Observers have been saying for years that large drug makers weren’t ready for the era when billions of dollars’ worth of patents would expire. That era is now. Generic-drug makers are set to take as much as 80% of the market once held by brand-name pharmaceuticals as blockbuster patents expire, triggering a flurry of deals.
Case in point: Sanofi-Aventis’ (NYSE:SNY – News) $18.5 billion bid Aug. 29 for profitable biotech Genzyme (NMS: GENZ).
Days earlier, Sanofi, the world’s sixth-largest by market cap, lost a court bid to protect the patent on its biologic anticoagulant Lovenox, which wasn’t supposed to expire until 2012. The court upheld an earlier Food and Drug Administration ruling that allows Momenta Pharmaceuticals (NMS:MNTA) to sell a generic version of Lovenox. Unless Sanofi wins on further appeal, it will lose a big piece of Lovenox’ sales — $2 billion in the U.S. in 2009.
The big kahuna of patent expirations is Pfizer (NYSE:PFE – News), still the largest drug maker by market cap despite a share price that has fallen more than 67% since 2000. Nine of Pfizer’s drugs, including famous blockbusters Lipitor and Viagra, will lose their U.S. markets to generics by 2015. Together, their U.S. sales accounted for 13% of Pfizer’s overall revenue last year.
The list of patent losses goes on and on, and the dollars of lost revenue pile up. That explains not just Sanofi’s bid for Genzyme, but previous mega-acquisitions. Pfizer bought Wyeth for $68 billion in 2009. Months later, Merck (NYSE:MRK – News) paid $41 billion for Schering-Plough.
All the big pharmas are beating the bushes for biotechs whose promising technology they can partner with on, license or buy.
Specialty drugs appear to be in a better position, pumping out a narrow range of products aimed at specific groups of patients. The products may be branded or generic, and range from skin lotions and prescription anti-acne pills to oral contraceptives and colitis medicine.
Strong performance from the likes of Valeant Pharmaceuticals (NYSE: VRX – News), Warner Chilcott (NMS: WCRX), Endo Pharmaceutical Holdings (NMS: ENDP), Medicis Pharmaceutical (NYSE:MRX – News) and Paladin Labs have helped propel IBD’s Ethical Drug Industry Group. As of Friday, the collection of 50 stocks ranked No. 14 among IBD’s 197 Industry Groups, up from No. 104 six months ago.
The drug business is all about two things: development and marketing. The big Pharma companies are great at marketing. Development is harder, as evidenced by some spectacular flops in recent months. Pfizer had hoped it had found a successor to Lipitor with Torcetrapib. It cancelled the project in 2007 after phase three trials showed a higher-than-acceptable risk of death.
Eli Lilly (NYSE:LLY – News) last month gave up on Semagacestat for Alzheimer’s, also in phase three. It made patients worse.
All those failures cost piles of money. While big Pharma has traditionally “swung for the fences,” specialty drug companies make money by “hitting singles,” says Damien Conover, strategist and senior pharmaceutical analyst for rating firm Morningstar.
For the most part, specialty drug makers don’t have huge research and development costs, he says. Many of their products are adapted from long-approved drugs available as generics, and they depend on a few drugs that carry high margins.
Specialty drug makers also don’t have the heavy marketing overhead, says Les Funtleyder, manager of the soon-to-launch Miller Tabak Health Care Transformation Fund.
Big Pharma, which is still focused on a mass market, needs armies of salespeople to persuade primary-care physicians to prescribe their products. The smaller, more focused companies don’t need giant sales forces to reach specialists.
“The big companies are more influenced by general market conditions,” Funtleyder said. That’s because they are diversified and are trying to find new, expensive-to-develop products for their pipelines.
Shares of the specialty drug companies have appreciated well over the last 12 months, led by Valeant, up 122%. Sanofi and Roche (OTC: RHHBY.ob – News), by contrast, are each down 16%, and Pfizer is down 5%. The best performer among the big Pharma companies is Bristol-Myers Squibb (NYSE:BMY – News), up 17%.
Name of the Game: For big Pharma, the keys are developing new drugs and marketing them well. Failing that, they buy up smaller, innovative companies with promising drug pipelines. For specialty drugmakers, success hinges on finding lucrative niches.
The U.S. remains the biggest market for pharmaceuticals in the world, but the industry is a global one, with some of the fastest growth in emerging countries such as China and India.
Big Pharma depends on foreign sales for about half its revenues, and the industry is turning its attention to emerging markets.
As people become wealthier, they can afford better medical care and more medicine.
Latin America, Eastern Europe, India and China are target markets for big- and small-cap pharmas to sell their generic products with brands they can advertise and promote. “There’s more growth there than here,” Funtleyder said.
Valeant has been more selective, focusing abroad on two therapy classes: dermatology and neurology. It limits itself to the U.S., Canada, Australia, New Zealand, Mexico, Brazil and Central Europe. It goes only where no competition exists for its products.
Valeant has a market cap of $4.4 billion on expected sales this year of $1 billion. Paladin has a market cap of $486 million and more than $121 million in expected sales this year.
Pfizer’s projected sales are $62 billion, and Sanofi’s are $43 billion.
For specialty pharma, the future is rosy. More generics give it more opportunity to make new formulations that don’t need to be blockbusters to be profitable.
Pharma was at the center of the debate over ObamaCare, the industry everyone loved to hate.Yet, as a proportion of all health costs, U.S. spending on pharmaceuticals was nowhere near as high as critics might think. Data firm IMS Health puts the 2009 U.S. expenditure on drugs at $322 billion. That’s just 13% of the total $2.5 trillion spent on health in the U.S. in 2009.
ObamaCare has not hurt drug makers — and likely will help them, Funtleyder says. part D, the Medicare drug benefit signed into law by former President George W. Bush, has meant more revenue for pharma, both branded and generic, and has cost taxpayers less than expected.
The Obama legislation filled a coverage gap. With the Obama-Care subsidy, more seniors should stay on their medications longer, increasing drug sales.
In 2014, millions more people will start to come into the insurance system, if all goes according to plan. That means new customers for drugs. As for fears that the government will impose price controls on drug makers, that’s not likely, Funtleyder says.
“Our reading of the reform bill finds no mechanism for the government to impose price controls,” he said. “That may hurt taxpayers but not drug companies.”
Experts see promise on multiple fronts.
Biologic drugs, made of proteins rather than chemicals, will better target specific diseases vs. the hit-or-miss approach of conventional drugs. And the era of the “me-too” drug — drugs that treat what’s already being treated well enough — is over, Funtleyder says. Cholesterol is one area well-covered by statin-class medicines, he says.
Alzheimer’s, cancer, diabetes and other life-threatening or chronic diseases are where the “unmet medical need” lies, he said. Genetic testing is a growing diagnostic field. It already lets doctors predict a patient’s predisposition for certain diseases such as breast cancer.
Within a few years, mapping a person’s entire genetic structure could be affordable, helping doctors determine what ailments may be treated or even pre-empted with what drugs.
In both North America and Europe, markets for many drugs have stopped growing, Funtleyder says. People who need today’s drugs aren’t getting sick at a faster rate.
As for big mergers of drug makers, they probably won’t resume until mid-decade, he says.
The prospects for the future in drug development “always comes back to the pipeline,” Funtleyder said. That depends on pharma funding enough science to generate medical breakthroughs. a few of those and the “tide will lift all ships,” Morningstar’s Conover said.
Upside: ObamaCare should bring new drug customers. An aging population will need drugs to treat chronic conditions. And genetics may open up a whole new wave of innovative treatments.
Risks: a wave of expiring patents will pressure big-name drug makers in the short term, hitting sales and margins as cheaper knockoffs flood the market. A Prescription for Growth?