Health and Healthcare

Why Teva's $20 Billion Bond Sale Makes Sense, as Long as It's a Fixed Rate

Rafi Farber

Published: July 14, 2016 12:20 pm

Last Updated: January 13, 2020 5:43 am

Teva Pharmaceuticals Industries Ltd. (NYSE: TEVA) is about to take on a huge $20 billion to $25 billion mortgage in order to finance its takeover of the generics business of Allergan PLC (NYSE: AGN). The move makes sense not just from an interest rate perspective, but from a comparative advantage one as well.

Lucky for Teva, interest rates on all kinds of debt have never been lower in recorded human history, and they keep getting lower even beyond basic logic. With negative interest rates throughout much of Europe, including most recently Germany, and bonds at all-time records in the United States as well, the demand for debt is so astronomically high that investors are anxiously buying up return-free risk. Loan money at a negative rate and you are guaranteed to get less of it back at negative coupons, and still buyers are jumping at the chance.

Unfortunately for Teva, negative rates have still not infected corporate bond markets, so Teva actually will have to pay something for the money it is borrowing. Imagine that. As long as Teva can lock in a fixed rate, either directly or through derivative hedging, the generics giant should be able to pay off the loan easily. These massive moves are precisely what central banks the world over intend to stimulate when they print money in order to lower interest rates. Apparently it’s working.

What percentage of this coming debt offering will be fixed versus floating is still unclear, but what we do know is that Teva is judicious with its debt load. Of the $10 billion plus that is now on its balance sheet, $8.3 billion of that debt is protected against rising interest rates, either due to the debt itself or protection through derivative interest rate hedging activity. That puts the amount of unprotected fixed rate debt to equity at only 3.2% for Teva, a microscopic number during a time when debt is being accumulated at unprecedented rates all over the world. Even assuming Teva raises the higher end of its estimate at $25 billion at fixed rates, that would put its total leverage at 67%. That’s a high number but nowhere near dangerous, assuming it is mostly fixed.

Beyond a pure debt perspective, Teva’s move makes sense from a dry math perspective as well as a political one. Teva’s generics business has been leveling off since 2012, with generic revenues at $10.4 billion back then compared to $9.55 billion in 2015, for a decline of 8% in three years. Allergan’s generics business also has stagnated, which is one of the reasons why it agreed to sell the segment to Teva. Head to head though, Teva is a more efficient generics firm than Allergan. Profit margins for Allergan’s generic segment amounted to 20% in 2015, way down from the 32% margins achieved in 2014. Teva’s generics margins have gone in the opposite direction, up to 28% in 2015 from 17% in 2013. That 28% is much higher than any interest the firm will have to pay on its new debt, so the numbers work out.

Politically as well, the biotech sector has been under attack ever since the fall of Valeant Pharmaceuticals International Inc. (NYSE: VRX) due to higher and higher drug prices that generic competition can help lower. By consolidating generics, Teva could be hoping to take advantage of the wave of negativity over skyrocketing drug prices and hedge itself a bit in order to protect its own branded business. If governments begin making it easier for generics to compete with brands in order to lower prices, Teva could end up riding that wave.

So long as Teva does not expose itself to floating rates on its upcoming $20 billion bond offering, the company should do just fine. Those willing to loan it all that money are the ones who are at greater risk of losing out if inflation beings to eat into principle.