Given the negativity surrounding generic pharma companies in the U.S., we are quite puzzled by the valuations of branded pharma companies such as Pfizer, Merck and JNJ. After all, weren’t generic companies the “good” guys who were supposed to give us cheaper alternatives to the expensive branded medicines of the likes of Pfizer, Merck and JNJ?
If generic companies are the culprits for the excesses of the U.S. health care system (namely high drug prices), then where does that leave the branded pharma giants? Apparently, in valuation la la land!
Consider this: Pfizer, Merck and JNJ have a combined market value of around $730 billion and a combined enterprise value of around $800 billion. Based on average analyst estimates for 2018, this implies an EV/revenue ratio of around 4.5x and an earnings yield of less than 7% for this trio of branded pharma giants.
In contrast, two of the world’s largest generic companies – Teva and Mylan – have market values totaling less than $35 billion (roughly $17 billion apiece) and enterprise values totaling around $85 billion. Based on average analyst estimates for 2018, this implies an EV/revenue ratio of less than 2.5x and an earnings yield of around 20% for the two black sheep (~25% for Teva and ~16% for Mylan).
How can such a valuation discrepancy between the branded and generic companies be justified? Of course, the high debt levels at Teva and Mylan, coupled with negative operating trends, make their equity valuations quite speculative. But should these two companies, combined, really be worth 1/10th of the combined enterprise value of Pfizer, Merck and JNJ?
According to a recent Bloomberg article, the problems of U.S. generic companies can partly be attributed to the rapid recent rise of India-based firms such as Aurobindo Pharma and Cadila. Somewhat ominously for the likes of Mylan and Teva, their India-based rivals – in total – apparently took 40% of new U.S. approvals for generics in the first half of 2017.
Be that as it may, why would the likes of Pfizer, Merck and JNJ remain immune over time to such competition and the apparent price pressure it is bringing? Or remain immune to the regulators who are supposedly so intent on curbing drug prices? Of course, one explanation could be that – given their much bigger size – the likes of Pfizer, Merck and JNJ have much bigger lobbying budgets in Washington…
If the U.S. health care system is suffering from too high drug prices, how can the answer be more competition among generic companies? What about the branded giants? Are they really that immune to competition as their high valuations suggest?
While we are not necessarily advocating investing in Mylan or Teva – even at their recent depressed share prices – we are quite puzzled why anyone would want to own Pfizer, Merck or JNJ, especially if they think that the troubles of Mylan and Teva are justified.