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Updated valuation of Teva Pharmaceuticals using worst estimate for outcome of lawsuits

In order to estimate the potential return on an investment in Teva i will estimate the cash flows that will be generated over the next 5-6 years by the company from generics, Ajovy and Austedo the two potential blockbuster drugs. I will then proceed to a value the company based on a p/e multiple of 12, subtracting the debt that is left on the balance sheet. I will use this number to estimate an annualized compound rate from the current valuation, which at the time of writing is 11.86 (market cap of about 12 bUSD).

I will then compare the valuation above with estimates for the combined potential outcome from two lawsuits related to opioids and price fixing. The lawsuits are described on page 151-153 in the annual report 2018. I ultimately believe the fines/settlements will be in the range from 0 (no fine) to 5 bUSD as the max. I will proceed to evaluate the outcome of three cases: 5, 2.5 bUSD and no fine. Please see the appendix on the next page for my reasoning behind the fine size settlement.

Table 1 contains my estimates for free cash flow from end of 2018 until 2023, the data in the table represents my estimates for end of year results.  The estimates are based on a cross reference of Kåre Schultz statements on the turnaround, continuing flat revenues for generics, projections for Ajovy and Austedo and a percentage point of improving margin per year for the next couple of years (please find estimates for peak sales and free cash flow for Ajovy and Austedo in the appendix starting on the next page).

Table 1. EBITDA, Free cash flow and debt estimates for Teva 2018-2024.

Year

2018

2019

2020

2021

2022

2023

EBITDA

5.3

4.6

5.2

5.4

5.6

6

Free cash flow

3.7

1.8

2.2

2.5

2.8

3.0

Debt

26

24.2

22.0

19.5

16.7

13.7

Debt/EBITDA

4.9

5.3

4.2

3.6

3.0

2.3

Case 1: No fine/settlement

If Teva wins the lawsuits or settles for a negligible amount we have the no fine case. Assuming free cash flow is 80% of earnings and applying a multiple of 12 in 2023 the market cap ends up being 45 bUSD. Subtracting the debt of 13.7 bUSD leaves 31.3 bUSD this corresponds to a share price of 28.65 USD or 2.4x the current share price of 11.86 USD. The compounded return is approximately 16% per year.  

Case 2: Medium fine/settlement estimate 2.5 bUSD of fine

In this case Teva settles for 2.5 bUSD let’s assume Teva has to raise equity (probably not necessary), this would cause a significant drop in share price. It might cause a 25% dilution given the current market capitalization of 12 bUSD. Given the dilution the share price at a p/e of 12 in 2023 would drop to 22.24 USD per share corresponding to a 1.93x return or a compounded return of about 11.5 % per year.

Case 3: Worst case fine/settlement estimate 5 bUSD

With a 5 bUSD fine the share price would plummet and we might see a 60% dilution in an equity raise, might also be 50/50 equity and debt, which would be a better outcome. However, i will consider the worst case and a 60% dilution, share price in 2023 would be 17.19 USD per share corresponding to a 1.45x return or 6.5% per year from the current level of 11.86 USD.

Conclusion

I find the stock price of Teva attractive; however, there are a lot of moving parts with an uncertain regulatory future in the US as well as unpredictable outcomes from the legal challenges. Ultimately i believe a 7% compounded return is likely even in the worst case at these levels. Should the business improve faster than my predictions that would also be bullish. Any deterioration in generic pricing or in the ramping of Ajovy or Austedo would be a red flag and i would probably exit the position. Teva is a risky stock but with a high return potential.  

Appendix

Fine/settlement opioids and price fixing lawsuits

Based on a quick google search i found the following list with fines from weekipedia: https://en.wikipedia.org/wiki/List_of_largest_pharmaceutical_settlements. As can be seen from the list the largest fine/settlement involved GlaxoSmithKline and amounted to 3 bUSD (1 billion criminal and 2 billion civil).

An analyst from IBI estimated the fine size relating to the price fixing law suit to be 2 bUSD (https://www.timesofisrael.com/price-fixing-lawsuit-deals-another-blow-to-already-fragile-teva-experts-say/)

Another analyst at UBS estimated the fine to be 4 bUSD.

HBSC estimates the fine from the price fixing lawsuit to be 3 bUSD

https://en.globes.co.il/en/article-teva-continues-to-tumble-amid-price-fixing-charges-1001285771

If we look at the earnings in 2014
 Teva's global sales and net profits reached 30 bUSD and 3 bUSD, respectively. The generics sales were 4.4 bUSD, estimated operating profits was approx. 1 bUSD and net profits around 0.7 bUSD. If we look at the period of 19 months with alleged price fixing and say the jury takes away the operating profit then that amount is about 1.6 bUSD, then they add a fine of 0.9-1 bUSD and we land at 2.5 bUSD.


I think Teva, based on Kåre Schultz statements during Q12019 earnings call, will fight the opioid battle to the supreme court. Ultimately i think Teva will win the opioid case if they fight it, but it might be cheaper to simply settle. Teva has leverage in the negotiations wth the US attorney because they have a levered balance sheet. The regulators cant bankrupt Teva, then they will get nothing. I believe a total fine of 2.5 bUSD is the likely outcome, 5 bUSD is the worst outcome.

Ajovy

5-6 billion potential market potential for non-addictive CGRP pain relievers for preventing chronic migraine, there are three products on the market: Aimovig (Amgen & Novartis), Ajovy (Teva) and Emgality (Eli Lilly). The market share for Ajovy is estimated to be between 20 and 28%, currently Teva has 28% market share (Q1 2019). The peak sale range can be estimated to be between:

20% = 1.0 bUSD

28% = 1.7 bUSD

Free cash flow is probably between 40-50% of the sales price i.e between 500 mUSD and 850 mUSD.

Table 2 Ajovy peak sales estimates and source.

Peak sales

Free cash flow (50% assumption)

Source

mUSD

mUSD

960

480

https://www.rttnews.com/2935217/botox-effect-lasts-longer-at-higher-doses-teva-gets-fda-nod-knsa-on-watch.aspx

500

250

https://www.stockgumshoe.com/2019/01/looking-backward-2/

1000

500

https://www.mmm-online.com/home/channel/regulatory/with-a-nod-from-the-fda-teva-enters-white-hot-migraine-market/

1600

800

https://en.globes.co.il/en/article-ibi-sees-annual-sales-of-1624-billion-for-teva-migraine-drug-1001253548

2400

1200

https://en.globes.co.il/en/article-ibi-sees-annual-sales-of-1624-billion-for-teva-migraine-drug-1001253548

Austedo

Austedo is for treating Tardive dyskinesia related to huntington's disease the total market is estimated to be around 2.4 bUSD per year. There are two drugs on the market, Austedo (Teva) and Ingrezza (Neurocrine). Teva is expected to snap up about 45% market share which leaves some 1.1 bUSD per year. Free cash flow of 40-50% corresponds to 440 to 550 mUSD.

Table 3 Austedo peak sales estimates and source.

Peak sales

Free cash flow (50% assumption)

Source

mUSD

mUSD

700

350

https://www.fiercepharma.com/pharma/hungry-for-specialty-sales-teva-undercuts-generics-new-huntington-s-med-austedo

1000

500

https://endpts.com/neurocrine-bags-an-fda-ok-for-tardive-dyskinesia-setting-up-a-showdown-with-teva-and-first-commercial-launch/

1330

665

https://www.fiercepharma.com/pharma/hungry-for-specialty-sales-teva-undercuts-generics-new-huntington-s-med-austedo

1300

650

https://www.fiercepharma.com/special-report/9-ingrezza