, cutting costs and creating a structure that can easily integrate new assets will be just as important as the acquisition targets themselves.

Shifting finally to the US, Perrigo also has a new boss: Uwe Röhrhoff, ex head of the pharma packaging company Gerresheimer. As with Teva, the Perrigo board (currently heavily influenced by activist investor Starboard Value) picked someone with operations experience rather than someone who really knows either generics or OTC, clearly feeling that cost-cutting was the priority over deal-making. While OTC has not been hit as hard by customer consolidation as generic manufacturing, Perrigo’s European business has struggled following the (over-priced) acquisition of Omega Pharma in 2015, while the US part has not been immune to the impact of an increased rate of ANDA approvals and the greater buying power of expanded pharmacy and supermarket chains. Following an initial review of the business, Mr Röhrhoff recently announced that the entire Rx division will be split from OTC, which we assume is more likely to happen via a sale than through a spin-off into a second quoted company.

Whether this really makes sense is a moot point. Starboard is keen on the split as it believes that this will realise more value for shareholders than keeping Perrigo under its current structure, but US generic asset prices are not what they once were even if splitting out Rx would clearly improve the short-term growth outlook. Interest in the Sandoz business mentioned earlier has reportedly been very low and even though Perrigo’s operations are a bit more niche, being focused mainly on topical forms, its revenue trend is also resolutely downwards, which will discourage financial investors in particular. And it is simply not true that there are no inherent synergies between OTC and Rx, even if Perrigo has managed to organise its own business in such a way that it is unable to exploit them. There is a big overlap in the customer base, both inside and (particularly) outside the US, so it ought to be possible to leverage the combined strength of both divisions to gain better traction with wholesalers and pharmacy chains. In addition, the Rx business is far more profitable than consumer health, so the loss of the cash flow will make it harder to fund future investments for the group. In our view, this is a good example of a situation where what makes sense for (short-term) shareholders is not necessarily of long-term benefit for the company itself.

Richter, Stada, Hikma et al have varying product and geographic mixes and do not all face exactly the same challenges, yet there are some clear themes that emerge from their recent hires. Firstly, a shift from price-hiking to cost-cutting as a way of delivering earnings growth in the US (and improving margins elsewhere). Secondly, a continued retreat by all but the lowest-cost operators from commodity generics in favour of value added products (up to and including truly innovative drugs, thus further blurring the distinction between generics and originators). And thirdly, a willingness to engage managers from outside the industry in order to effect change: the new CEOs of Richter and Perrigo are from outside pharma altogether, while Teva’s new boss is from big pharma rather than generics. Another theme is the rise of the European manager. In the Richter case, the entire management is (and always has been) Hungarian, but Hikma, Stada and Perrigo (not to mention Teva) have all picked Europeans and northern Europeans at that. It would be nice to think that this will lead eventually to a greater focus on markets outside the US, but for now it probably makes more sense to see it as another facet of the desire for an ‘outsider’ perspective as a way of dealing with challenging times. Dr Reddy’s choice of a non-Indian clearly also fits this pattern. Of course, no CEO has a totally free hand: all of them will have to deal to a greater or lesser extent with entrenched interests in the form of the company’s owners. This may not be all bad, as non-generic specialists also have a rather mixed track record when running generic companies, but fresh thinking and new talent are definitely what the industry needs.

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