Date: 2018-02-26
Teva
Just few years ago, when I first started listening to Teva’s conference calls, buying and holding generic drug makers seemed like a no brainer/ fail-safe long term investment to many. Then Martin Shkreli covered the headline; election narratives in the US bundled specialty and generic players together and attacked the pharma sector as a whole; Valeant scandal covered the headline; drug distributors further consolidated and eroded pharma companies’ pricing power; some acquisitions Teva made turned out to be reckless and wasteful; concerns over Teva’s heavy debt grew especially due to Actavis; patent for Teva’s most important specialty drug expired; and of course Venezuela did not help. In the process, top managements were replaced; major cost cutting programs (that include asset sales and downsizing) were implemented; and the company eliminated the dividends.
I first bought Teva in 2015, where the stock made its historical high, and this was my worst performing position after 2 years, so I admitted my defeat and realized much of my losses.
Then I added it back shortly after. This was because it seemed to me as the investors thought Teva was not expensive (I should not say ‘cheap’ because I felt that it was cheap in 2015 and I turned out to be so badly wrong), especially vis-à-vis rest of the equities. And more importantly, I assess that the original investment theses for Teva are still relevant, while investing in generics became a very unfashionable thing to do because many now seem to believe that generics business model is broken. I believe it is quite the opposite.
Healthcare systems differ country by country, but certain degree of generalization and pattern identification is possible. Among many areas where improvements are needed in modern healthcare systems around the world, I identify service fees for doctors and drug prices as two most notable areas to work on, because of their contribution to total cost. These two are closely linked for a number of reasons, and the dynamics between the two are noteworthy.
(1) Specialty drugs are far more expensive than generic drugs.
(2) Mass market consumers tend to pick specialty drugs over generic drugs due to specialty drug companies’ marketing and the consumers’ lack of expertise.
(3) It is much more likely for prescription drugs to be generic ones than for over-the-counter ones to be generic ones, because specialty drug companies’ marketing effect is much weaker on doctors than on patients. Doctors are also often much more willing to and able to consider the generic drugs of the same/similar effect than the patients are, and prescription drugs is the area where generic players can compete against branded ones more effectively. This is because generic ones are necessarily late-comers vis-à-vis specialty ones, and so via mass market advertisements, generic players tend to have a difficult time overcoming specialty ones’ first-comer advantage and a very long-run learning effect among consumers.
(4) For patients, combined costs for doctors and drugs matter. So if a patient had a symptom whose remedy is simple (taking a drug that he or she already knows about), the patient’s choice of ‘remedy’ is most likely to be a specialty drug, and the patient is also most likely not to decide to see a doctor. This way, it is difficult for this patient to explore any options (generics) other than the original specialty drug.
And that is the status quo.
I view the natural policy responses (and I hope they materialize) as:
(1) Increase in the number of doctors (especially general practitioners), and
(2) Further push for generics over specialties.
Initial push for easier access to doctors in terms of fee structure is important. Even though medical care and pharmaceutical industry is a very complex one with lots of political struggles of various parties, what has to be done seems pretty clear. In fact, the governments (especially those in developed markets) have already been working towards this direction, and the trend continues. And the use of generic drugs will probably grow.
Generic drugs are still not widely used in developing countries, but they will surely adopt generics over specialty drugs, as soon as enough number of doctors are produced.
Per drug quality issues, so far I have never heard any doctor telling me that generics fall behind significantly in terms of quality.
Commoditization of businesses and subsequent margin pressure can be painful, and I am little concerned about Teva because the company is not best positioned for further expansion at this point. However, Teva still is the biggest generic maker with strong vertical integration and partnerships with top companies in many regions, and I like that. Given that all blockbuster drugs' patents eventually expire, generics business model is very much sustainable (so RnD risk and expense is minimal), and the ultimate winner in the generics space is likely to be the one with the largest scale. A common argument against the generics business model: margin pressure due to lowered drug price first in specialty hence the generics, seems rather myopic.