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Monday, January 18, 2010

Musings on Commando Teva: Besting Big Pharma?

In recent investor forums, Teva executives have sounded like Big Pharma of the old days-- strong and bullish--while Big Pharma execs now sound more like old-time generics companies-- vulnerable and rather defensive.

The contrast was glaring when top Teva execs at their annual investor meeting earlier this month formed a wall of unremitting optimism, embracing both the vast opportunities before them and extolling what they see as their company’s equally vibrant ability to exploit them. The commandos appeared uncharacteristically giddy – using words like "unbelievable," "fantastic," and "flawless" to describe their numbers.

Only the day before, Pfizer CEO Jeff Kindler had spent his time at a Goldman Sachs analyst forum soberly doing a mea culpa on Pfizer's previous inability to control itself (spending) and emphasizing how they – Kindler, his CFO Frank D'Amelio and the rest of the Pfizer team – have learned from their past mistakes. We promise, people, that it won't happen again because Pfizer is taking steps to change (Are mea culpas a business fashion?).

Certainly Teva does have a track record of meeting its long-term targets – even if that means aggressive M&A, heavy-hitting patent challenges in the US, and even tougher at-risk launches and pull backs. All of these the executives mentioned only in passing, however, by-and-large avoiding any discussion of the messy details of their day-to-day work in the generics trenches. Pfizer and its brethren, in contrast, can't avoid mention of their troubled realities and steps they're taking to respond.

To take these observations a step further, in an exercise done perhaps largely for our own amusement--and admittedly crude given the vast differences in business models--we compared Teva's key financial ratios to those of Big Pharma to see ultimately if Teva's hybrid approach warrants such high-minded arrogance. Obviously, top-line growth rates are driving the executives' attitudes—Teva's is jumping, while Big Pharma is generally stagnating.

In general, the fundamental ratios of Teva and Big Pharma diverge significantly, especially for key figures like gross margins, SG&A and R&D to sales – hardly a surprise. Teva's gross margins hover in the high 50s percentile (forecasts have them climbing, however), while Big Pharmas are in the 70s and low 80s. R&D obviously isn't comparable – Big Pharma's R&D-to-sales ratio tends to be more than double that of Teva's, which its executives say should stay in the mid-single-digits.

Some of Teva's other ratios, however, are converging with Big Pharmas'. Its operating margins hover between 25 percent and 30 percent—within the lower range of normal for Big Pharma. And that range has been trending up, even as analysts expect most Big Pharmas' generally to stay flat (Glaxo, Pfizer) or decline (Sanofi, Lilly, AstraZeneca, and it's a toss-up for Bristol-Myers).

Teva's net margins, however, currently exceed those of Bristol and Roche and are comparable with Lilly (although they trail Pfizer and Merck), points out Standard & Poor's healthcare analyst Herman Saftlas. But Saftlas projects Teva's adjusted net margin should expand from the 22 percent range it falls into today to close to 30 percent over the next few years, powered by its top-line growth, cost cutting efforts, and M&A. That would put its net margins smack in line with Big Pharma's, and way above the rest of the generics industry, giving it more room to maneuver.

Despite all the challenges facing Big Pharma, its business model still has tremendous advantages over most generics companies—higher gross margins, stronger cash flow, and stronger balance sheets, as Moody's pharma analyst Michael Levesque points out. But he notes, Teva is indeed in a unique position, given its success in both generics and branded businesses, which generate lots of cash flows and profits, its leading market share, and its product and geographic diversity. So maybe diversity can pay off – if other parts of the equation, like Teva's military-like discipline at integrating new acquisitions and careful deployment of resources, are aligned. That's a message Big Pharma should take note of as it tries out its own new playbook.

image by flikrer Thorsten Becker used under a creative commons license

1 comment:

Ami said...

I am not sure if this article is criticizing TEVA or wowing them.