Teva-Mylan-Perrigo: Merger Mania In Pursuit Of Generic Margins
There are very few assurances in life, but in the field of generic pharmaceuticals, there are three certainties we are about to witness:
1. This is now the Spring of offers and counter-offers with the prices for generic drug makers setting new highs. Yesterday the Teva (TEVA) $82 per share offer for Mylan MYL -0.04% (MYL) is sure to be raised and the Perrigo ’s (PRGO) rebuff of Mylan’s $205 per share offer will have similar considerations.
2. Every man, woman and child in the U.S. will eventually take a pill manufactured by the new entity if Teva is successful in its pursuit of Mylan
3. Given the Hart-Scott-Rodino Act, the Federal Trade Commission (FTC) will certainly require divestiture of assets in any generic combination. This will most certainly allow for a top down restructuring to the winners of this merger gambit retaining the highest margin products and divisions while divesting lower margin legacy products.
Teva Pharmaceuticals CFO Eyal Desheh, second left, Chairman Dr. Phillip Frost, third left, and CEO Jeremy Levin, fourth left, applaud during opening bell ceremonies of the New York Stock Exchange Wednesday, May 30, 2012. The Israeli company said last week it expects weaker sales of generic drugs, which bring in most of its revenue, and of brand-name products, which has become a priority for Teva in recent years and drove its recent $6.8 billion acquisition of Cephalon Inc. (AP Photo/Richard Drew)
Prescription drugs are a $271 billion dollar business in the U.S. The generic market, once considered to be the low-cost, low-profit drug business has become highly profitable as generic manufacturers close the price gap between their products and more expensive exclusive drugs. Today 80% of U.S. prescriptions are written for generics and whatever Teva/Mylan/Perrigo merger is concluded, a combined company could control almost a quarter of the unbranded generic market which could equate to more than $50 billion in sales. Just looking at the Teva/Mylan merger it could eventually result in the fourth largest pharmaceutical company by revenue worldwide, edging out Pfizer PFE +0.09% and trailing only Johnson & Johnson JNJ +0.1%, Novartis and Roche .
While the recent trend has been for companies to merge so they gain advantage under global tax codes, using a Teva/Mylan merger as an example it would most certainly focus on a business structure that would gain margin advantage with FTC consent/agreement on divestitures. Because the merged company would be so huge, it would have to shed some products and business lines to gain approval. In this case it would make sense for Teva comply by shedding low-margin drugs while retaining high-margin drugs. By doing so Teva’s revenue would of course decline but so would operating costs, and with margins increased, this would provide an overall boost to EPS. Let’s not forget that any required divestiture/spinoff could also yield Teva a one-time cash injection from the elimination of lower-margin assets.
Additionally, if these two companies were to merge, the merged company could displace Pfizer as the fourth largest pharmaceutical manufacturer in the world, leaving Johnson & Johnson as the only U.S. company in the top five.
Teva, Mylan and Perrigo are all well-managed companies that make safe and reliable products. However, in an industry where the elimination of redundant infrastructure is instantly accretive to the bottom line this becomes almost a necessity to ensure sustained double digit earnings growth in today’s healthcare industry model.
It appears that Wall Street’s demands for sequential EPS growth now dictates consolidation in the pharmaceutical industry and obviously the generic market is not immune to these demands. A Teva transaction may very well be a template for maximization of margins, ironically in this case made easier by FTC divestiture rules. Quite a few analysts have written that this type of merger is too large a pill to swallow, but the size will be a critical key to its success. The real question to arise from this should be what merger is next in the pharmaceutical industry and if that pill will be too bitter to swallow.
Steve Brozak Contributor