After Big Drop in Generics, Ride the Rebound

No matter how bad the Department of Justice's investigation into possible price collusion by generic drug makers turns out for the industry, the huge drop in generic and other pharma and biotech shares on Nov. 3 after reports that criminal charges are pending is unwarranted, said some analysts. That may mean investors have a buying opportunity in select companies, given that the estimated $8.5 billion in market cap initially destroyed after the news far exceeds any plausible damage that will be inflicted by the feds.

That's not to play down the threat the investigation poses to anyone caught participating in a price fixing scheme--the DOJ takes that kind of illegal activity seriously, and the possibility of huge fines and prison sentences can't be dismissed.
However, "it is hard to imagine a scenario in which the financial penalties, if any, would end up approaching the ~$8.5bn in market cap that was wiped out," Gregg Gilbert, Deutsche Bank Group specialty pharmaceuticals analyst, said in a research note Friday.

The likelihood that Thursday's plunge was an overreaction seemed to be gaining credence by the market. Shares of the 12 generic drug makers reportedly targeted by a DOJ investigation that plunged only the day before had by and large inched upward through late afternoon trading Friday.

Among the shares enjoying small upticks were Mylan (MYL) , which rose 2.53%, to $35.01; Teva Pharmaceutical (TEVA) , risng 2.50%, to $40.18; Endo International (ENDP) , up 1.61%, to $14.87; Lannett (LCI) , up 3.48%, to $17.85; Impax Laboratories Inc. (IPXL) , at 17.57, it was up 6.52%; and Taro Pharmaceutical (TARO) , which climbed 2.86%, to $96.36. Shares of Allergan (AGN) , started heading upward too, rising to $195.18, up 3.37%.

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The DOJ's investigation has been under way for at least two years, and a number of companies have reported receiving subpoenas related to the investigation. The selloff was sparked by a Nov. 3 Bloomberg report that the Department of Justice was on the verge of issuing criminal charges for suspected price collusion.

The seriousness of DOJ price-fixing charges were spelled out later that night in a speech Renata Hesse, the DOJ's Acting Assistant Attorney General for antitrust, delivered to the California state bar. Cartels and other price-fixing schemes have been a top priority of the Antitrust Division, she said, noting that the division has obtained more than 300 individual convictions, with prison sentences averaging 23 months. "We continue to hold individuals accountable for the crimes imputed to their corporate employers, asking for sentences that reflect their seriousness and send a powerful deterrent message," she said.

Hesse noted that in recent years, "We've obtained the largest fines in the division's history." Criminal fines from continuing cases against an auto parts cartel now total nearly $2.9 billion. Last year, the division announced over $2.5 billion in criminal fines and penalties from corporate offenders in a single investigation in the financial-services sector.

How bad it will be for the generics industry is anyone's guess. "We do not know the scope or timeline involved, and it is difficult for us to predict which companies and/or individuals, if any, will ultimately be affected, and to what degree," Deutsche Bank's Gilbert said.

Credit Suisse's Vamil Divan said the selloff in the two shares he follows, TEVA and AGN were unwarranted. Because of this year's sale of Allergan's Actavis Generics unit to Teva, "it appears the selloff in AGN shares was inappropriate," he said.

Divan said Thursday's drop in TEVA shares was "likely an overreaction, although we acknowledge the investigation will likely be an overhang on TEVA and the generics space until we have more clarity on the outcome and understand any potential financial or criminal penalties that may be imposed."

Makan Delrahim, a former deputy assistant attorney general in the DOJ Antitrust Division and now an antitrust partner for Brownstein Hyatt Farber Schreck LLP, said the mere fact that a criminal investigation has been opened indicates that the DOJ believes it has pretty damning evidence.

"To open up a criminal investigation, as has been reported, is a big deal," he said. "They don't just do that as a fishing expedition. They have to convince a federal court there is probable cause to get warrants and secure compulsory discovery."

Because the DOJ will lessen the severity of punishment those who cooperate with an investigation, how broadly any sanctions affect the industry will depend on the number of companies and individuals that agree to participate in the agency's amnesty program, Delrahim said.

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