Tuesday, May 03, 2011

What's Behind Teva's Cephalon Deal

The other big news yesterday is that Teva Pharmaceuticals (NASDAQ:TEVA) will be acquiring Cephalon (NASDAQ:CEPH) after outbidding Valeant Pharmaceuticals (NYSE:VRX)‎. Here’s the official press release: Teva to Acquire Cephalon in $6.8 Billion Transaction

This is a great, albeit expensive, strategic move by Teva. Management clearly recognizes the business model problem looming ahead for the generic drug business. The deal boosts Teva's brand business while maintaining a broadly diversified revenue base, positioning Teva as the "anti-Pfizer."

The pharma industry of tomorrow will be about expensive drugs for small patient populations and cheap drugs for large populations. I wonder how many manufacturers will be ready.


To set the context, the chart below illustrates the pace and entry of generic drugs projected by Medco Health Solutions as of November 2010. It appears in the 2010-11 Economic Report on Retail and Specialty Pharmacies.

The drop-off shows the business model problem as the generic wave ends and competition reduces margins on mature generic drugs. Everyone in the generic ecosystem—pharmacies, PBMs, generic manufacturers, and drug wholesalers—will feel a corresponding slowdown in profit growth without a viable post-2015 strategy.


Teva's acquisition of Cephalon boosts its exposure to specialty drugs, which have much more pricing power. (See the Express Scripts 2011 Drug Trend report.) Here is Teva’s branded portfolio both before and after the deal as shown in Teva’s investor call presentation.

Consider Teva’s relative industry position in 2010 (per IMS Health):
  • U.S. Sales=$13.7 billion (4.5% of total U.S. market; #7)
  • U.S. Prescriptions=639.3 million (16% of total market; #1)
On a pro-forma basis, a Teva/Cephalon combination would have been the fourth largest pharma company by revenues—and also the most diversified. As BNET points out quite astutely, Teva and current #1 Pfizer (NYSE:PFE) are going in opposite directions.
"While Pfizer is getting smaller and concentrating solely on expensive, branded prescription products; Teva is growing through acquisitions, cheap generics, and a joint venture to market Procter & Gamble (PG)’s non-prescription over-the-counter brands outside the U.S. Everything that Pfizer intends to do, Teva is not doing. Strategically, Teva is the anti-Pfizer." (source)
Think about it another way. If you are an actor and want to be taken seriously, then you tell people: “What I really want to do is direct.” See Affleck, Ben.

If you are generic company and want to be taken seriously, then you tell investors: “What I really want to do is sell specialty drugs.”


Like you, I am extremely pleased to see Osama Bin Laden brought to the rough justice that he so richly deserved. Congratulations to President Obama and the U.S. national security team for pulling off this mission.

Jon Stewart at The Daily Show had a funny six-minute rant. I especially loved the movie posters starting at 4:18—"Hairy Plotter and the Deathly Hello," "Bye Bye Beardy," and more. Great stuff, and a great day for the USA.

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