There is little doubt by investors that Gilead (NASDAQ:GILD) has developed a miracle drug for hepatitis C treatment. With the initial US prescription data for Sovaldi tracking to bring in $5-$9 billion in its first year on the market, the popularity and success of the drug is unprecedented. Building on this success, Gilead recently submitted the Sovaldi/NS5A inhibitor ledipasvir drug combination to the FDA, which was granted breakthrough therapy designation, and treats the most frequent genotype 1 strain. Although others, such as AbbVie (NYSE:ABBV), Merck (NYSE:MRK), and Bristol Meyers Squibb (NYSE:BMY) are working on their own hepatitis C treatments, there is little argument among analysts that Gilead's treatment is superior. So with nothing but good news flowing out of Gilead and money flowing in just as fast, why is the stock being pressured down? Investors are reacting to political posturing and recurring comments from Express Scripts (NASDAQ:ESRX) medical director, Steve Miller critiquing the $84,000 Sovaldi price tag. Investors should use the public shaming campaign by Express Scripts to add Gilead shares at a considerable discount. To be fair, Express Scripts is not really concerned about the rising price of drugs for Americans, but more about how it will impact its own bottom line.
There is little doubt that a hepatitis C cure for $84,000 in the long run will directly save the overall healthcare system money, when factoring in drugs, liver transplants, doctor visits, etc. In fact, it's estimated that hepatitis C indirectly costs employers over $4-5 billion a year just due to employees infected with the virus missing work. However, when you listen to the recent bantering by Dr. Miller, you would think Sovaldi is going to bring down the whole healthcare system.
"If everyone with hepatitis C was treated with Sovaldi, the cost would exceed $300 billion -- more than the U.S. currently spends on all prescription drugs."
Now obviously, Dr. Miller is smart enough to know that everyone infected with hepatitis C won't all be treated at once. Also, he is only taking into account what Express Scripts is worried about, and that is drug prescription costs, while insurance companies must also worry about doctor visits, surgeries, etc. In addition, we all know that insurance plans negotiate pricing deals that don't reflect the sticker price of the drug. Dr. Miller goes so far as to state he is going to try and bring insurance companies together and threaten to boycott Sovaldi once a competitor hits the market, if they don't lower their prices. Dr. Miller states,
"Gilead could have a great year this year and lose all its market share a year from now. The FDA has fast-tracked several other medications and we believe early 2015 is when there will be competitors in the marketplace."
Investors need to understand that Express Scripts and Dr. Miller are trying to make money just like Gilead. Express Scripts, the 24th-ranked Fortune 500 company, is a multi-billion dollar pharmacy benefit management company that serves as the middle person between insurance companies and pharmaceutical companies. Their whole pitch is that they will save customers money by negotiating lower pricing for drugs. They cut deals with pharmaceutical companies like Gilead and then sell the drug to drug stores, insurers, etc. at a discount, and collect the difference. With this type of system, Express Scripts prefers generic drugs over branded drugs, as they can negotiate rock-bottom prices for generics due to price competition between drug makers. For example, they may get the drug at an 80% discount and sell it to their customer at a 10% discount, and pocket the difference. None of this is transparent, by the way. Whereas, with branded drugs, there is not much leverage on pricing, and therefore, being the middleman doesn't provide much benefit. Obviously, if they can get a price war going between companies offering hepatitis C drugs, it will benefit them. Utilizing this method of spread pricing, Express Scripts made enough of its own money last year, raking in revenue close to $25 billion, enough to pay for the CEO's $50 million compensation package. This year, Express Scripts forecast they will be able to grow earnings 10%-20% for the next several years. Although these benefit manager companies would argue they save consumers money, there are a lot of people who think they actually double the costs of drugs. In fact, many have found you can buy drugs for cheaper by bypassing the middleman and going directly to places like Costco.
It is quite clear that Dr. Miller is trying to spark a pricing war between AbbVie and Gilead. However, with AbbVie's Humira patent expiring in 2016, and the need to replace ~60% of revenue, it is not clear if there will be much of a price break for the drug they were banking on helping recover some of this loss. Realistically, companies like Express Scripts would have pressured whoever was first to market to reduce prices, regardless of what they were initially set at. I would assume that Gilead will reduce their price some once competition hits the market, but will still be priced at a premium due to the better efficacy and lower pill burden of their treatment. In addition, they could adjust the pricing of their upcoming combination treatment upon launch as well.
Regardless, I was humored by Dr. Miller's comments regarding blocking Sovaldi treatment, and think he may need a refresher on how their formulary development process is marketed to the public. On their website, they provide a white paper detailing the 3 principles in which their formulary coverage is determined.
1. Clinical appropriateness of the drug, not cost, is Express Scripts' foremost consideration.
2. The prescribing physician always makes the final decision regarding an individual patient's drug therapy.
3. Express Scripts will develop clinically sound formularies based on evaluations of independent physicians.
Therefore, to block a drug like Sovaldi, Express Scripts would have to revise their criteria for coverage to reflect cost of drug as the number one factor. Last year, Express Scripts blocked ~40 branded drugs from coverage after determining they were not medical breakthrough products. I'm pretty sure this argument wouldn't hold water for Sovaldi. As an investor, I've been adding to my Gilead position every time Express Scripts makes a public comment regarding Sovaldi pricing, as I think there is an easy 30% upside to the stock in the next 3-6 months. At the end of the day, I don't expect the competition to provide a substantial enough price break on their treatments to warrant Sovaldi exclusion. Conversely, if by some chance AbbVie does decide to play the pricing game and Gilead reduces their pricing, it would likewise be highly unlikely Sovaldi would be excluded. Just as Express Scripts is questioning Gilead's Sovaldi pricing, perhaps Express Scripts clients should be questioning if having a pharmacy benefit manager actually provides any benefit.
Disclosure: I am long GILD. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.