Harriet Lefton

About the Author Harriet Lefton

Harriet originates from the UK where she worked as a journalist specializing in the metal markets. She graduated from the University of Cambridge before becoming a qualified UK lawyer.

Ex-Harvard Endowment Bosses Make Surprise Bet on Teva Pharmaceutical Industries Ltd (ADR) (TEVA), Say Goodbye to Valeant Pharmaceuticals Intl Inc (VRX)

This billion-dollar hedge fund initiates new position in struggling pharma TEVA as exits VRX.

The wildly successful Adage Capital hedge fund left one struggling pharma giant for another in the last quarter, according to just-released 13F forms filed with the SEC. We can see that the fund demonstrated a surprisingly bullish sentiment on Teva Pharmaceutical Industries Limited (NYSE:TEVA) while taking profits on Valeant Pharmaceuticals International, Inc. (NYSE:VRX).

Intriguingly, the fund was founded back in 2001 by two former Harvard endowment execs, Philip Gross and Robert Atchinson. Both Gross and Atchinson worked at the billion-dollar Harvard Management Company- and according to Harvard Magazine their team outperformed the S&P 500 index by an average of 4.5 percentage points annually.

Investors track this $28 billion fund carefully as it has a record of making very profitable decisions. The most noticeable: its almost $1 billion gain on Puma Biotechnology in just one day. The stock quadrupled back in July 2014 on the announcement that its experimental drug blocked the return of breast cancer in women with an early-stage of the disease. At that time, Adage was the largest shareholder in Puma with a 19% stake (5.69 million shares). “They [Adage] consistently add value,” Meyer, who now runs hedge fund Convexity Capital Management told FINalternatives. “I am a huge fan.”

Now the Adage fund uses a rare fully “net-long” trading strategy with a heavy emphasis on long bets over shorts, and keeps 100% exposure to the S&P’s rise and fall. And the fund also has a very attractive cost-structure for investors as it only collects its 20% performance fee if it beats the S&P 500 including dividends. This hasn’t been too costly for the firm however as it has beat the S&P 500 by 3.27% a year on average over the past 14 years.

Bearing this in mind, let’s take a closer look at the fund’s take on these two pharmaceuticals now:

Teva Pharmaceutical Industries

In the last quarter the fund initiated a surprise position in flailing giant pharma Teva. Adage Capital picked up 250,000 Teva shares valued at $4,400,000.

Shares in copycat drug maker Teva plummeted in July to the lowest levels in almost two decades – and it appears that Adage sees these new prices levels as a much more attractive entry point. Following a disastrous earnings report, Teva shares fell from $33 at the end of July, to a low of $11.23 in November. Now the stock is trading slightly up at $16.06. Teva has made a series of somewhat encouraging recent announcements regarding its plans to turn the company’s fortunes around.

The latest word on the Street is that Teva now plans to cut a further 10,000 jobs. According to Bloomberg sources, the new CEO Kare Schultz intends to slash expenses by between $1.5 billion to $2 billion. Apparently approximately half of these cut will be from the research and development (R&D) department. These sources also revealed that Teva has no short-term plans to raise money via an equity offering. The market approved of these revelations, and share prices are now trading at a two-month high. Further details of the company’s plans to cut debt should become clear when Schulz discloses his detailed strategy in mid-December.

But he will have to make drastic decisions if Teva wants to substantially improve its $35 billion debt position. Indeed, Teva’s credit rating has already been cut to junk status by rating agency Fitch in early November. Fitch cited the company’s “significant operational stress” as impairing TEVA’s ability to cut the debt. The company has been struggling since taking out loans to buy a generic drugs division of Allergen for $40.5 billion last year. Global sales of its best-selling Copaxone drug for multiple sclerosis are also dropping. The pharma giant has already announced that it will shut 17-18 plants in 2017/2018 and exit 45 countries by the end of this year.

“We are growing increasingly constructive on TEVA because we think new management plans to announce stronger-than-expected cost cuts and provide visibility towards future de-levering in an attempt to avoid a downgrade” says top Mizuho analyst Irina Rivkind Koffler. She has a Hold rating on the stock and $16 price target. Koffler expects Schultz to announce major cost cuts and to pause asset sales for the time being (possibly to improve operating margins and drive higher valuations). Teva could also dial back its common dividend remainder of $380 million.

Unsurprisingly perhaps, this stock has a Hold analyst consensus rating on TipRanks. In the last three months, we can see from TipRanks that Teva has received only 3 buy ratings versus 12 hold ratings and 4 sell ratings. These analysts have an average price target on the stock of $14.86, which stands at a -7.5% downside from the current share price.

Valeant Pharmaceuticals

In the last quarter, the fund exited this controversial Canadian pharma stock completely. The fund sold off 200,000 VRX shares worth $2,866,000.

Perhaps the fund’s patience has run out with Valeant- because any recovery will certainly take several years at the very least. However, despite this difficult long-term prognosis VRX is currently trading at a three-month high of $19.70. This is still hugely below 2015 price levels of around $250- but it is a positive sign for those who are sticking with this troubled stock. VRX stock plunged an epic 90% back in 2015 on allegations of improper accounting and predatory pricing coupled with a huge appetite for acquisitions.

The reason for the current share rise of 11%? There is no specific reason- suggesting that the market is becoming increasingly comfortable about Valeant’s current position. The company reported a solid earnings beat on both the top and bottom line for the third quarter, and while most analysts are still sidelined on the stock the tone regarding VRX does seem to have improved. For example, VRX has met its EBITDA forecast for the full year without resorting to selling key assets like eye division Bausch + Lomb.

At the same time, investors and analysts alike are impressed by the scale of new CEO Joe Papa’s debt management skills. By the end of the third quarter, Papa has even beat his own targets with a debt cut of $6 billion since the first quarter of 2016. He had been aiming for $5 billion by February 2018. While this reduction has been made possible mainly via selling assets rather than generating positive cash flow- it is still something of a relief to investors and gives the company further flexibility going forward.

TipRanks reveals that Valeant still has a cautious overall analyst consensus rating of Hold. This isn’t too surprising when you consider that even with these improvements, VRX still has a $27 billion debt position to deal with- and the corresponding interest payments of around $459 million per quarter. Indeed, the stock has only received 1 buy rating in the last three months, alongside 7 hold and 3 sell ratings. With the stock currently trading at $19.70, the average analyst price target of $16 translates into a -19% downside from the current share price.

For example, top BMO Capital analyst Gary Nachman recently reiterated his Hold rating on VRX with a $17 price target. He respects the company’s ‘solid execution’ in Q3, and says this represents a step forward for Valeant. “VRX appears to have made some headway generating respectable growth in the B&L/Intl. and Branded Rx businesses, delivering better-than-expected cost savings, executing on some asset divestitures, and pushing out debt to 2020 and beyond” says Nachman. Ultimately however he concludes “we are still concerned about durability of growth in key franchises and continued headwinds with US Dermatology and US Diversified.”


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