The cost of modern healthcare is slowly bleeding the United States economy and accounts for the majority of the Federal government's projected budget deficits in the coming decade. The Congressional Budget Office (CBO) projects both Medicaid and Medicare entitlement spending will rise rapidly and make up an increasing portion of government expenditures in coming years. While the impact of the Affordable Care Act (ACA) on slowing the growth of healthcare costs in the U.S. remains an open question, it seems clear that the current healthcare situation in the United States is untenable in the long term.
Into this economic backdrop Gilead Sciences (NASDAQ:GILD) launched its new Hepatitis C drug Sovaldi. The release of the drug has been heralded as a near cure of chronic liver disease associated with Hepatitis C viral infection, but the company's pricing of Sovaldi touched off a political and media firestorm that is working to depress the company's share price as investors worry about the sustainability of Sovaldi's pricing and the earnings it engendered in Q1 of 2014 ($2.27 billion in sales) for the company.
Criticism of Sovaldi pricing has been strong and diverse, most infamously in the form of a letter from Democratic Congressman Henry Waxman who requested an explanation of Sovaldi pricing from Gilead in March of this year. More recently AHIP (American Health Insurance Plans), a Health Insurance industry lobbying group, charged that Gilead's pricing of Sovaldi is unsustainable.
Sovaldi is fairly priced for the U.S. market and attacks on the $1,000 a pill treatment ($84,000 for the recommended full course of treatment) are motivated by a combination of voices who are philosophically opposed to a market system in medicine or those who are willing to sacrifice the long-term cost savings of the drug for the short-term savings on immediate costs (government) and profits (Health Insurance Companies). Gilead should seize the economic and ethical high ground and aggressively push back against its detractors. Investors should take comfort that the company is acting responsibly to price Sovaldi so that they see a return on their capital and serve the greater good for society (you can read a full analysis of Gilead here).
An Uncomfortable Truth for some...
Gilead's defenders must first acknowledge that a cursory examination of Sovaldi pricing plays in their opponents' favor. Sovaldi is a little pill and nearly everyone has taken a pill in their life - pain relievers, antibiotics, vitamins, etc. So how could this little pill, that costs pennies to mass produce, possibly sell for a $1,000? Indeed, how could a company morally justify such a price when Hepatitis C dooms the infected to a life of chronic liver disease and eventual liver failure and death? The answer, of course, is that Gilead spends pennies to manufacture the second and all subsequent pills, but the first pill cost Gilead and its shareholders well in excess of $11 billion. In 2011 the company acquired the original developer of sofosbuvir (Sovaldi), the biotech firm Pharmasset, in a move that many in the industry questioned. Gilead paid more than an 89% premium for Pharmasset and its promising but still experimental PSI-7977 (Sofusbuvir) compound. But Gilead's acquisition was more than just a roll of the dice. It was a carefully weighed investment that leveraged the skill and expertise of Gilead scientists to collaborate with Pharmasset to bring a new life saving compound to market.
The larger question is why the founders of Pharmasset pursued the development of Sofosbuvir in the first place. The biotech firm was founded by two Emory University scientists and headquartered in Princeton NJ with a focus in clinical stage pharmaceuticals. In other words, the company had no product on the market when Gilead paid over $11 billion to acquire its intellectual property. So why did the scientists from Emory University choose to found their own company and conduct research with its investors' capital? It was of course to maintain ownership of their work and profit from its success.
Patients take for granted that in the modern world there will be a drug or procedure to cure or treat whatever malady may have befallen them. The sheer number of drugs available for the treatment of illnesses is a truly amazing achievement of modern science and modern finance. It is an uncomfortable truth for some, but a truth nonetheless, that nearly all the drugs we rely on for the treatment of the multitude of cancers, high blood pressure, high cholesterol, infectious disease and the gamut of other illnesses are the direct result of a market-based incentive. Brilliant scientists and physicians worked to develop new treatments with investors' money for both the freedom to pursue their intellectual and professional passions, but also the opportunity to profit. A huge number of biotech firms and the compounds they develop end in failure. A 2009 study found less than 15% of all compounds ever enter the market, with the majority ending in the loss of investors' capital. It is a system that, when measured on its ability to bring life-saving innovative therapies to market, is exceedingly successful.
What Price is Fair?
Gilead's pricing of Sovaldi could easily be viewed as conservative when compared with recent competitors and the alternatives for treatment of chronic liver disease. Incivek, a Vertex Pharmaceuticals drug that previously offered the best treatment option for Hepatitis C, sells for nearly $50,000 for a full course of treatment, and the price stretches to nearly $100,000 when combined with the cost of the longer course of ribvavirin and interferons that are required with the use of Incivek. Amazingly, Incivek showed a cure rate 25% lower than Sovaldi in clinical testing.
The alternatives to Sovaldi for Hepatitis C patients are grim and expensive. The expenses are spread over a much longer time frame, but the total costs for the average patient suffering from liver disease easily exceeds the cost of Sovaldi cure. A 2011 study conducted by the Henry Ford Health System, that was presented at the 62nd Annual Meeting of the American Association for the Study of Liver Disease, looked at a population of over 57,000 Hepatitis C patients and found monthly costs of Hepatitis C are considerable. While the costs vary depending upon the patient's stage of liver disease, the mean average cost for patients with chronic Hepatitis C infection was estimated at $24,175 per year. Costs skyrocket to nearly $60,000 per year when patients begin suffering from later stages of the disease. The study's lead author Dr. Stuart Gordon, the Director of Hepatology at Henry Ford Hospital, noted:
"As we see patients with more advanced stages of liver disease, we see significantly more costs to the system. The key, therefore, is to treat and cure infections early to prevent the consequences of more advanced disease and the associated economic burdens."
It is important to remember that Sovaldi has shown a 92-100% cure rate after a 12-week course of treatment. Dr. Gordon's study and others like it have shown the costs of chronic Hepatitis C infection to be far greater than the near certain cure of Sovaldi.
Sovaldi Earnings Growth Will Continue
Gilead's Sovaldi is a near cure for Hepatitis C and is appropriately priced. The current $84,000 price tag for the drug both affords a profit that rewards investors and provides the incentive for continued investment and innovation, while simultaneously reducing the long-term costs associated with chronic Hepatitis C infection. Despite the noise emanating from Washington, special interest groups, and the media, Gilead has the legal and ethical standing to maintain Sovaldi pricing. New drugs with similar success rates may lead to price reductions through market competition, but Sovaldi's reasonable market price will not likely be significantly undercut by competitors. Investors should use the continued concern over Sovaldi pricing as a buying opportunity.
Disclosure: I am long GILD. 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.