Teva's Schultz Faces Dwindling Choices as Rating Cut to Junk

(Bloomberg) -- Teva Pharmaceutical Industries Ltd. Chief Executive Officer Kare Schultz is finding himself in the hot seat in his first week on the job with rapidly shrinking options to halt the slide in the Israeli company’s securities after its debt was cut to junk overnight.

Fitch Ratings cited the “significant operational stress” that the world’s biggest maker of copycat drugs faces at a time when it needs to pay down debt, and pared its rating by two levels to non-investment grade late on Monday. Teva’s debt obligations are almost three times its market value following an ill-timed $40 billion acquisition last year of Allergan Plc’s generics business.

“We find it troubling that management, which presumably met with Fitch before the downgrade, was not able to convince the rating agency that it would take more dramatic deleveraging actions in order to preserve investment grade ratings,” Carol Levenson, an analyst at bond research firm Gimme Credit, said in a report.

The company will have to either sell assets or find external sources of financing to meet its obligations, Fitch said. Sales of Teva’s biggest drug, Copaxone, are under siege after a cheaper copycat version of the multiple sclerosis medicine entered the U.S. market last month. Schultz, who took the helm at the start of this month, has pledged to increase profits and cash flow.

While Teva has enough free cash flow and proceeds from asset sales to pay down short-term debt, tackling longer-term leverage could be much more difficult. With the stock down 70 percent this year, issuing straight equity is an increasingly less attractive financing option. That may leave hybrid securities like mandatory convertibles the best source of new capital, Levenson said.

Fitch downgraded the company’s debt rating to BB from BBB-. Standard & Poor’s and Moody’s Investors Service have both assigned it the lowest investment-grade rating, and all three have warned another downgrade is possible.

Forced Sellers

“The two-notch downgrade by Fitch is harsher than expected,” said Bastian Gries, head of investment-grade credit at Oddo BHF Asset Management GmbH, which manages about 100 billion euros ($116 billion) of assets. “It triggers index changes to high-yield and emerging-markets, which will probably force some more people to sell.”

Teva’s bonds fell further following the downgrade. The company’s 700 million euros ($810 million) of notes due in March 2027 dropped as much as 3.5 cents on the euro to a record low of 86 cents before paring much of the loss, according to data compiled by Bloomberg.

Shares of Teva slid 3.6 percent in Tel Aviv. Denise Bradley, a spokeswoman for the company, declined to comment.

Another Cut

Last week, Teva slashed its 2017 profit forecast for a third time as generic drugs face intensifying competition and declining prices in the U.S., their largest market, compounding the company’s woes with Copaxone’s declining sales. 

Interim Chief Financial Officer Michael McClellan said on a call with analysts that a downgrade to junk would lift the interest rates on Teva’s $6 billion term loans by 0.25 percent. The company may look to refinance the $13.5 billion of bonds due in the next three years, in which case the rating cut would tack on up 1.5 percent to Teva’s financing costs, he added.

Levenson would rather see Teva try to reduce its nearly $35 billion of short- and long-term debt rather than refinance it. Much of that stems from its acquisition of Allergan’s generics business, Actavis, which Teva funded with bonds that generally have maturities between two and 12 years.

“Ironically, we all thought it was a good sign that it was using intermediate-term maturities, signifying its intention to pay down acquisition debt quickly,” Levenson said. “The world has changed since then for Teva, however, and these maturities are hampering its financial flexibility.”

To contact the reporters on this story: Katie Linsell in London at klinsell@bloomberg.net, Yaacov Benmeleh in Tel Aviv at ybenmeleh@bloomberg.net, Cynthia Koons in New York at ckoons@bloomberg.net, Molly Smith in New York at msmith604@bloomberg.net.

To contact the editors responsible for this story: Chitra Somayaji at csomayaji@bloomberg.net, Marthe Fourcade

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