Big Pharma's Future Death Spiral?

One of this blog's regular correspondents has just been attending a chemistry outsourcing conference (program here), and heard a very interesting talk from Stefan Loren of a Baltimore investment advisory firm, Westwicke Partners. Loren's a product of the Sharpless lab, who went on to Abbott (ABT), then Wall Street (Legg Mason (LM) and into the hedge fund business), and had some very provocative things to say about our industry:

His talk, "The Pharma Titanic: It's Time to Root for the Iceberg" presented a sobering view of the challenges that big pharma will have to deal with if it wants to survive.

Loren opened with an overview of the US national health care debate. Regardless of the ultimate form that a national system takes, he believes we'll see mandatory insurance; this will be good for big pharma. He also believes that there will be strong pressure for mandatory comparative effectiveness testing...probably not good for big pharma. Who will pay for this and what resources this would require is another matter. Wearing his investment advisor glasses, he sees global pharma sales declining, led by North America, with future growth coming in Asia and Latin America. He also sees evidence of healthcare avoidance in the US: unfilled prescriptions, unfinished courses of prescriptions, and people just not visiting medical and dental practitioners - not a good trend.

The coming wave of patent expirations of the top 10 drugs will hit big pharma hard. Generics will grow: In 5 to 10 years, he predicts that 80 percent of ALL prescriptions will be generic. When coupled with the meager investments in bow wave research over the past 15+ years, as measured by IPOs, there's trouble ahead. Global biotech IPOs are in the toilet and the US is no longer viewed by the investment community as the global leader in biotech. There have been an unprecedented number of bankruptcies in biotech. There is going to be a huge oversupply of production capacity for small molecule manufacturing. ROIs for pharma and biotech are largely negative...it gets worse. He calls this the "death spiral."

Pharma pipelines are seen as very poorly run and wasteful. Poor projects linger far longer than they should. Too much emphasis is placed on me-too and line extensions. Too much emphasis is placed on acquisitions and licensing rather than innovation. Here it comes: he says "I have NEVER seen a merger that worked". We were then entertained by a chart showing Pfizer's (PFE) stock market performance over the period of time from pre-WLA, through Pharmacia-Upjohn, and now Wyeth...you would not be a happy camper if you had put your retirement account in Pfizer management's hands and their merger mania. Wall Street has a saying, "Two dogs don't make a kennel." Of course, what we hear is "this time it's different" along with the usual happy talk about synergies. Loren does believe that mergers can work and can be synergistic if the two companies merging are small...large mergers just don't work and large companies get paralyzed by bureaucratic inertia.

His solution? Break up large pharma into therapeutic areas and build shared networks between distinct entities. Small organizations can operate far more efficiently in decision making about research directions - use the network to maintain manufacturing efficiencies. Small focused companies will revitalize the industry and offer opportunities for scientists coming out of academia. In response to a question from the audience regarding Merck's (MRK) ambitions to adopt this networked architecture, he doesn't believe they can make it work.

He does see light at the end of the tunnel with respect to supply chain assurance driving a return to sanity. The heparin, glycerin, and melamine disasters have awakened people and the cost of securing global supply chains is going to make US industry much more competitive. It also will focus serious scrutiny on big pharma. The "next heparin" case will have serious personal consequences for big pharma managers..

Well, a good amount of this I agree with, but some of it I'm not sure about. Taking things in order, I don't know about a decline in US sales, but Asia is most definitely where a lot of companies are expecting growth. (And for "Asia", you could substitute "China" and be within margin of error). And his generic prescription figures may not be right on target, but the trend surely is. We've discovered a lot of useful drugs over the years, and anything new we find has to compete against them. The only way to break out of that situation is to find drugs in new categories entirely, and we all know how easy that is.

But as for the US not being the global leader in biotech - well, if we aren't, then who is? You could possibly make a case for "no clear leader at all, for now", but I think that's as far as I can go. And that coming oversupply of manufacturing for small molecule drugs, which may well be real, will be bad news for the companies that have already invested in that area, of course, but good news for up-and-comers, who will be able to pick up capacity more cheaply.

But Loren's comments about mergers I can endorse without reservation. I've been saying nasty things about big pharma mergers since this blog began, and nothing in the last seven years has changed my mind. And I certainly hope that his idea of smaller companies coming along to revitalize the industry is on target, because it's sure not going to be revitalized by (for example) Pfizer buying more people. I've made that Pfizer stock-chart point of his here, as well - like the rest of the industry, PFE stock had a wonderful time of it in the 1990s, but this entire decade it's been an awful place to have your money.

I expect these comments to bring in a lot of comments of their own - so, how much of this future are you buying?

Comments

[ray69:]

Turn them into cash cows. and give the money to the owners ie. shareholders
Reduce marketing (including reps) by 75%. Management by 80%, etc. etc..
Float off research units - if they can't float let them sink.

The future is biotech/dedicated research units funded by venture capital.

Products that work will sell.

Sep 18 06:45 AM

[Robert0713:]

>> Reduce marketing (including reps) by 75%. Management by 80%, etc. etc..

Like that's ever going to happen. Have you looked at the G&A line item in any biotech/pharma?? In some it's many multiples of CoGS. These companies exist only to fund those guys (and occasional gal), and those guys control them. Not a one of them bucks could earn an honest day's pay for an honest day's work; which is why they have to suck the hind teat. End rant.

Sep 18 08:58 AM

[Robert0713:]

>> The future is biotech/dedicated research units funded by venture capital.

Not convinced of that. That was a time when most research (pre patent frenzy) was funded by the Feds, and the resulting compounds were in the public domain. Might be worth a trip Back to the Future.

Sep 18 09:00 AM

[Jocular:]

PFE was overvalued in the 1990's - its P/E was fueled to 50 based on high expectations for viagra which never materialized. While PFE's mergers with Warner-Lambert and Pharmacia were largely failures, because the company did not effectively removed duplicative functions, etc, that mistake is unlikely to be made following the Wyeth merger (where you are likely to see several site-closures/layoffs and consolidation into independent business units). Also, the industry is rapidly diversifying away from research-based branded pharmaceuticals into generics (both biologics and small molecules), consumer goods/nutriceuticals and other healthcare businesses. The result will be more stable, diversified companies, but ultimately fewer dollars spent on R&D (as opposed to non-pharma business lines) and thus less innovation for consumers/patients.

Sep 19 12:43 AM

[USisCorrupt:]

The ONLY Pharma worth holding at this point is Dendreon "DNDN" and once they shake the Corruption from the SEC & FDA there is and will be a much deserved UPSIDE still in their future.

Sep 19 08:56 AM

[Leo45:]

>> ultimately fewer dollars spent on R&D

If fewer dollars are spent on R&D that's bad news for R&D suppliers such as Beckman, Charles River or Sigma-Aldrich.

Sep 19 01:05 PM

[Tom B:]

You're mistaken. PFE jettisoned all of Warner Lambert (but not right away) except for the cancer unit in La Jolla (formerly Agouron). And they jettisoned about 80% of PHA. Kept St.Louis.

The problem was, it's hard to invent new drugs when you've gutted your research staff. Hope they DON'T do the same but Wyeth, but we all know they will.

As for generics: companies who have been DOING generics and have the savvy are FAR more likely to find gold in the generics market than Big Pharma.

The patient is the biggest loser: the less research going on; the more likely there won't be better treatments for you or your loved ones in the future, should you become ill.


On Sep 19 12:43 AM Jocular wrote:

> PFE was overvalued in the 1990's - its P/E was fueled to 50 based
> on high expectations for viagra which never materialized. While
> PFE's mergers with Warner-Lambert and Pharmacia were largely failures,
> because the company did not effectively removed duplicative functions,
> etc, that mistake is unlikely to be made following the Wyeth merger
> (where you are likely to see several site-closures/layoffs and consolidation
> into independent business units). Also, the industry is rapidly
> diversifying away from research-based branded pharmaceuticals into
> generics (both biologics and small molecules), consumer goods/nutriceuticals
> and other healthcare businesses. The result will be more stable,
> diversified companies, but ultimately fewer dollars spent on R&D
> (as opposed to non-pharma business lines) and thus less innovation
> for consumers/patients.

Sep 20 12:03 AM

[Jolly_Rancher:]

Most of Big Pharma has been in a serious bear market since 2005-6 -- and some since 2000! So it's really impressive that Stefan Loren goes out on limb now, haha, predicting disaster. True , Pfizer is one of the most poorly managed of the bunch, so it's easy to hold up high as a basis for an ongoing bearish argument, but really the picture isn't quite as dreary as it looks for the rest of BP.

First, drugs are cheaper than hospital procedure, and drugs are getting better. Though not a by any means perfect substitute, this is a simple concept that will drive drug company profits.

Second, BP has a plan to grab some of those generic profits by partnering with generic companies to take their off-patent drugs generic. The consumer benefits by getting the "real thing" rather than a similar drug. This will deflate the generic companies a bit.

As for small biotech, now is a great time to invest in the ones that have real drugs in the pipeline.

Sep 20 10:16 AM

[OneRichOne:]

You are right on target about mergers. I worked for a fairly large company that merged (took over) another fairly large company to become the biggest company in the industry. What happened? They kept all the high paid vice presidents and unit managers of the company they took over rather than merging the business units and reducing high paid management. This ruined the company and after only a few years, they had to be rescued by another company that actually knew how to handle a merger.

Sep 21 04:56 AM

[Investigator:]

I agree it is a death spiral. Get healthy, get strong, do everything in your power to stay healthy. Do not let these companies poison you.

Sep 21 10:37 AM

[noonne:]

Since all of you seem to have an fairly good view on the future I´d like to see your comments on the small Swedish biotech company Karo Bio, and more specific on their chanses of success with their drug Eprotirome.More information here:www.karobio.se/en/Rese.../"noonne from Sweden"

Sep 21 01:55 PM

[meridian575:]

Mergers seem to be the future thus far. If anyone is involved with the healthcare stocks scene, I came accross an article from Yahoo Finance that discusses that sector:
finance.yahoo.com/news...

Sep 21 02:09 PM

[Jocular:]

Actually, i'm not wrong. Pfizer did not jettison Warner Lambert until several years after the merger - in January of 2007 as a matter of fact (the closure of Ann Arbor was announced on 1/22/07). As for Pharmacia, it still exists within Pfizer - the St Louis site remains, it currently houses Pfizer's biologics pharm sci capability as well as its inflammation research unit and it was the only thing worth keeping. And they haven't gutted the research staff - several folks from Agouron remain at the LJ facility in senior roles and at St Louis. Pfizer simply did what they needed to do - they scaled back and diversified. Pfizer values Wyeth for its biologics capabilities and the proof is that a Wyeth scientist will head Pfizer's biopharma division. All of big pharma will do the same. The model of the future is J&J.


On Sep 20 12:03 AM Tom B wrote:

> You're mistaken. PFE jettisoned all of Warner Lambert (but not right
> away) except for the cancer unit in La Jolla (formerly Agouron).
> And they jettisoned about 80% of PHA. Kept St.Louis.
>
> The problem was, it's hard to invent new drugs when you've gutted
> your research staff. Hope they DON'T do the same but Wyeth, but we
> all know they will.
>
> As for generics: companies who have been DOING generics and have
> the savvy are FAR more likely to find gold in the generics market
> than Big Pharma.
>
> The patient is the biggest loser: the less research going on; the
> more likely there won't be better treatments for you or your loved
> ones in the future, should you become ill.

Sep 22 12:48 AM

[Tom B:]

If you read my post, you would see that you essentially repeated what I said. WL and PHA, at this time, are basically gone. The fact a few individuals still exist, here and there, hardly seems relevant.


On Sep 22 12:48 AM Jocular wrote:

> Actually, i'm not wrong. Pfizer did not jettison Warner Lambert
> until several years after the merger - in January of 2007 as a matter
> of fact (the closure of Ann Arbor was announced on 1/22/07). As
> for Pharmacia, it still exists within Pfizer - the St Louis site
> remains, it currently houses Pfizer's biologics pharm sci capability
> as well as its inflammation research unit and it was the only thing
> worth keeping. And they haven't gutted the research staff - several
> folks from Agouron remain at the LJ facility in senior roles and
> at St Louis. Pfizer simply did what they needed to do - they scaled
> back and diversified. Pfizer values Wyeth for its biologics capabilities
> and the proof is that a Wyeth scientist will head Pfizer's biopharma
> division. All of big pharma will do the same. The model of the
> future is J&J.

Sep 22 10:28 AM