Teva Pharmaceuticals’ EBITDA may decline beyond estimates communicated to investors if the company faces additional generic competition to its Copaxone 20-mg and 40-mg multiple sclerosis treatment products. Although the timeline is unclear, such a decline is likely to happen, given rulings against Teva in patent hearings and litigation.
Teva management’s most comprehensive guidance for the impact of generic alternatives to Copaxoneassumes the introduction of onlyone to two new generic manufacturers. Five potential competitors have lodged first-to-file applications to produce generic alternatives to the drug, suggesting Teva will be more pressed to defend current market share.
Copaxone has contributed significantly to Teva’s LTM financial results, generating 17% of the company’s consolidated net revenue and 59% of segment operating profit, as previously reported by Reorg Research.
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Aggressive defensive tactics used by Teva to successfully promote and empower Copaxone 40 mg in the face of 20-mg generic competition may not be as effective against the threat of a 40-mg generic competitor. Momenta Pharmaceuticals, which introduced the 20-mg generic competitor to Copaxone and may imminently bring a 40-mg generic to market, has said that some of Teva's most successful strategies against the 20-mg generic will fall apart in the face of 40-mg competition. For example, Teva tied provider rebates on Copaxone 40 mg to continued use of Copaxone 20 mg, significantly hindering Momenta’s ability to capture market share with Glatopa 20 mg. It is an “exclusionary” strategy, but it will crumble once Momenta releases its 40-mg generic product, Momenta CEO Craig Wheeler said at a conference in March 2016.
“If you have a 40-mg product, then you basically take away that weapon because you can actually duplicate that strategy. You have the full portfolio of products that your competitor has, that Teva would have,” Wheeler said.
Teva continues to face an uphill battle given accelerating declines in generic drug prices and broader incentives that exist for pharmacies and insurers to prescribe generic drugs over branded versions. Teva has raised its expectations of generic price erosion to the high single digits on a percentage basis, as has Mylan, which is the second-largest generic drug producer.
These expectations for steeper erosion are in addition to Teva's rapidly consolidating buyer base, which consists of increasingly powerful group purchasing organizations that have used their clout to push generic drug prices lower. Teva also faces a regulatory environment intent on paring back drug costs.
Assuming a starting figure of Teva’s midpoint 2017 adjusted EBITDA guidance, downside scenario run-rate EBITDA could drop to approximately $5.5 billion, factoring in the impact of Copaxone generic competition and total U.S. generic price erosion, offset by new generic product launches and the realization of synergies after the acquisition of Actavis Generics. Teva can counter the impact of declining Copaxone sales by introducing new specialty pharmaceuticals that are currently in the pipeline. Those launches take time to execute and for the market to develop. Although generic competition to Copaxone has been delayed, it is important to gauge Teva’s run-rate EBITDA in the event of a sizable drop in Copaxone market share.
Considering the company’s potentially limited options for combating generic competition to the 40-mg product and assuming sales and pricing declines in line with industry averages after facing generic competition - factors that are discussed below - our illustrative overview of potential downside case EBITDA impact is as follows:
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Teva Guidance
In February, Teva provided guidance to quantify the impact of one to two generic competitors to 40-mg Copaxone. It guided to a 2017 revenue impact between $1 billion and $1.3 billion and earnings per share impact between 75 cents and 95 cents, assuming one to two competitors were to launch a generic in February 2017. On the company’s second-quarter earnings call, management indicated that one full quarter of competition from one or multiple generics would affect EPS by 20 to 25 cents.
Teva does not break down Copaxone revenue between the 40-mg and 20-mg products, but it does provide detail on the number of prescriptions filled. Over the last 12 months, Teva generated $3.328 billion of revenue from Copaxone in the U.S. According to the company’s latest quarterly filing, 85% of U.S. Copaxone prescriptions were filled with the 40-mg version. According to prices listed on GoodRx, the average price of a 40-mg Copaxone carton from Walmart, Costco and Target is roughly 82% of the price of a 20-mg carton.
Although net pricing to Teva could vary from the gross prices listed above, adjusting for the pricing information that is available, Teva is estimated to have generated approximately $2.7 billion from U.S. sales of 40-mg Copaxone and $589 million from U.S. sales of 20-mg copaxone over the last 12 months. Applying the LTM franchise operating margin to those figures implies $2.2 billion of operating profit generated from 40-mg U.S. Copaxone sales and $473 million from 20-mg sales.
Applying this split in revenue to the company’s guidance on the impact of generic Copaxone suggests Teva appears to be guiding toward a roughly 40% decline in estimated U.S. 40-mg revenue. The 20-mg version of Copaxone has lost approximately 40% market share to Glatopa, the only generic alternative currently available in the 20-mg market:
Despite these estimates, differences in context indicate that Teva will have a more difficult time defending market share of the 40-mg product, suggesting that the EBITDA impact estimated by Teva may be low over the long term. Momenta, which brought the Glatopa 20-mg to market to compete with Copaxone as a generic alternative, aims to obtain FDA approval for a generic version of the 40-mg drug. The company does not expect the same level of difficulty encountered when trying to penetrate the 20-mg market, according to management. The barriers that Momenta faced were largely orchestrated by Teva in what has been referred to by analysts as one of the best switches executed in the pharmaceutical industry.
The 20-mg Experience
When Momenta launched Glatopa 20-mg, it was in the face of three years of “counter-detailing” by Teva as part of a campaign to empower its 40-mg Copaxone product and fiercely defend its share of the 20-mg market. Counter-detailing is described by the medical community as the use of educational “props” by pharmaceutical companies and drug representatives to influence drug prescribing practices. In addition, Teva “did everything they could in terms of throwing wrenches into the FDA approval process, as well as trying to create concern in the medical community,” Momenta’s Wheeler said at the conference in March last year.
The biggest challenge for Momenta was that Teva complicated contracting for various potential accounts in the 20-mg market through a “franchise rebating strategy” that tied rebates on Copaxone 40 mg to continued use of Copaxone 20 mg, Wheeler said on Momenta’s fourth-quarter and year-end earnings call for 2015. As a result, Sandoz, the generics division of Novartis that Momenta partners with for marketing Glatopa 20 mg, has had “a very hard time” penetrating the corner of the market that Teva controls, Wheeler said. Given the dual Copaxone rebates, Sandoz ends up unable to make money in accounts where Glatopa must compete with the Copaxone rebates, Wheeler said.
Teva aggressively cut the cost of Copaxone 40 mg relative to Copaxone 20 mg to incentivize a shift in patients. When the U.S District Court for the District of Delaware invalidated four Copaxone 40-mg patents in January, the judge discussed in his memorandum opinion this aggressive pricing strategy as it related to Copaxone 40 mg’s commercial success. The judge’s opinion cites evidence presented at trial describing how Copaxone 40 mg was priced “substantially lower” than the 20-mg product. The opinion notes a specifically planned 10% price increase in the 20-mg product to widen the spread between the 20-mg and 40-mg products, thereby driving 40-mg conversions.
Before the launching of Glatopa 20 mg, Teva employed a strong “dispense-as-written campaign” so that patients would implore their doctors to keep prescribing branded Copaxone over the cheaper generic. Teva urged patients to be “proactive” by calling their pharmacies “right away” to insist that branded Copaxone be filled over the cheaper generic. Doctors were compensated by Teva for video advertisem*nts in which they extolled the benefits of thrice-weekly 40-mg injections for glatiramer acetate, as opposed to daily 20-mg injections.
As a result, Momenta watched Glatopa prescriptions change back into Copaxone prescriptions, Wheeler said on Momenta’s call to discuss 2015 fourth-quarter and full-year results. Earlier this year in March, a former Teva executive told analysts that Copaxone 20 mg still held 60% of the 20-mg market versus Glatopa, with 50% of those Copaxone prescriptions dispensed as written.
The Context TodayAs described above, Teva’s 40-mg Copaxone served in part as a defensive move against imminent generic competition to its 20-mg product by Momenta’s Glatopa. The strategies employed, as well as the attraction of a higher dosage with fewer requisite weekly injections, allowed Teva to lure providers and their patients to its 40-mg product. More than 85% of Teva’s 20-mg patients have switched to the 40-mg product, management said on the company’s last earnings call. To counter generic competition in the 40-mg market, Teva has said it would consider employing strategies similar to those used to protect Copaxone 20 mg while promoting Copaxone 40 mg.
Momenta has communicated its confidence that Teva’s aggressive contracting methods will not have the same detrimental effects on a generic 40-mg product. For its part, Teva has neither publicly discussed nor disclosed whether it would tie Copaxone rebates to other in-demand medications, so it is not clear how Teva would be able to defend its market share in the same manner or how Teva would be able to shift the market for multiple sclerosis treatment in its favor under the threat of generic competition.
If Teva were to introduce a Copaxone product of an even higher dosage to be administered more infrequently, the company’s experience attempting to protect the patents for its 40-mg product could provide valuable insight. The five U.S. Orange Book patents meant to protect Copaxone 40 mg until 2030 face numerous legal threats in various venues, with courts and patent authorities thus far siding with the generic competitors seeking to overturn Teva’s claims to patent protection. All of Teva’s claims for three of its Copaxone 40-mg patents were declared unpatentable by the U.S. Patent Office in inter partes review proceedings, though Teva has appealed those decisions. In January, four of the Copaxone 40-mg patents were invalidated by a federal judge in paragraph IV litigation in the U.S. District Court for the District of Delaware.
The judge’s memorandum opinion from January’s patent ruling may provide insight on Teva’s ability to retain patent protection based on claims related to dosage and administration. The four Copaxone 40-mg patents that were struck down by the Delaware court were found by the judge to be “invalid as obvious,” meaning that the patents did not demonstrate the novelty or innovation necessary for patent protection. For three out of the four patents, the court took issue with claims that the 40-mg dosage, at thrice-weekly administration intervals, represented innovations requiring patent protection. Those three patents hinged on the size of the dosage and the frequency with which glatiramer acetate, Copaxone’s active pharmaceutical ingredient, is administered.
The obviousness standard requires that an invention not be obvious to a person skilled in the area of invention based on one or more other inventions known at the time.
Aside from the medical and legal challenges posed by introducing another new product, Teva has separately indicated openness to re-engaging in dispense-as-written campaigns in the event of generic product launches.
Each U.S. state has a law allowing pharmacists to substitute generic drugs for many brand-name products, as long as the prescribing doctor does not specify that the brand-name drug is required, according to the FTC. Dispensed-as-written campaigns can prevent this substitution by encouraging doctors to make these specifications.
Beyond the strictures of dispensed-as-written requirements, pharmacies and benefit managers can, for their part, employ various strategies to promote generic alternatives. The FDA estimates that generic drugs cost 20% to 70% less than their brand-name counterparts. Pharmacies and insurance companies sometimes get rebates or other incentives when they convince a plan member to switch from branded to generic drugs, according to the FTC.
Indeed, increasing generic dispensation has been financially advantageous for CVS Health, which runs a national chain of retail pharmacies as well as the major benefits manager CVS/Caremark. In the three months ended June 30, CVS’ total generic dispensing rate increased 87.2%, compared with 85.9% in the prior year, which in turn drove growth in the segment’s gross profit margins, according to the 10-Q. The largest insurance providers, including Cigna, Aetna, Anthem BlueCross BlueShield and Humana, openly advocate for use of generic drugs over branded drugs. Because generic drugs cost less, they can be cheaper from a coverage standpoint for the insurance companies.
That said, a recent investigation by ProPublica and The New York Times found that some pharmaceutical companies are cutting deals with insurance companies and benefit managers including CVS/Caremark to favor brand-name products over cheaper generics. The news outlets reported that in December, CVS/Caremark sent a memo to pharmacies to inform them that some of its Medicare prescription drug plans would cover only the brand-name versions of 12 drugs, including Teva’s Copaxone.
Cash Flow ImpactAlthough Teva subdued the impact of generic competition to the 20-mg version of Copaxone, for the reasons discussed above, the company appears to have less tools available to defend the 40-mg version. The market share loss and impact on Teva’s financials from the introduction of generic alternatives may be greater than what the company experienced with the 20-mg version.
Research from a 2016 Journal of Medical Economics article by Grabowski, Long, Mortimer and Boyo titled “Updated trends in US brand-name and generic drug competition” suggests that generic competition continues to take market share from branded drugs at an accelerated pace and to a larger degree than 30%. The research concludes that for drugs experiencing initial generic entry in 2013-’14, “after generic entry, brands rapidly lost sales, with their average unit share being 7% at 1 year” for new molecular entities with sales above $250 million and 12% overall.
Considering this industry average and assuming Teva loses 90% of the current U.S. 40-mg Copaxone market and applying the same margin to the remaining sales would imply a roughly $2 billion impact to Teva’s operating profit. The impact to operating profit could be greater given the potential difficulty in cutting fixed costs to support the MS franchise and given that management has indicated that additional funds will be required to support the overall glatiramer acetate market if generic alternatives are launched.
Introduction of a generic alternative to 40-mg Copaxone could affect Teva’s sales of 20-mg Copaxone as well. First, the overall 20-mg Copaxone market could continue to decline as patients shift to the more patient-friendly 40-mg version. In addition, it should be simpler for new generic manufacturers to produce varying doses once they have achieved initial approval for the active pharmaceutical ingredient, opening the door to additional generic competition to 20-mg Copaxone too. Teva has approximately 60% of the 20-mg market with one generic alternative available. If additional generics enter the 20-mg market and Teva’s share is driven to 10%, the impact to Teva’s operating profit could be roughly $400 million.
Although management has not officially indicated that Teva will introduce an authorized generic to help retain market share if third-party generic alternatives to 40-mg Copaxone are launched, the company has discussed the strategy.
FDA data indicates that generic drug prices drop as a percentage of the branded price when additional parties launch generic alternatives. The largest drop occurs when a second generic manufacturer enters the market, and by the time a fifth manufacturer enters the market, the price drops to 33% of the branded price on average.
Assuming Teva launches an authorized generic as the fifth generic manufacturer and retains one-fifth of the 90% of the 40-mg market captured by generic manufacturers, Teva could generate an additional $191 million in revenue at the lowered price. Assuming that the authorized generic operates at the same cost structure as the current 40-mg platform, roughly 20% of the branded price, Teva could generate an additional $78 million operating profit from the launch of an authorized generic. Similarly, Teva could introduce an authorized generic version of 20-mg Copaxone; however, the benefit would likely be smaller given the shrinking size of the 20-mg market.
Teva generated $1.3 billion of revenue from its generics division in the U.S., implying an annualized rate of nearly $5.2 billion. Teva’s management has highlighted that the company expects to see high single-digit price erosion within its U.S. generics business going forward. We assume further price erosion of 8% to the current U.S. platform beyond this year, implying a roughly $413 million negative impact to run-rate operating profit.
To offset generic price erosion, Teva has launched new generic products to add to the company’s portfolio. Management said that it expects to generate $500 million from new product launches this year. During Teva’s second-quarter 2017 earnings call, management highlighted that products expected to generate $270 million of revenue had already been launched. Although the impact of the incremental $500 million is included in Teva’s full-year guidance, the products will be launched unevenly throughout the year. Assuming the new generic products can generate an incremental $500 million if available in the market for an entire year, the products could add approximately $135 million to Teva’s operating profit at current margins.
Management has highlighted $1.6 billion of cost and expense synergies they expect to achieve by end of 2017. According to management, the company realized $800 million through the second quarter. We assume that means an $800 million run rate and also assume synergies will be linear, implying average savings of $800 million for the full year. Therefore, we add an incremental $800 million benefit on top of 2017 end-of-year guidance to account for a full year of savings.
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