by Clement Thibault
Big pharma is perhaps one of the world’s most scrutinized business sectors. Its main goal is a bit of a conundrum—create and provide drugs that maintain health and cure diseases, while at the same time profit from the entire costly enterprise. The challenge involved in balancing the two seemingly polar aspects of business and health is tricky. Sometimes they complement each other well, for example when a new blockbuster drug is developed and approved for common illnesses such as leukemia or chronic liver disease (both of which have new blockbusters scheduled to be released in 2016, by AbbVie (NYSE:ABBV) and Intercept Pharmaceuticals (NASDAQ:ICPT) respectively)—and the medication’s developers see their profits skyrocket.
But blockbuster drugs are harder to come by these days, and the expiration of patents often opens the door for cheaper, generic medication substitutes, badly hurting profits of the companies developing the new drugs. For this reason, some pharmaceutical companies have been engaging in a different kind of business model.
Of course, the best news from the pharmaceutical industry is another FDA approval triumph, but lately, pharma industry news has been rather bad. Back in August 2015, Turing Pharmaceuticals' then-CEO Martin Shkreli decided to raise the price of Daraprim, a drug used to treat toxoplasmosis, by 5,000% after Turing acquired the medication. A NY Times article covering the sudden price hike sparked public outrage and numerous debates regarding the commercialization of healthcare and profit taking off lifesaving medicines and the seriously ill population that can’t live without them.
Shkerli isn’t alone. Valeant Pharmaceuticals (NYSE:VRX) also came under fire for the same practice during September 2015—price gauging. Leaders of the Democratic Party have called for a subpoena of the company’s records, in order to examine its price setting processes, and on September 21, Democratic presidential candidate Hillary Clinton fired off a tweet calling the practice "outrageous". That one tweet kicked off a bad week for the Dow Jones Pharmaceuticals Index, as it lost 8.5% between September 21st and September 28th.
Valeant Pharmaceuticals soon discovered that not all publicity is good publicity. The company's share price has lost over 74% from its high of $263.81 in August; It currently trades at $61.31. This past Monday, the company acknowledged a U.S regulatory probe of its business related to fraudulent practices and misleading investors.
If these stories can teach us anything, it’s that all that glitters is not necessarily gold, even and maybe especially in the pharma sector. Still, there's a deal brewing in the sector that we believe is already creating opportunities for savvy market players.
In late 2015, Allergan (NYSE:AGN) agreed to an acquisition-in-principle by Pfizer (NYSE:PFE). It’s a much criticized mega pharmaceutical deal, but it continues to move forward.
The criticism stems from the view some have that by acquiring Ireland-based Allergan, and moving business operations to that lower-tax country, Pfizer’s U.S tax bill will be seriously cut via a loophole called tax inversion. President Obama referred to the tax loophole as unpatriotic and presidential candidates Clinton and Trump have also sounded off on the deal.
According to the terms of the deal, Allergan shares are priced at $333.24 a share. However, Allergan shares are currently trading at $288.67, potentially rewarding buyers today with a 15% return in the future.
The price discount reflects concerns of intervention by the U.S Treasury which could block the deal in order not to lose the tax revenue. Still, the deal is expected to go through in the second half of 2016, and provide new markets for the merged mega-company, which is set to become one of the world’s largest companies, with a combined value of over $300 billion.
This is an exciting investments opportunity both in the short and long term; The quasi immediate return of price-per-share profits is enhanced by a larger, combined drug pipeline. The two companies claim to have over 100 drugs in mid-to-late stage development, in altogether different markets.
While Pfizer is focusing its development efforts on treatments for cancer, heart disease, and more conventional illnesses, Allergan is mostly focused on specialty markets such as cosmetics and dermatology. The merger will therefore not cannibalize sales of either company’s list, which is both good and surprising news for the two big pharma companies.
Teva Pharma Industries (NYSE:TEVA) is another beneficiary of the Allergan-Pfizer deal. The Israeli company, valued at $57.5B, is set to acquire Allergan's generic drugs division for $40.5B, which would strengthen Teva's position as the world’s largest manufacturer of generic drugs.
With a TTM EPS of 5.42, the company today trades at a P/E ratio of 10.2, following a bad start to the year when the company's shares slid by 15%. Teva's revenue has fallen YoY, and analysts expect Teva to post a small growth number in 2016, with an EPS expectation of $5.49, hence the discount price.
Its sclerosis drug Copaxone, which accounts for 20 percent of its revenue, is now facing competition from Novartis (NYSE:NVS), and is another source of worries for the company and its shareholders. However, 2017 and beyond should be brighter for the drug maker, with growth expected to continue at about 7% annually.
Moreover, the company expects to generate a free cash flow of 20 to 25 billion according to CEO Erez Vigodman, allowing it to continue making moves to cement its position in the pharmaceutical industry. With its standing as market leader strengthened within the generic drug market and a relatively low P/E, Teva should be near the top of your list if you have the patience to wait a bit for larger gains down the road.
