Novartis Reveals the High Cost of Failure

Oct. 7.10 | About: Novartis AG (NVS)

Novartis’ (NYSE:NVS) decision this week to abandon development of anti-fungal agent Mycograb highlights the high cost of R&D failure. Mycograb follows anti-bacterial agent Aurograb into the R&D dustbin, two products that have cost Novartis $569m plus four years of development investment, finished off with a $595m write down.

While R&D is-- of course-- an inherently risky business, this situation provides a rare example where a price can be placed on what turned out to be a poor investment decision. Covering the cost of R&D failure is clearly a major factor behind claims by big pharma companies that it costs over $1bn to develop a new drug – a statistic that the industry also often uses to justify high prices and profit margins.

Paying over the odds

Novartis acquired both Mycograb and Aurograb through its $569m purchase of NeuTec Pharma four years ago, essentially the only two assets owned by the British drug developer. Novartis paid a 100% premium to the market price of NeuTec’s shares, seen at the time as a particularly costly and risky deal for just two pipeline assets.

Although the financial world was a very different place in 2006, such a deal would be inconceivable in today’s environment, where risk-sharing and milestone-based transactions are the norm.

Novartis ditched Aurograb in August 2008 after phase II data showed a lack of efficacy as an add-on therapy for life-threatening, deep-seated staphylococcal infections. Phase III trials were ongoing at the time and Novartis took a $235m asset write down.

The decision this week to abandon Mycograb (efungumab) as an add-on therapy to treat invasive candidiasis in adults has resulted in a write off of $360m, to be taken in Novartis’ third quarter financial results.

Cutting losses

No reason was given for the termination but it can be assumed the latest return on investment analysis was not favourable. Mycograb was originally filed in Europe in 2005, but rejected by regulators in November 2006. This was due to questions over the manufacturing process and characterisation of the product, which meant the agency was not comfortable with the safety of the compound.

Having spent almost four years trying to resolve these issues, Novartis has clearly decided to cut its losses.

Intriguingly, this move-- taken in conjunction with the abandoning of hepatitis C candidate Zalbin with a $230m charge-- has been taken well by the market and analysts as a new sign that Novartis is focusing on the real value in its pipeline. This is a somewhat perplexing conclusion, in that it assumes the company was not doing this properly before, which investors will hope is not the case.

The fact that these impairment charges can be partially offset by a $390m gain from the recent sale of urinary incontinence drug, Enablex, to Warner Chilcott (NASDAQ:WCRX), undoubtedly helps to numb the pain.

Yet the losses are significant. Aside from the impact on Novartis’ bottom line this year, Mycograb was still a relatively important pipeline asset. With a launch expected in 2013, consensus forecasts put sales reaching $211m by 2016; indeed Credit Suisse had penciled in sales over $500m by 2016, decent levels by any big pharma yardstick.

This case illustrates just how costly research can be over a very short period of time. There will always be failures, but NeuTec will not go down as Novartis' finest investment decision.

Disclosure: No position