This is from the portfolio update released Wednesday, June 24, 2015. If you want to see the latest portfolio update as soon as it’s released then join our mailing list here.
We sold Teva Pharmaceuticals (TEVA) in all dividend strategy portfolios on Monday, June 22. We began buying TEVA for dividend strategy portfolios in September 2012. We were originally attracted to TEVA because of its leading position in generic drugs, its free cash flow generation from its branded drug division, its recent dividend growth, and its cheap price to our estimation of its intrinsic value. Teva’s stock price was also suffering from a recent executive shake-up and short-term market uncertainty in its management. The qualities above lead Teva to produce annualized returns of 19.46%* in client portfolios from our first purchases in September of 2012.
While Teva still remains a leader in the generic drug business its other qualities have changed enough to warrant a sell in portfolios. Most notably, Teva’s dividend growth has been flat on a year-over-year trailing 4 quarter basis and we don’t expect the dividend to increase meaningfully in the near-term for the following reasons:
1) Teva’s blockbuster branded drug Copaxone went off patent this year. Novartis (NVS) through its generic drug division, Sandoz, and Momenta just launched their copies of Copaxone. Mylan Labs (MYL) is expected to launch their own copy in 2016. Reduced revenue from Copaxone will pressure Teva’s free cash flow and ability to increase its dividend.
2) The risk of Teva overpaying for Mylan Labs (MYL) is growing. Teva wants to offset its waning branded drug sales and increase its position in generic drugs through the purchase of competitor Mylan. Teva offered $40.1 billion or $82 per share in cash and stock for Mylan and management turned the offer down. Mylan’s management also said they will only entertain offers near $100 per share. In response, Teva has purchased a 4.6% stake in Mylan stock and plans to undergo a hostile takeover.
A “friendly” merger between two companies is hard enough to execute but a hostile one is very challenging. Also, to win over the other shareholders in a hostile takeover will likely require a high price per share, perhaps one that drastically overvalues the target company. We’ve stated many times that the price you pay for any asset determines your return. Any asset becomes a bad investment if you pay too high a price. Teva may ultimately win their pursuit of Mylan but whatever cost savings and scale they think they can achieve might not make up for the price they ultimately pay.
3) To get to the high price needed to win over outside Mylan shareholders, Teva will need to take on a lot more debt. Any excess cash flow from the combined businesses will go to paying down this debt instead of increasing its dividend at an acceptable rate.
We don’t expect the cash from the sale of Teva to remain idle for long. We’re tracking a couple other potential investments that we think offer greater dividend growth and more value for the price they’re currently trading at.
If you would like to discuss anything from this letter further, please don’t hesitate to reach out to us.
Your Portfolio Management Team
*While all clients were profitable on their position in TEVA, not all clients achieved this return. Clients who invested in the dividend strategy after September 2012 invested at a different price and did not achieve the specific return outlined above. Additionally, clients who invested in the strategy more recently likely did not own shares of TEVA as we have not added to this holding since the fourth quarter of 2013.