Teva: Don’t Be so Generic

Teva’s Troubles

This past August, strong industry headwinds forced Teva Pharmaceuticals, an Israeli-based pharmaceutical company that focuses primarily on manufacturing generic drugs, to report a $6.1-billion writedown on its U.S. generics business. The poor financial performance resulted in a sell-off of the stock that wiped out more than 40 per cent of Teva’s market capitalization within a week. The industry trends that forced Teva to write down the value of its generics business can be largely attributed to both an increase in buyer power due to demand-side consolidation as well as heightened competition from increasingly sophisticated foreign manufacturers. To maintain its market position, Teva will need to shift its focus towards a more defensible segment of the market.

Teva’s focus is currently on manufacturing generic drugs, representing 55 per cent of revenues in fiscal year 2016. These are cheaper, but chemically-equivalent alternatives to brand name drugs. A common example is ibuprofen and its branded version of Advil. Over the past 50 years, U.S. national health-care expenditure has tripled as a percentage of gross domestic product (GDP). Thus, at an average of 70 per cent of the price of its branded counterpart, generic drugs offer a way for public payers such as the government, and private payers such as health insurance companies, to manage the increasing cost of providing care for an aging population. Filling one out of every six generic prescriptions in the U.S., Teva develops drugs that millions of people use daily to treat diseases such as asthma, multiple sclerosis, and cancer.

Demand Side: Consolidation of Buyer Power

To combat the increasing cost of providing health coverage, health-care payers ranging from government organizations, such as the National Health Service and the Centers for Medicare and Medicaid Services, to private insurance companies, such as Aetna and Anthem, have focused on reducing the exorbitant prices of pharmaceuticals.

In addition to stating strong preferences for generic drug prescriptions over their branded versions, some payers have begun implementing tendering systems to further reduce costs due to the commoditization of these drugs once they are off-patent. When a tender is issued for a generic drug, pharmaceutical manufacturing companies, such as Teva, bid to own a temporary monopoly in supplying the given market. These tendering systems that have been implemented across the EU have resulted in extreme price competition among manufacturers, with prices of generic drugs decreasing up to 90 per cent post-tender in some instances. The empirical success of this system in the EU has acted as a model for other governments, including Quebec’s provincial government, which are seeing tenders as a method of controlling health-care spending.

In addition to government tendering systems, recent consolidation downstream in the value chain among retail pharmacies has increased buyers’ purchasing power. In 2016, McKesson, a pharmaceutical distributor, bought out Rexall for C$2.9 billion. More recently, Metro announced a deal to acquire Jean-Coutu for C$4.5 billion and Walgreens finalized a $4.4-billion deal to buy the majority of Rite Aid stores. This pattern of consolidation has ultimately reduced the negotiating leverage of generic drug manufacturers.

Supply Side: Increased Competition

The exponential increase in the supply of generic drugs by international drug makers is another aggravating factor exerting downward pressure on prices. In particular, Indian firms are aggressively expanding their U.S. operations in pursuit of international growth opportunities. India’s top 10 drug makers grew their share of the U.S. generics market to 24 per cent in 2017 from 14 per cent in 2010. This supply phenomenon can be traced back to two factors: the acquisition of U.S. assets by Indian firms and loosened U.S. regulation in an attempt to stimulate market competition.

Historically, Indian pharmaceutical companies have been unable to penetrate the U.S. market due to stringent FDA regulations and product quality issues. To navigate this, Indian firms have invested heavily in acquiring their U.S. counterparts, spending $1.5 billion in 2015 alone. Purchasing the underlying U.S. company assets gave Indian firms compliant production facilities and cleared them for manufacturing drugs that require domestic production such as opioids. Coupled with India’s low labor cost environment, these foreign manufacturers have aggressively expanded into the American market.

Furthermore, the FDA has expedited approval processes to increase competition and drive down generic prices. By the end of its fiscal year 2017, the FDA approved 763 new generics, more than the agency has ever approved in a single year. As a result, Indian firms have taken advantage of this by securing 40 per cent of all FDA generic approvals during the first half of 2017.

Current Strategies are Failing

Major generic pharmaceutical companies have combatted declining margins by consolidating to achieve economies of scale. However, while record merger and acquisition activity in the pharmaceutical industry occurred in 2016, these deals have not held accretive value. In fact, when analyzing the top five largest generic pharmaceutical mergers from 2008 to 2017, the average stock price change 12 months after the acquisition completion was an abysmal -16.9 per cent. This is contrasted by a small 4.5-per-cent drop in stock prices for the top five non-pharmaceutical acquisitions of 2016.

Exemplary to this is Teva’s $40.5-billion acquisition of Actavis, the generic subsidiary of Allergan, in August 2016. Less than a year later, Teva wrote down the value of its U.S. generics division, which includes Actavis, by $6.1 billion signalling to the market that it had overpaid for the company. In summary, industry consolidation for generic drugmakers is not a viable long-term strategy if the entire industry is falling off a cliff due to pricing pressures. As such, Teva must formulate a strategy that focuses less on traditional generics revenue streams and instead utilizes its core competencies in search of the next big growth opportunity.

Biosimilars vs. Generics

A compelling opportunity for Teva to hedge the risk of further pricing pressure on generic drugs is expanding into the market for biosimilar drugs. Both generic drugs and biosimilars are effectively off-brand versions of their branded, reference molecule. However, the difference in classification lies in the structure and production method of the drug.

Biosimilars vs Generics

Generic drugs are relatively simple molecules, such as ibuprofen or aspirin, which are the exact bioequivalent of their branded small-molecule counterparts. In contrast, biologics are complex molecules that are manufactured in living cells through genetic engineering. The result is a highly complex and sensitive product, making it impossible for biosimilars to completely replicate its branded “biologic” counterpart. Instead, biosimilars are only required to be highly similar and possess no clinically meaningful difference from the branded biologic. Consequently, the regulatory approval process for biosimilars is much more exhaustive than it is for generic drugs, which can be easily proven to be chemically equivalent to their branded counterparts.

These biologics and their biosimilars have found widespread use in treating chronic conditions such as rheumatoid arthritis. Although biologics often target overlapping therapeutic areas as existing small-molecule drugs, biologics have the advantage of targeting the disease more specifically, leading to drugs that are oftentimes more efficacious than the small-molecule alternatives. Biologics are often some of the most profitable drugs due to their high price, reflecting their complex and expensive development processes. Unlike generics which are steeply discounted to their branded counterparts, the complexity of manufacturing biosimilars results in larger and more stable margins for this class of off-brand drugs.

The biologics market was $210 billion in 2016, representing 20 per cent of the total pharmaceutical market with $67-billion worth of biological products coming off patent by 2020. By 2025, the biologics market is anticipated to grow to $400 billion, driven by the development of biologics that target previously untreatable diseases as well as biologics that supplant current treatment options by targeting diseases more efficiently. With such rapid growth, biologics offer an opportunity for Teva to capitalize on its competencies of producing off-brand versions of the drugs, while preventing the erosion of its margins by the unfavourable outlook of generic manufacturing.

Strategy: Biosimilars, Biosimilars, Biosimilars

Despite the clear growth opportunities with biosimilars, they represented less than 1.8 per cent of Teva’s annual revenue in fiscal year 2016. Specifically, Teva’s current pipeline of 25 drugs only has two drugs that are biosimilars: CT-P103 (Rituxan) and CT-P63 (Herceptin). Although Teva is one of the early entrants in the biosimilar space, the company must answer two key questions to successfully capture a significant foothold in the global biosimilars gold mine. In particular, where it should operate and how to streamline promotions strategies to gain prescriber/physician and patient acceptance.

Market/Region: Focus on Developed Countries (U.S. First, Japan Second, EU Last)

Understanding which regions for biosimilar manufacturers to enter plays an integral role in capturing the largest revenue opportunities, and also helps firms navigate through regulatory hurdles. Six key areas to consider when selecting a region to operate in are: current access to affordable biologics, regulatory environment, payer advocacy in favour of biosimilars, prescriber acceptance, patient acceptance, and biosimilar presence. Upon analyzing countries across these dimensions, developed countries (U.S., Japan, EU) reign superior in terms of a favourable regulatory environment and incumbent biosimilar presence. In fact, the first biosimilar framework was created in the E.U. in 2003 by the European Medicine Agency. Existing biosimilar presence is especially important as it navigates through any regulatory hurdles and normalizes biosimilar consumption for increased prescriber and patient acceptance. As such, Teva should focus its biosimilars growth strategy on developed countries starting locally in the U.S. where it already has large generic presence; expanding long term into Japan, and then the EU.

Japan is a leading candidate for Teva’s biosimilar international expansion, as generic drug penetration is relatively lower compared to other developed countries. This is predominantly driven by two forces: the consumer perception that generic drugs are inferior to their branded reference products and slower generic review times in the drug approval process. Fortunately, Japan is anticipating a 60-per-cent generic drug penetration rate in fiscal year 2017. This speaks to Japan’s motivation to drive down drug prices while maintaining the product efficacy of biologics, the cornerstone of the value proposition behind biosimilars.

Promotions/Marketing: Win Physicians & Patients through Interchangeable Status and Grassroots Marketing

Biosimilars require specific physician and patient marketing to gain adoption over branded biologics. In contrast, generic drugs are completely interchangeable with their branded counterparts, indicating that patients are free to request a generic version of their branded prescription at the pharmacy if they wish to seek a cheaper treatment. However, since biosimilars have slight variances from their branded counterparts, the patient is unable to interchange a branded prescription at the pharmacy for the cheaper biosimilar. Consequently, biosimilar manufacturers must focus on developing a marketing plan to gain adoption from both physicians and patients alike.

Teva Matrix

One potential avenue for Teva to investigate is the opportunity to put its biosimilars through an optional regulatory process that is more stringent to gain this status of interchangeability. If approved, Teva would be able to make a strong financial case to consumers and payers due to the astronomical cost of these complex biological drugs.

Drug manufacturers find it economically feasible to sell biosimilars at discounts upwards of 30 per cent of the corresponding biologic’s price, making it a much more attractive alternative. As a case study, an examination of the cost savings of the Herceptin biosimilar that Teva is currently developing points to the high costs of branded biologics. At an annual cost of $54,000 a year for the branded breast cancer drug, many patients find the financial burden of the treatment to be a barrier. Even for patients with health insurance plans, the private payers that ultimately pay for the treatment would prefer biosimilars that can produce similar clinical outcomes for a greatly reduced price.

In addition to gaining interchangeable status, Teva must also gain patient acceptance and awareness. Although most of the developed countries have strict rules against direct-to-consumer pharmaceutical marketing, there are numerous “patient advocacy groups” that can accelerate patient awareness. Some examples of these groups include Patients for Biologics for Safety & Access based in the U.S. and the Global Alliance for Patient Access in Europe. Developing partnerships with these stakeholders to educate local markets about the financial benefits of biosimilars will be integral for Teva’s success.

Similar Strategies; Not the Same

In the face of extreme pricing pressures on its extensive portfolio of generic drugs, Teva must refocus its efforts on the production and sale of biosimilars. In doing so, it will benefit as a first-mover in this young, nascent industry while maintaining its core competency of reverse engineering existing pharmaceuticals and undercutting prices.

To combat the rapid increase of public health-care expenditure, the continued production of low-cost generic alternatives necessitates the profitability of generic pharmaceutical manufacturers. Only then can manufacturers like Teva continue to challenge intellectual property rights, prevent price gouging and democratize pharmacare access for the greater good of society.