"I Pray for the Welfare of Your Company..."

October 1, 2006

Pharmaceutical Executive

Volume 0, Issue 0

Isr?l makov has adventure in his blood. A fourth-generation Isr?li, he speaks proudly of his great grandmother, who bought and sold wool in Russia until the late 1890s when, at the age of 50, she moved to Palestine, bought a piece of land, and helped found a town in the wilderness. It was the kind of career move that Makov, CEO of Teva Pharmaceuticals, admires and emulates. As a boy, he rode a donkey to work in his father's orchards on the land his great grandmother bought. He attended an agricultural boarding school, started his career in citrus exports and-decades before Teva recruited him-managed Abic, the second-largest pharma company in Isr?l, and founded Interpharm, the country's first biotech company.

Israel makov has adventure in his blood. A fourth-generation Israeli, he speaks proudly of his great grandmother, who bought and sold wool in Russia until the late 1890s when, at the age of 50, she moved to Palestine, bought a piece of land, and helped found a town in the wilderness. It was the kind of career move that Makov, CEO of Teva Pharmaceuticals, admires and emulates. As a boy, he rode a donkey to work in his father's orchards on the land his great grandmother bought. He attended an agricultural boarding school, started his career in citrus exports and—decades before Teva recruited him—managed Abic, the second-largest pharma company in Israel, and founded Interpharm, the country's first biotech company.

"I was a pioneer in almost everything that I did," says Makov, 66, who also had a brief and successful career in women's fashion. "I moved from one industry to another, which is a huge personal challenge."

At-Risk Launches

Not that he was never fearful. Makov served as a paratrooper in the Six-Day War in 1967. When he later boarded his first commercial flight (to London to work as an economist with Israel's Citrus Marketing Board), he was alarmed to discover, he says tongue-in-cheek, that the airline expected him to fly without a parachute.

A sunny and cheerful man, Makov arrived alone for an interview with Pharm Exec, without the public-relations entourage that typically accompanies pharma CEOs, at the Sherry Netherland Hotel in New York. He seemed amused at the notion that his company, the largest generic-drug manufacturer the world has ever known, might frighten the branded industry. "I was introduced to the president of a very large pharmaceutical company," he recounts in his colorful, heavily-accented English. "When they said, 'This is Mr. Makov,' he said, 'Ooh, you are my enemy!' It happened in front of many people and was very embarrassing. So I told him, 'Mr. So-and-so, I really don't understand what you're telling me. I wake every morning and I pray for the welfare of your company.'"

In fact, Teva is growing enormously fast on drugs that made Big Pharma rich. Pravachol (pravastatin), Zoloft (sertraline), and Zocor (simvastatin) are among the compounds heading up the 2006 product list that boosted second-quarter sales by 77 percent over the previous year to more than $2 billion. In North America alone, Teva's sales nearly doubled to $1.2 billion in the quarter. And with 148 abbreviated new drug applications (ANDA) awaiting final FDA approval as of August 1, 2006, Teva is waiting to take over (and yes, slash prices on) $84 billion worth of branded drugs. Third-quarter sales will easily outstrip those of the previous quarter, says Edward Thwaite, an analyst focused on the generic industry.

Teva is a master of efficient manufacturing-it plans to produce 36 billion tablets in 2006. Jacob Winter , head of global generic resources

For the branded pharmaceutical industry, Teva's success is a blessing and a curse. A robust generic industry is a prime driver of innovation. To survive, pharma must create new drugs that payers will buy over older, cheaper ones. Successful generic drugs also keep money in payers' budgets to cover newer and pricier innovative medicines. Only 10 percent of the estimated $250 billion the United States spends on pharmaceuticals each year goes for generics. But that relatively small sum pays for more than 50 percent of all prescriptions. "Just imagine if all those drugs would be prescribed with their original prices," Makov says. "Even in the US, you can't pay so much money."

Amir Elstein, head of biogenerics, are charged with creating new efficiencies in Teva's next growth platform-generic biologics.

Such sentiments are cold comfort to a brand manufacturer facing the generic threat. It's tough for pharma companies to love Teva as they watch blockbuster revenues shrink to a trickle. But Makov thinks companies should take another look at the company that now sells their former top performers. Teva, he says, has the adventurous spirit and tough business discipline that pharma needs. His managers know how to thrive even when risks are high, revenues are down, and it is time to cut costs.

Teva become a legal powerhouse in the Hatch-Waxman era, and built a tight, responsive organization within a vast network of international subsidiaries. The company that sits on the long end of the seesaw when it talks to tight-fisted payers in the age of Medicare Part D has a few things to teach Big Pharma. And the industry will do well to listen. Teva has applied what it learned in the generic business to its expanding innovative division, and plans to bring its pioneering spirit across the Atlantic when the US market opens to generic biologics. Listen up: Here are some of Israel Makov's lessons about life on the generic side.

LESSON #1

Eat or Be Eaten

Teva got its start around the turn of the century as a medicine-distribution company, which sent its wares throughout Palestine on the backs of camels and donkeys. The company gained momentum as many Jews boycotted German products. And then, all of a sudden, with the start of the second World War, Teva became one of the few sources of drugs for the region.

A History of Successful Integrations

After Israel was established in 1948, the local drug market grew, and Teva began exporting its products. In 1976, Israeli-based Assia and Zori, two smaller pharma firms, formally merged with Teva, launching its three-decade acquisition spree. It acquired Abic, Israel's second-largest pharmaceutical company; Plantex, which produced active pharmaceutical ingredients (API); and Migada, a manufacturer of disposable medical equipment. Most important, it opened the door to two key elements of its future: In 1986, it acquired Lemmon, a small generic manufacturer in Pennsylvania; in 2001, it gained full ownership of Teva-Marion Partners, which would later become the company's research-based division, Teva Neuroscience.

Makov came on board as vice president of business development in 1995 at an important cross-section in the company's history. (He was appointed president and CEO in 2002.) He had the experience of establishing Interpharm, the company that created Rebif, a treatment for multiple sclerosis and the first drug based on recombinant human interferon-beta. Now, Teva was preparing to launch its first innovative drug, Copaxone (glatiramer), to compete with Rebif. "So you see," says Makov, "I actually developed my own competitor for the future."

The company was struggling to understand what type of organization it wanted to be. Infatuated with the promise of Copaxone, Teva's leadership leaned toward becoming an innovator. "At the time—little did we know—we thought that the world was coming to us," says Makov. But it soon became clear that a small company in Israel couldn't compete with the brawn of the big, branded companies.

Perceiving that the generics industry was about to go through a major consolidation, Teva execs faced an existential dilemma: It was eat or be eaten—and they decided to eat. "But we knew that if we took that road and failed, it was the fate of the company," says Makov. "You can just cease to exist."

As generic competitors were swallowed up, Teva survived, and led the pack with some of the largest deals. Teva's $3.4 billion acquisition of Sicor in 2004 gave it an important new resource, the ability to manufacture specialty injectables—generic biologics. The recent $7.4 billion acquisition of Ivax made Teva the 16th-largest pharma company by prescription drug sales, and the largest by prescription drug volume.

But it's not just size that matters. Teva has an admirable track record of managing mergers so they create value—a rarity in pharma. (See "A History of Successful Integrations,".) "Our expertise in acquisition and integration of companies is unique not only in our industry," says Makov. "I don't know any other company where its two largest acquisitions became accretive in the second quarter."

LESSON #2

Hire Lawyers.A Lot ofLawyers

At innovator companies, execs dream of drugs that sail through clinical trials with stunning effectiveness and safety. Executives at generic companies probably dream about lawsuits. Under the Hatch Waxman Act, the first company to file an ANDA and a "Paragraph IV" patent challenge (named for the relevant section of Hatch-Waxman) wins 180 days of market exclusivity. This legal maneuver is Teva's bread and butter. "Teva is the most prolific—and most successful—of all companies when it comes to Paragraph IV filings," says Gregory Glass, editor of the Paragraph Four Report, which tracks these filings. "They're really head and shoulders above everyone else."

The company spends serious money on lawyers. "Teva's legal department is big," says Makov with a laugh. "We have many, many top-notch lawyers that work for us around the country. What do you think? That Pfizer puts against us the low-key lawyers?"

Paragraph IV: An Ever-Present Challenge

Only FDA knows how many of Teva's Paragraph IV challenges have succeeded, and FDA isn't talking. Teva reports that over the last four years, it has won eight cases, settled another eight, and lost two, although this count includes only court decisions that cannot be appealed. Teva says it is currently engaged in 50 patent challenges. Other numbers offer a different view. "Despite considerable success in the past in invalidating patents on key products—such as Merck's Fosamax—Teva has lost almost as many court cases as it has won," says Alasdair Milton, Wood Mackenzie's senior life sciences analyst. Milton's research says that, as of February 2006, Teva filed 160 ANDAs with FDA, 88 of which were Paragraph IV applications. Teva claims it was first to file a Paragraph IV challenge on 46 applications, all of which would win six months of market exclusivity if successful.

"Teva knows how to play the numbers game," says Joseph O'Malley, a lawyer at Fitzpatrick Cella Harper & Scinto and lead trial counsel for Pfizer in its case to stop Teva and Ranbaxy from selling Accupril (quinapril). "If you file enough challenges, you'll diversify your risk enough that it will only take a few successes to make you profitable," says O'Malley. "Between filing your ANDA and your legal fees, the risk is only about $10 million. And if it wins that case, it can catch 80 percent of the innovators' market—sometimes within two months."

The conventional wisdom holds that generic companies are quicker and slyer in the courtroom than innovator companies. But Big Pharma is fighting back. Take the case with Zocor, which Makov refers to, almost affectionately, as "simva."

Zocor's patent was set to expire on June 23, 2006. In December 2000, Ivax, then an independent company, was the first Paragraph IV challenger for the 5 mg, 10 mg, 20 mg, and 40 mg doses, while Ranbaxy was the first to file a patent challenge for the 80 mg dose. Teva finished out of the running—for the moment.

The stakes were high. A patent worth $4.4 billion dollars in brand sales hung in the balance. Merck made a surprise move and delisted the Zocor patents. It withdrew them from the Orange Book, apparently reasoning that if there was no patent, there could be no patent challenge. Ivax countered with a Citizen's Petition to FDA, arguing that it deserved exclusivity for following Hatch-Waxman protocol. Teva filed a petition too, arguing against exclusivity for its competitor. Eventually, Teva acquired Ivax—and with it, the status of first filer. Then Teva withdrew its original petition advocating non-exclusivity.

FDA eventually ruled that no company could claim the market for itself. It looked like there would be multiple generic entrants for Zocor, and the price would drop steeply. Undeterred, Teva sued FDA. And as the clock on the Zocor patent wound down, a federal judge ruled in favor of Teva. In a last-ditch effort, Sandoz attempted to block Teva's exclusivity. Finally, just one day before the patent on Merck's blockbuster expired, Teva won its case—and the right to be the sole purveyor of "simva" for six months.

"They survived the delisting, got through the FDA obstacle and the court process favorably, and then they got through other generic companies' protests," says Glass. "That's pretty good."

LESSON #3

Authorized Generics: What, Me Worry?

Authorized generics have challenged the generic manufacturers' role as pricing aggressor. Innovative companies create new drugs. When patents expire—or are invalidated—generic companies take over. "This is the cycle," says Makov. "We see it as very natural. But they want to extend the protection. The truth of the story is that it's not rivalry from our side; it's rivalry from their side. Every time we go to the market, they try to stop us with a huge fight."

Makov fought back against Pfizer, which released an authorized generic version of its epilepsy drug, Neurontin (gabapentin). But in Teva v. Crawford, the District Court of Appeals of the District of Columbia ruled against Teva in 2005, stating that Hatch-Waxman did not prevent a patent owner from reselling its own product at a cheaper price.

Most Teva execs will tell you that authorized generics violate the spirit of Hatch Waxman. They are unfair, unjust, and in the long run, bad for consumers. Branded companies argue just the opposite: More competition, specifically during the six months of market exclusivity, helps drive down prices. However, one thing is certain: Branded companies will try to stem their revenue losses with authorized generics and a variety of other tactics. "The branded industry is going to fight tooth and nail to minimize the impact of generics, be that through authorized generic deals, building up their own in-house generics division, or lowering the price of their branded drug to combat the generic," says Wood Mackenzie's Milton.

Merck's pricing strategy for Zocor provides a good example. As Teva began its six months of marketing exclusivity for generic simvastatin, Dr Reddy's began selling an authorized generic. Then, in a move that surprised most of the industry, Merck offered rebates to selected insurers, drastically cutting the price of its own drug.

"Typically, when a generic becomes available, the brand's rebates and contracts tend to go away," says Tim Heady, CEO of UnitedHealth Pharmaceutical Solutions, who was one of the architects of the deal. UnitedHealth offered to keep Zocor in the second tier and put the generic in the third tier, if Merck was willing to continue its rebate program. "But then we [agreed] that we would be willing to put them in the first tier if they increased the rebate," says Heady.

Makov expected Merck to do something to preserve Zocor revenue, but this particular move caught him by surprise. The morning Merck's deal with UnitedHealth was announced, Makov got calls from people all over Israel. "I told them that it's really against the interests of all the players," says Makov. "And I borrowed from Shakespeare and told the media, 'It's much ado about nothing.'"

Why nothing? Despite Merck's maneuvering, Teva's generic simvastatin is expected to earn more than $300 million over the 180-day period, making it the biggest launch in generics history. "I think that if you look at our results, we can live with [their authorized generics]," says Makov. "It is not so bad."

After releasing its second-quarter earnings, Teva told analysts that Zocor captured more than 70 percent of the market in doses that Teva sells. No Teva drug has ever done better.

"For every trick that they have, we have an anti-trick," says Makov. Including launching its own authorized generics.

"If it looks completely clear that this is becoming an established part of the system, then we'll have to evaluate it differently," says George Barrett, president of Teva North America. "As a company, we have to keep an open mind to authorized generics as the legislation moves forward."

In fact, Teva has already made some authorized-generic deals, most of which were in the pipeline at Ivax before Teva bought the company. "Post-Ivax, you see Teva saying they are more than happy to go ahead and do authorized generics," says Milton. "They've done two: the deal with Cephalon for Provigil, which will launch in 2012, and the deal with Wyeth for Effexor XR, which will come to market in 2010."

Unless Congress puts a stop to it. This summer, Senators John Rockefeller (D-WV), Charles Schumer (D-NY), and Patrick Leahy (D-VT) introduced legislation that would prohibit authorized generics during the 180-day exclusivity period. Elsewhere in Washington, the Federal Trade Commission plans to study how authorized generics affect drug pricing in the long term.

Whatever lawmakers and regulators decide, authorized generics may not last. The problem, says Makov, is that companies must factor the cost of authorized generics into the best price and average sales price they report to the government. This determines how much a company can charge federal payers for its brand. "It's more to deter us than to make money—even now they are not making a fortune on authorized generics," says Makov. "They will have to think about it because it might cost them even more than they think right now."

LESSON #4

Be a Lean, Mean, Manufacturing Machine

With operations in more than 50 markets, Teva expects to produce 36 billion tablets and capsules this year. Around the globe, the company maintains 44 manufacturing sites, 15 generic R&D centers, and 18 facilities that produce active pharmaceutical ingredients. In all, Teva makes 700 compounds in more than 2,800 doses and formulations.

"In general, manufacturing isn't considered a core competence in the pharmaceutical world—not the way it is with Toyota or Dell," says Chris Bogan, CEO of Best Practices, a consultancy based in North Carolina.

Manufacturing efficiency isn't just a matter of process excellence, Bogan emphasizes. Companies like Teva maintain a decisive edge over the branded industry when it comes to lean manufacturing techniques. "It makes sense that generic companies could teach Big Pharma a thing or two when it comes to manufacturing," says Doug McCormick, editor-in-chief of Pharmaceutical Technology. "After all, it was never a core strength of pharma's, while increases in process efficiencies is where generics make money."

Jacob Winter, Teva's vice president of global generic resources, says most efficiencies stem from large batches, long runs, and automation. In one of its manufacturing facilities, for example, Teva used automated warehouse technology to eliminate many labor-intensive activities, such as picking the product from shelves, and packing and shipping it. "Automation," Winter adds, "is more reliable. It's where you avoid human mistakes and gain efficiencies."

The generic industry strives to keep things simple, says David Bergstrom, senior vice president and general manager of pharmaceutical development for Cardinal Health. "I think this results in efficient manufacturing, less analytical testing, and the use of new or numerous excipients."

Another one of Teva's key competitive advantages is its robust API business—with sales totaling more than $1 billion in 2005. Teva manufactures many of its own raw materials, which makes it less dependent on outside sources, keeps production costs low, and provides absolute transparency in terms of timing and availability of materials. Such vertical integration drives Teva's gross profitability higher, quarter for quarter.

Teva is its own API unit's biggest customer. During 2005, Teva-to-Teva sales were approximately 51 percent of total API sales. It sells the other 49 percent to competitors. Makov calls this "co-opetition"—the ability to cooperate and partner with your competitors.

To bolster its API business, Teva acquired an Indian subsidiary called Regent Drugs in 2003 to reduce manufacturing costs. That division buys and sells raw materials in India.

LESSON #5

Beating Brands at Their Own Game

Teva thinks like a generic company, even when it produces innovative drugs. A look at the balance sheet explains why: In 2005 alone, Copaxone, Teva's multiple-sclerosis drug, became the company's first blockbuster, with revenues of almost $1.2 billion—about 25 percent of the company's total sales. And from January to June 2006, sales of Copaxone rose 21 percent from a similar period last year to $483 million.

"Historically, branded and generic businesses have been distinct in the industry," says Teva's US chief George Barrett. "But Teva applies the managerial approaches and culture to our branded businesses that really comes from our generic approach to the world."

For example, after Teva licensed Copaxone from the Weizmann Institute of Science in Israel, it spent just $100 million dollars to bring it to market. Azilect (rasagiline), the company's second innovative drug, which treats Parkinson's disease, was launched in the United States in July 2006. Teva bought research originating from the Technion Israel Institute of Technology and once again kept development expenses under $100 million.

How can Teva succeed in the innovative industry with such small budgets? Makov points out that the budget isn't the problem. "Even with huge budgets, the problem is that the productivity of innovative companies' R&D is going down," says Makov. "How do they try to overcome it? By pouring in more money.

"I've managed many scientists in my life, and each of them is a prima donna. And one day you expect that this prima donna will develop an innovation which will change the world." But in reality, Makov says, most of them just produce higher R&D budgets.

Teva also runs a tight ship when it comes to marketing. For Copaxone, it targeted a select group of physicians who treat multiple sclerosis and has been "particularly effective in building relationships with key opinion leaders," says Wood Mackenzie's Milton. Teva co-markets Copaxone with Lundbeck in the United Kingdom and Sanofi-Aventis in the United States.

Teva signed a co-marketing and co-development agreement with Eisai for Azilect, the Parkinson's disease treatment, in the United States. That partnership made sense because Azilect may also be effective as an adjunct to Eisai's Aricept (donepezil) in treating Alzheimer's disease. A study of that indication is still ongoing. But Eisai pulled out of the co-marketing deal, leaving Teva with sole US rights.

"It is going to be a bit of a test of Teva's marketing ability to drive Azilect in the US," says Milton, "particularly in a competitive disease area like Parkinson's Disease."

LESSON #6

Don't Look Now: Biogenerics Are Here

Today's innovations are tomorrow's generics. So companies like Teva are increasingly focused on biologics.

Without a clear understanding of how changes in the manufacturing process affect the structure and biological activity of proteins, critics say, protein-based drugs can't be replicated like small molecules. Makov doesn't buy that argument. "The biotech industry confuses everybody with, 'The production is the product,'" says Makov. "I was in that business. It's not true."

Indeed, Teva is already producing and selling biogeneric human growth hormone (hGH), interferon beta, and colony stimulating factors (CSFs). But it manufactures those drugs in Lithuania, Mexico, and China and sells them in markets outside the United States and the European Union. Now, Teva is collaborating with Bio-Technology General and Savient to produce biogeneric versions of recombinant hGH, for which it intends to seek regulatory approval in Western countries.

Amir Elstein, Teva's group vice president of biogenerics, says it is just a matter of time before biogenerics are accepted. "The concept of 'Let's first be careful' with biogenerics is reasonable," he says. "But within two or three years, there will be good proof in the marketplace that the products delivered by the biogeneric community are not only essentially similar, but equivalent. You cannot fight gossip without facts."

Elstein says manufacturers already have the technical expertise to produce biogenerics. In China alone, 17 companies produce generic epoetin. But for biosimilars, FDA has established no regulatory shortcut similar to the ANDA process for small molecules—so the economics of biogenerics are riskier and more complex. Generic companies need to fund clinical trials, which are very expensive—as much as 80 percent of the innovator's trials. Few generic companies have the resources to take the risk. Elstein estimates that nine companies are capable of producing follow-on proteins, but he thinks several will be acquired, leaving four or five players.

On the other hand, less competition means less downward pressure on price, and better margins. Teva is well positioned, thanks to its acquisition of Sicor. "We are doing a lot of things in biogenerics which we don't talk about," says Makov. "We are going to be a major, major player in biogenerics when the market is open."

When follow-on biologics come to the market, they won't be cheap—the high cost of manufacturing and the relative lack of competition will see to that. For example, Sandoz's Omnitrope is priced just 25 percent lower than the innovative drug. However, Elstein expects biogenerics to eventually carry a 30-to-40 percent discount. When that happens, countries, particularly in Europe, will use reference pricing (a system that reimburses a class of drugs at a single price) to drive down the cost of biologics.

This new category of generic drugs will require new marketing strategies. Instead of fighting to be first to market, some biogeneric manufacturers may hang back to avoid an uphill battle with regulators. "In biogenerics, strategizing the first steps is important because it can be an endless chess game," says Elstein. "It's not straightforward and we don't have a textbook."

Tomorrow's biogeneric launches will resemble today's branded launches because companies will need to establish bioequivalence in physicians' minds. Teva will have to rely on the marketing skills it is developing in its innovative division—and be willing to invest in promotional strategies to battle with branded manufacturers for market share.

"I expect some companies to be detailing physicians and advertising in journals," says Andrew Merseth, an analyst for Decision Resources. "Once the clinical trials that biogenerics go through begin to be published in medical journals, it is going to be a pretty hot topic."

A Pioneer's Path Forward: "From Here to Eternity"

Whether Israel Makov intends it or not, pharma fears Teva. But as blockbusters give way to niche drugs and government pressure on pricing increases, the industry needs to look again at the business practices of the generics industry. Today's business climate requires a leaner and more efficient approach, and much of what generic drugmakers have learned may apply to the branded industry soon—if it doesn't already.

"The generics and branded business have been very distinct for many years, but now they may start to converge on some level," says Barrett. "That convergence is being driven by the concerns about the total cost of healthcare. We recognize that our experience living on the healthcare-cost side will help us as we do our development on the proprietary side."

As generic companies launch innovative divisions and Big Pharma slashes prices to retain revenues of mature brands, Oliver Engert, a partner at McKinsey & Company, sees the two sides forging partnerships. "There's two ways of looking at this world: It's the Big Pharma company interested in participating in generics," he says. "And there's the reverse happening, where you have a generics company that is moving upstream into pharma with patented products." GlaxoSmithKline, for example, has already partnered with Biovail for its extended-formulation technology on Wellbutrin XL (bupropion), and it has inked a drug discovery deal with Ranbaxy.

"Ranbaxy says it sees the writing on the wall and that it needs to get in the branded space," says Joanna Chertkow, Datamonitor's lead pharmaceutical analyst. "Working with GSK gives them some experience to fall back on. GSK obviously saw something in the deal that could benefit them— maybe the cost saving of having scientists based in India."

Teva, already with subsidiaries on five continents, believes 2006 sales will reach $8.5 billion, a 60-percent increase over $5.3 billion last year. With more than $100 billion in branded drug sales coming off patent in the next seven years, there are few players better positioned to reap a windfall. Teva expects to launch 70 to 80 drugs in 2007 and 2008.

Increasingly willing to straddle the branded and generic worlds, Teva is launching a new respiratory business that combines generic molecules with innovative drug-delivery systems. But even with such new developments, Makov says Teva will remain true to the generic model: The company will continue to dispute patents it regards as invalid and work to streamline its increasingly complex network. Whether or not Big Pharma adopts the generic discipline that made Teva tough, new generic players will continue to spring up quickly, often using Teva's acquisition model. Activis, for example, has grown from a small generics player to a company worth watching, says Chertkow.

No matter what the competition, Makov sees enough business to go around: "The consumption of drugs and healthcare services is growing with the aging population," he says. "This is a process which you are not going to stop. You cannot stop it. Now, you must find ways to reduce the cost and to make the system more efficient. That's the reason I believe the demand for generics will grow from here to eternity."