Traditionally, drugmakers have tried to supply the mass-market with pills to fight mass market problems such as high blood pressure, cholesterol, pain.
But patent expiries and generic competition have undermined their profits. By contrast, rare diseases offer premium prices and far less competition.
Alexion Pharmaceuticals (NASDAQ:ALXN) is a good example how well the orphan drug model can work. Despite treating only a few thousand patients worldwide, sales of its rare blood disease drug Soliris are forecast by analysts to reach $1.5 billion in 2013 and $2.6 billion by 2017.
Alexion represents Big Pharma's next business model: very expensive treatments for very few patients. With Soliris costing $440,000 per year per patient, Alexion only has to reach a few thousand patients to hit blockbuster territory. And payers can hardly balk at covering a treatment that can relieve intense suffering and prolong patients' lives.
Alexion, with 1,100 employees, is a multinational pharmaceutical company with offices in more than 30 countries, but only a few thousand patients in the whole world. Soliris is a blockbuster and Alexion a juggernaut, because of the drug's astronomical price, although it is sometimes given away for free, in hardship cases.
Yet the drug is so effective that private insurers and even penny-pinching governments like the United Kingdom and Australia, are willingly fork over the money. It sells surprisingly well in nationalized health care systems.
Soliris is approved for the treatment of patients with PNH (paroxysmal nocturnal hemoglobinuria), a progressive and life-threatening disease characterized by the excessive destruction of red blood cells (hemolysis). Soliris is the first and only therapy approved for the treatment of PNH to reduce hemolysis.
In the United States and European Union, Soliris is also approved for the treatment of patients with aHUS (atypical hemolytic uremic syndrome), an ultra-rare, life-threatening, genetic disease that can progressively damage vital organs, leading to stroke, heart attack, kidney failure and death. Soliris is the first and only therapy approved for the treatment of aHUS.
Soliris is involved with the so-called "complement system" of the human body.
The complement system is the most primitive part of the human immune system, a series of enzymes that lurk in the blood like sea mines, primed to explode when they encounter foreign substances. It is not adaptable and does not change over the course of an individual's lifetime. However, it can be recruited and brought into action by the adaptive immune system.
But the complement system can be highly dangerous, when activated inappropriately and it plays a role in serious diseases like PNH and aHUS.
The human body is protected from these enzymes by its own set of complement blockers. The idea behind Soliris was to make these complement blockers into drugs to fight rheumatoid arthritis, terrible skin diseases, kidney problems and maybe even the inflammation that occurs during heart attacks.
Soliris did not succeed in any of those areas yet, but it does work on PNH.
PNH results almost entirely from the complement system gone awry. Blood cells that lack their complement-blocking armor become the dominant form in the bloodstream, killed by complexes of enzymes aimed at intruders, causing anemia. Red blood cells usually live for four months, but in PNH patients they die in two days. The blood (and urine) fill up with hemoglobin, causing damage to the body. Platelets are also harmed, causing blood clots that frequently kill patients.
The success of drugs treating rare diseases started with a legislation in the US that has created the "orphan drug" concept. The Orphan Drug Act of 1983 provided pharmaceutical firms with tax credits and marketing exclusivity for drugs that treat ultrarare diseases which otherwise would not have been economically feasible. Later similar laws were adopted in Europe, Japan, Australia and Singapore.
A Thomson Reuters analysis put the global orphan drug market at more than $50 billion at the end of 2011, with spending accounting for about 6 percent of total drug sales.
A number of these drugs started out as treatments for rare cancers but have since become multibillion-dollar sellers as their use has expanded.
The orphan drug market is expanding faster than traditional pharmaceuticals with annual growth averaging 25.8 percent from 2001 to 2010 compared with 20.1 percent for non-orphan drugs.
Alexion's success is drawing attention from other drug developers. More than a quarter of the 39 new medicines approved in the United States in 2012 were designated as "orphan drugs".
Soliris is one of at least a dozen drugs whose price for the average patient is greater than $200,000 per year. All of them target dangerous, obscure conditions, such as Naglazyme for Maroteaux-Lamy Syndrome (enzyme replacement medicine from BioMarin Pharmaceuticals (NASDAQ:BMRN), costing $350,000 per year) and Elaprase for Hunter syndrome, (from Shire (NASDAQ:SHPG), costing $375,000 per year).
Some other expensive drugs with wholesale costs above $200,000:
Cerezyme from Sanofi (NYSE:SNY) for Gaucher disease. It helps to eliminate the fatty clumps that damage the spleen, liver, lungs and bone marrow and it can cost $300,000 per patient per year.
Cinryze from ViroPharma (VPHM) prevents attacks of hereditary angioedema, a dangerous swelling of the abdomen and lips that can cause suffocation. Average cost: $417,000 a year.
Kalydeco from Vertex Pharmaceuticals (NASDAQ:VRTX): First drug to target a genetic defect causing the lung disease cystic fibrosis but only works in a small percentage of patients with a specific mutation. Annual cost: $294,000.
Elelyso from Pfizer (NYSE:PFE) and Protalix : A new Gaucher treatment produced in genetically modified plant cells. It competes with Cerezyme. Priced at a discount, it still costs hundreds of thousands of dollars a year.
There are about 6,000-7,000 diseases that affect less than 1 percent of the population, and as more drugs developed for them and sold at high prices, payers may be pushing back, especially in austerity-hit Europe.
Until now, governments and insurance companies have largely accepted prices that can run into hundreds of thousands of dollars, since only a handful of patients need the treatment, the overall cost to health budgets is relatively small.
However, healthcare providers are increasingly looking at the big picture: how to balance the acute needs of the few against the wider interests of society. Scrutiny of the sky-high prices charged for this wave of new drugs is growing.
"The issue of the sustainability of orphan drug pricing is really front and center for investors at the moment," said David Pinniger, investment manager of the International Biotechnology Trust, whose holdings include shares in orphan drug companies such as Alexion and Biomarin Pharmaceutical.
The question is will the orphan drug strategy become a victim of its own success?
Soliris was launched in 2007 to treat a rare cause of anemia. In 2012 that drug has done more than $1.1 billion in revenue, with Wall Street expecting that figure to double again over the next three years. Its current net margin: 22%.
Alexion shares has climbed 600% since the drug's approval, outperforming even tech darlings such as Apple and Salesforce.com over the same period. The company has a market capitalization of $17.68 billion.
In 2012 total sales have reached $1.134 billion, up 45 percent from $783.4 million in 2011.
Alexion reported net income of $254.8 million, or $1.28 per share in 2012, compared to 2011 net income of $175.3 million, or $0.91 per share.
As of December 31, 2012, the Company had $989.5 million in cash and cash equivalents compared to $540.9 million at December 31, 2011.
Guidance for 2013 is a strong 33% increase in revenues to the range of $1.490 billion to $1.505 million. The company forecasts a 37% increase in 2013 earnings per share in the range of $2.82 to $2.92.
The stock price's 52 week range was $81.28 - $119.54.
The biggest problem with Alexion, from an investor's perspective, is that it trades at a shocking 71 times earnings, compared to the industry average of 14.49. In order to justify that multiple, it needs to sustain its astounding pace of growth.
Maybe for that reason, Alexion has been on a buying spree.
In December it paid $610 million in cash, plus the promise of up to $470 million more for performance, to buy Enobia, a small Montreal-based company. Enobia had some initial success with ENB-0040 or asfotase alfa, a treatment for a rare genetic disease seen, among other places, in a Mennonite population outside Manitoba. Children with this mutation may have weak bones and, in a few severe cases, are born with such weak rib cages that they cannot breathe. In one recent case a child was born with almost no bone structure at all and yet was still saved by this experimental drug.
An even riskier bet may be Orphatec's cPMP replacement therapy, a drug bought from the German company a year and a half ago. It treats a disorder in which babies are born missing an enzyme and, as a result, their brains dissolve over the first weeks or months of life.
"So it's not life-threatening," says CEO Leonard Bell "It's lethal." As best as Bell can tell, there are only ten cases of this disease a year in the U.S., but children given the drug seem to recover remarkably.
Throughout the global recession and resulting austerity measures over this same six-year period, Alexion has remarkably well maintained its focus to serve more patients in more countries around the world. The company promises to continue its patient focus as it navigates through some more of the treacherous macroeconomic times.
What the future holds for the "orphan drugs" industry in general, is hard to say.
Some of their products have certainly brought miracles to individual patients and many investors. However the miracles may stop one of these days. When that happens, the reason will not be lack of scientific innovation, but sheer economics.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.