Greater market power

Historically, the generics industry has been highly fragmented, with many small companies crowding the space due to low barriers to entry. Since generics don’t require original R&D, drug makers can produce them cost effectively with relatively lesser risk. The deal comes amid a wave of consolidation in the drug industry, which can leave any single player out in the cold unless it has size.

Teva’s deal with Allergan will create a market behemoth with considerable power. The combined business will command more than 20% of the global generics market, according to market intelligence firm Evaluate Ltd., cited by Reuters. Even with an estimated $500 million in forced divestitures, according to Evercore ISI analyst Umer Raffat, Teva would still control one-fifth of generic drug volume, giving it greater clout in negotiating with governments and health insurers.

Higher Margins

Teva claims that the Allergan acquisition will produce substantial cost savings through operating synergies to the tune of $1.4 billion. That’s good news since the company could realize higher margins even at current drug prices.

At the same time, Teva is facing patent cliffs of its own, most notably for its popular multiple sclerosis drug Copaxone (which accounts for more than 30% of the U.S. market) later this year, after which other generic manufacturers could sell their versions of the drug. For now, the company has gotten around the problem by introducing a new higher-dosage version that could enjoy patent protection until 2030, but the battle is not over yet. Teva could lose up to $1 billion in annual Copaxone sales to generic competitors, according to estimates by ratings agency Fitch.

This means Teva could face downward pressure on its earnings in the future and will need the synergies with Allergan to mitigate that. The alternative would be for the company to raise drug prices to maintain profits, but that could hurt its market share.

Complex Generics

At a healthcare conference early last year, Teva’s acting CEO said that complex generics will likely make up 50% of the company’s market by 2017. Complex generics are relatively more difficult to produce and require greater testing but they also have higher margins and higher barriers to entry for potential competitors. Even though the Allergan acquisition excludes its biosimilars business, it gives Teva a boost in this arena through products such as injectable medicines.

Part of the synergy arises from Teva’s market-leading API manufacturing operations, which produce the active pharmaceutical ingredients needed to create complex generics quickly to gain a first mover advantage in a market (an application for a new generic drug can give the maker 180 days marketing exclusivity, which is extremely valuable). While Allergan has its own supply chain, it could certainly benefit from Teva’s extensive API development and manufacturing capabilities as well, according to investment research firm MarketRealist.

S. Kumar is a tech and business commentator. He has worked in technology, media, and telecom investment banking. He is not an investor of Allergan or Teva.