Big Pharma's Future Death Spiral?

 |  Includes: MRK, PFE
by: Derek Lowe

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 (NYSE:ABT), then Wall Street (Legg Mason (NYSE: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 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 (NYSE:PFE) stock market performance over the period of time from pre-WLA, through Pharmacia-Upjohn, and now 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 (NYSE: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?