Introduction - politics may be providing good entry into the biotech and high-tech Big Pharma space
Last week, Mrs. Clinton roiled the biotech stocks, as well as Mylan (NASDAQ:MYL), by pointing to MYL's price increases on its flagship brand product EpiPen as well as certain overpricing of biotech cholesterol drugs. One of Mrs. Clinton's proposals that knocked down R&D-focused biotech stocks was that the statutory period of exclusivity should be lowered to 7 years.
I reviewed MYL and biotech stock prospects and their relationship to Mrs. Clinton's actual proposals, and provided my opinion that the chances of materially lowering the period of exclusivity for biologics to anywhere near 7 years were slim to none. Of course, that's entirely my opinion about the legislative chances of such a proposal, so take it for what (little?) it may be worth.
As far as her complaints about EpiPen, in that article and a follow-up, I reviewed the intellectual property surrounding EpiPen in detail, and pointed out that there is direct competition in the autoinjector epinephrine space from Adrenaclick and its authorized generic. I also noted that there was no actual proposal on the HillaryClinton.com website for legislation that would address price increases of this nature. (I also expressed general bearishness on generic stocks such as MYL.)
Likely no one in the Clinton campaign needed me to point that out, and her website now features a statement addressing this issue. As it contains new information that could affect pharma and biotech investors, it's worth reviewing it before going on to my evolving views on the underperforming biotech sector. The latest Statement and some the key passages from it are cut-and-pasted below. I'm going to take the passages in a different order from their arrangement on the website, in order to first highlight the focus on MYL and EpiPen.
Hillary Clinton's Plan to Immediately Respond to Outlier, Unjustified Drug Price Increases:
Today, Hillary is offering an aggressive, immediate response plan to provide relief from unjustified drug price spikes for treatments, like EpiPens or pyrimethamine [Daraprim, the Turing/Martin Shkreli drug], that have long been on the market, where there has been little or no innovation or additional research and development. In combination with her broader agenda to lower prescription drug costs, which she is reiterating today, these strong new tools will ensure Americans can afford prescription drugs, and make sure that drug companies get ahead through innovation and research [which is my "thing"], rather than unjustified price increases...
Hillary believes we need to move beyond talking about these price hikes to acting to address them. Today she is calling for action to protect consumers from unjustified prescription drug price increases by companies that are marketing long-standing, life-saving treatments and face little or no competition. Her plan will establish dedicated consumer oversight at our public health and competition agencies. They will determine an unjustified, outlier price increase based on specific criteria including: 1) the trajectory of the price increase; 2) the cost of production; and 3) the relative value to patients, among other factors that pose a threat to public health.
Should an excessive, outlier price increase be determined for a long-standing treatment, Hillary's plan would make new enforcement tools available, including:
... Penalties for unjustified price increases to hold drug companies accountable and fund expanded access: Holding drug makers accountable for unjustified price increases with new penalties, such as fines - and using the funds or savings to expand access and competition...
Holding drug makers accountable for unjustified price increases with new penalties - and using the funds to expand access and competition. In cases where there is a price spike and a lack of competition for a life-saving treatment that has long been on the market, Hillary's plan will enable the ability to fine or increase rebates from drug companies who are excessively raising prices.
The bottom sections of the latest Statement reiterate previous proposals; I commented briefly on some of them, and don't see anything there that's materially negative to pharma companies. For example, drug companies might be happy or at least not unhappy to negotiate with one buyer -- Medicare -- rather than numerous competing insurers, PBMs, etc.
To begin with, before addressing EpiPen, let's see how important these proposal are quantitatively to pharma companies in the aggregate.
Do these proposals, if implemented, matter much, anymore, to pharma and biotech stock market investors?
My view is: probably not, though of course, there's always headline risk. But if so, maybe the stocks will already be higher.
What usually happens in the pharma industry, including biotech, is that a general upward creep in prices of most successful drugs occurs. Importantly, most drugs have competition, and a key phrase in the Statement is for "life-saving treatments" (generally drugs) that face "little or no competition." In addition, the same sentence further qualifies the above by saying that the treatment needs to have been "long-available."
Using definitions of the above terms that I am inferring should be used (no certainties here), there are few drugs on the market covered by this proposal.
So, on its face, the above may or may not be a good idea, or contain a variety of good ideas; it (they) may or may not make it into law if introduced into Congress, but from the standpoint of pharma and biotech investors, there's nothing really here that is quantitatively a problem to me as an investor in innovative, R&D-focused biotech and Big Pharma stocks.
My view remains that what continues to matter are competitive dynamics within the industry, which has attracted so much investment and has had a full gamut of price increases ahead of general inflation. Thus we see today such matters as Novo Nordisk (NYSE:NVO) complaining of strong pricing pressures within insulins in the US, and various complaints that PBMs are snarfing up too much of the pharma dollar rather than acting as low-cost efficiency enhancers.
The above said, it's worth looking at EpiPen to see if even now, is it covered by these proposals. Doing so suggests that actually writing legislation, even narrowly-focused legislation, may be easier said than done. And if it's too narrowly focused, is it then worth the trouble?
Does the Clinton proposal even cover EpiPen?
First, one has to define "long-standing." Is it long enough for a drug or treatment (such as a drug-device amalgam as EpiPen is) to have gone generic? That is the case with Daraprim, and with certain Valeant (NYSE:VRX) brands such as Isuprel that so upset so many people last year and before then, with giant price increases for what unquestionably were old drugs. But what about EpiPen, which is an improved version of an old version? If it's covered by a patent with years to run, is it really a long-standing product? I'm not sure. Patents are the lifeblood of innovation, to the extent that they are mentioned in the Constitution. In fact, patent lawyers are a special type of attorney, ones licensed not by a state but by the Federal government. Contrary to some opinions, it's not easy to receive a patent, and it's especially not easy to receive one that's commercially important. I think these considerations could weigh heavily when considering legislation.
You then have to ask about the phrase "little or no competition." How little is "little" and how much is enough competition to be excluded from having "little" ... competition?
As an extremely relevant point, one has to define the market when one defines the degree of competition that a product faces. It's not always an easy thing to do. Take what I would call a life-saving drug, Revlimid for multiple myeloma from Celgene (NASDAQ:CELG). Is Revlimid competing with bone marrow transplants? With thalidomide? Look at all the first-line treatments.
What if consensus comes to be, or already is, that Revlimid is the best foundation treatment for myeloma, but others are approved as well?
Does that then mean that it Revlimid would be subject to this outlier rule, but if it is merely outcompeting the others in the marketplace, CELG is free to raise prices as much as the market will bear? (And, of course, when does it become a "long-standing" drug? Do you look at the patent expiration for the drug substance? Do you look at the number of years since FDA approval? Do you look at the number of years since ascendancy to best in class?)
I'm not asking any reader to actually answer those questions; they're rhetorical at this point. But they help explain my opinion that defining the details will not be easy -- at least, in my humble opinion. Just as defining pornography is not easy; the "I know it when I see it" is not easy to write into law for porn, and it's not easy for the legal drug biz.
All that said, EpiPen has competition -- except for its patented designs. That aside, there is Adrenaclick and, especially, its authorized generic, which sells for much less than EpiPen.
Then there is the question of whether a plain, old epinephrine vial with a syringe can be considered competition to both EpiPen and Adrenaclick. Those two brands use more sophisticated autoinjector technology, but epi from a vial can also save a life quickly and effectively.
So, using the website's terminology, I'm not sure whether EpiPen in its current, patented configuration is a "long-standing" product. The old EpiPen is not patented and is more or less copied by Adrenaclick, as I understand it.
Moving on to yet another set of questions I have, it's not clear to me if Adrenaclick provides "little" or more than little competition. What market share would prove that? How would the government even obtain reliable data on market share? It's proprietary information, after all.
If the government were to define "little" competition as, say, 10% or less of the market, then does a dominant company in a specific sub-sector of the market, say MYL with EpiPen, make sure that it has only 85%-89% share, so that it can raise prices more easily?
Will the situation turn a bit strange, and be like some employers with the Obamacare insurance mandate, bringing the weekly hours of workers to 29 1/2?
And if a company does do that with what's widely viewed as the superior product, doesn't that mean that a certain percentage of the population are going to now receive the lesser product when, without this proposed legislation, they would have received the superior market leader?
Finally, what appeal process would a company that would be injured by governmental action have? Certainly it could not hold up the process for years, or the new law would be toothless. But aren't pharmaceutical companies entitled to due process, and not arbitrarily have the government declare a pricing emergency and take the fruits of its investment in a superior product from it on the grounds of saving society money? So, would a court hold an emergency hearing on these matters? If so, what costs and controversies would that entail?
To summarize this section, it's not clear to yours truly that it will be easy to write legislation that's worth the trouble. Once the Federal government begins defining what is an "outlier" product in any industry, in this case the drug industry, problems ensue. As analyzed in this section, the ultra-complex nature of the pharmaceutical industry, or drug-device subsector of the industry in the case of EpiPen, may make crafting clear legislation difficult.
In any case, this is an investment article about stocks, not a policy article. The broader, relevant point to this article is that unless legislation strays substantially from what appears on the website, the topic of interest to Mrs. Clinton is of limited importance to investors. It is something to watch, for sure, as my Revlimid example shows, but we all make judgments in markets all the time. I'm comfortable as an investor with what I've seen from Mrs. Clinton based on my views of what may pass Congress.
Here's what would make the difference to me:
What would matter to pharma stocks
It's my view that there is only one way to really get a grip on pharma pricing, and that's via a one-payer system such as Canada has, or something very close to that such as the UK has. This is not a political blog, and I'm offering no opinion on whether one should be implemented. The question is whether one will be implemented any time soon.
Based on what I've seen from Mrs. Clinton's website, I see nothing close to that sort of sweeping proposal. There are also unresolved issues with Obamacare, which in my judgment would further make extensive new legislation implementing a one-payer system difficult any time soon.
One is the issues that a number of healthcare exchanges have been having with solvency. Another is that if memory serves, President Obama unilaterally suspended a key employer mandate and that this suspension has never been dealt with legislatively. Correct me if I'm wrong here, as I'm not a policy wonk.
In the bigger picture, it has to mean something that a political campaign as savvy as the Clinton campaign has put forth the limited, specific proposals that it has. They cover a number of areas and may appeal to many voters. But they are incremental proposals.
One that might matter a bit would be to require new drugs to justify their pricing as the UK's NICE does. I would be fine with that as an investor. In fact, if Regeneron (NASDAQ:REGN) had done that when it introduced Praluent with Sanofi (NYSE:SNY) for high cholesterol, they would have had to have lower their asking price -- and they actually might have moved some of the inventory off their shelves. The same comment goes for the competing drug Repatha from Amgen (NASDAQ:AMGN). This proposal was made in the subsection titled "Ensure American consumers are getting value for their drugs.")
As an aside, the US does have a problem with me-too drugs. A classic example of that comes from Lexapro following on to Celexa.
Lexapro is a single-isomer version of Celexa, introduced some years ago by Forest Labs strictly as a life-cycle management tool. When approved by the FDA, which had no choice but to approve it as safe and effective, Forest was promising doctors and investors that it would present data that Lexapro had fewer side effects than Celexa. Nope. In fact, when it was introduced, a psychiatrist who was consulting for my start-up told me that he was sticking with Celexa, which was going generic, as Lexapro had no advantages over it.
A year or so later, I asked him whether he was prescribing Lexapro. There were still no advantages shown for Lexapro over Celexa. He admitted sheepishly that he was using a lot of Lexapro. Why? Because, he said, Forest brought him a lot of samples.
Lexapro is reported to have had peak sales of $2.3 B. Over the years, were $10+ B extra dollars shoveled out of the pockets of consumers and insurers for Lexapro when Celexa (generic) would have served just as well?
There are indeed low-hanging fruit examples such as this that any President and any Congress might empower the FDA to determine. Then, if the FDA determined that a new drug was not superior to one or more existing ones for the same indication, insurers could simply make the drug a Tier 3 product, with exceptions for allergy or intolerance to the less expensive product.
There could also be a governmental or government-sponsored body that opines as NICE does on the cost-effectiveness of new treatments. If viewed as fair and impartial, its opinions could be used by insurers as definitive in negotiating pricing with pharma companies. I assume that anyone, such as the drug company, could present other analyses, as there are many ways to look at things.
As pharmaceuticals gain a higher share of healthcare spending, which itself has gained a much higher share than 20 years ago of GDP, mild actions such as these may be difficult for the industry to resist.
However, while actions (or reforms, as one may view them) such as the above probably could readily be implemented, they may never be; and if they are, they are quantitatively relatively small matters in the scheme of the vast, generally innovative high-tech pharma industry that I follow. Most importantly to me, this sort of thing can occur under any administration and with any Congress. Logic and basic economics may compel something more to be done -- but all that may be in, or more than in, stock prices already. Change is incessant, but if an industry brings good things to life, and it costs a lot of time, money and risk to do so, I do not fear that the US government will go out of its way to destroy that industry.
Time to sum up and segue to specific investments.
The most important conclusion I draw from Hillary Clinton's Statements on pharmaceuticals is that they are incremental and even if they all were passed into law, even collectively they are not especially harmful to the R&D-oriented pharma industry.
I think the biotech stocks (NASDAQ:IBB) were ready for profit-taking, something I predicted in June through early August in 2015. That was long before Hillary's famous tweet and then speech complaining about Turing and Valeant (among other matters, of course). When a small sector of the stock market, biotech in this case, is the leading market sector 5 1/2 years in a row, 2010-14 and the first half of 2015, excesses build up in many places, and excess profits build up as well amongst investors.
So I see the reactions to the political input the way I have always seen them, as stochastic moves in stock prices that were going to occur one way or another as froth left the biotech sector.
I've been saying all along that from an investment standpoint, it didn't matter who was elected as far as the R&D-oriented biotechs went: that the sector was a winner for the long term, and an important and ecologically green money-maker for the US, and would be so for years to come. In fact, I expect biotech to be governmentally favored over the long haul, as a clear win-win industry for the United States.
From a trading standpoint, I'm finally getting just a bit more satisfied with the technicals and valuations of my favorite companies in the Big Pharma and biotech sectors.
I had partly stuck with the sector in a shrunken allocation through the 2015 summer sell-off, and by December had brought my allocation to a low level - though a high level relative to all stocks, most of which I basically exchanged for long term bonds. Now that long bonds such as Treasuries (NYSEARCA:TLT) or even intermediate term Treasuries (NYSEARCA:TLH) have outperformed stocks (NYSEARCA:SPY) this year in price while yielding more, and IBB has far underperformed the SPY, there has been a huge underperformance of IBB versus TLT.
Any time a leading biotech such as Gilead (NASDAQ:GILD) trades at or below 7X trailing EPS, the froth is gone from the secotr and investors are fretting about whether there will ever be growth again.
Actually, there will be, in my view.
(Though this may well not be "the" bottom.)
So even though I think that the overall market for "safe" stocks such as electric utilities (NYSEARCA:XLU) or soap and cola marketers have no clear advantages over bonds, and that many industrial stocks have extremely high PEG ratios and could fall heavily in a recession, at this point I think that biotech has seen enough of a relative sell-off versus the safe stuff to begin increasing my (still somewhat low) allocation to it following this latest downdraft pursuant to Mrs. Clinton's latest proposals.
In specific, after BMS (NYSE:BMY) fell sharply from the $70s into the low $60s on an important Opdivo trial failure, I wrote an article saying that I was reassessing my interest in it and wanted to buy it cheaper, namely in the $50-$55 range. When it dropped below $56 Friday, I finally bought a little and will look to ramp up deeper into this name if it drops lower.
Novo Nordisk has dropped more on (well-deserved, given the price inflation) insulin pricing pressures and a routine change of CEO. NVO trades with a low 20s multiple on trailing EPS with a high-potential late-stage pipeline. So I think it discounts a year or two of stagnant EPS while the pipeline has a chance to prove itself. I added a little more today on the further sell-off. Finally, GILD could see a 50% decline in EPS and still trade below 14X EPS. At $77 and below, I suspect that it is becoming so cheap that Big Pharma is considering a takeover offer. At this point, isn't the easiest way for a US-based pharma/biotech company to "invert" for tax reasons simply to get acquired by a giant such as Novartis (NYSE:NVS) or Roche (OTCQX:RHHBY)? Crazy though it sounds, maybe even Allergan (NYSE:AGN), with sales far below those of GILD, could obtain financing to swing such a deal to make GILD's tax structure Irish.
Yours truly is not ready to proclaim the end of the IBB underperformance, or that of specific stocks. That's not the point. IBB has vastly underperformed TLT year to date and even the past 2 years, but it's outperformed TLT and the SPY the past 5 and 10 years substantially. Just on technical grounds, further relative underperformance of biotech or what I consider the higher-tech Big Pharma companies may occur.
But if one has the long-term perspective that I have with these stocks, especially if they are dividend payers with strong finances, I always keep in mind that Amazon.com (NASDAQ:AMZN) bottomed not when tech bottomed in 2002, but in 2001. It dropped below $6 after the 9/11 attacks in 2001. By the time the overall market and tech sector bottomed in October 2002, AMZN had tripled from its low. You just never really know.
When I say "long-term perspective," when it comes to the names mentioned as longs in this article, I mean years. The cycles are very long in pharma, and Mr. Market is subject to mood swings in biotech that can be large, sudden and random. The key for me is that I see the breakthroughs on the horizon ranging from parenteral therapies for cancer, to newer oral drugs replacing older parenteral ones, all of which every Presidential candidate and every Congressperson will favor. With those breakthroughs here and many more coming, how can this not be a growth opportunity for the best-managed, strongest companies as far as the eye can see? And a large opportunity, as well?
Yet the P/Es of several of the leading horsemen of biotech -- AMGN, Biogen (NASDAQ:BIIB), AbbVie (NYSE:ABBV) and GILD -- are all below 20X, whereas the average P/E of the SPY is above 25X. It sure looks to me as though a correction in the sector has already occurred.
Thus I have gained long-term confidence in the relative valuations of biotech and well-positioned Big Pharma stocks, and look to continue to add shares on weakness with a very patient outlook.
Disclosure: I am/we are long BMY,GILD,NVO,REGN,TLT.
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.
Additional disclosure: Not investment advice. I am not an investment adviser.
Editor's Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.