The One Question You
Need to Ask
By George Huang, editor, S&A FDA Report
December 5, 2008
Every year, I meet with at least 50 companies to find the best opportunities for my readers. This year, I've logged more than 100,000 miles, visiting companies headquartered in the U.S., Asia, South America, and Europe. I've also attended endless investment conferences, where I see as many as 15 companies a day.
At these meetings, companies try to feed you the rosiest possible scenarios. Just like every Internet company believes it's the next eBay, every biotech thinks its drugs will be the next big thing. Sorting "corporate speak" from the truth is a difficult task.
But there's one question that helps me cut through the "bull"...
I stole this question from famous mutual-fund manager Peter Lynch. Lynch has said he first learned about many of his great investments by asking this question.
The question I ask every CEO I meet is: What other companies do you most admire?
Many biotech CEOs idolize Genentech. After all, Genentech is a pioneer in the field. The company has returned early investors over 30 times their money since 1988. Most CEOs dream their companies will become the next Genentech.
On the other hand, none of the CEOs I've spoken with has ever confessed to admiring the big pharmaceutical companies – Pfizer, Merck, Bristol-Myers, or Eli Lilly, for example.
That's unsurprising. After all, Big Pharma management has turned these once-innovative companies into marketing firms. They focus less on saving lives and more on selling life-style drugs like Viagra. And executives have paid themselves millions in compensation while ignoring shareholder interests.
(It hasn't gone unnoticed. The five pharmas I mentioned above are down an average 50% over the last decade.)
But one pharma-like company has collected quite a few admirers: generic maker Teva Pharmaceuticals (TEVA). One CEO went even further, saying, "Teva has the best management team of any company in health care."
Teva is the largest and most profitable generics maker in the world. Sales will top $11 billion this year. Market forces are on its side, too. Drugs with $200 billion in sales will lose patent protection in the next five years. I expect Teva sales to top $20 billion in four years.
After its $7.5 billion acquisition of Barr, the fourth-largest generics maker in the world, Teva will become even more dominant. The company's enormous scale and global operations enable it to generate huge returns on capital. For every dollar in revenue, more than 20 cents fall to the bottom line after deducting all expenses. That's incredible in the cutthroat, low-margin generics business. And this year, Teva should generate $2.5 billion in free cash flow.
Long-term Teva shareholders are up huge. The stock has returned about 1,000% in the last decade, or 26% per year.
With a market cap of $35 billion, the stock is trading for only about 14 times free cash flow. For the best-run company in the rapidly growing generics business, 20 times cash flow is more appropriate. So even after that monstrous run, Teva stock is cheap.
When you ask a CEO who he admires, you're likely to get insight into his business you won't find in any press release. More importantly, you'll occasionally pick up a great investment idea...
Biotech leaders admire Teva because of its incredible operational efficiency and smart acquisitions. I agree. And at these prices, you should put Teva in your portfolio and not look at it again for five years. You will be glad you did.
Good investing,
George
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