"We had it once, we ain't got it anymore … don't you feel like you're a rider, on a downbound train?" -- "Downbound Train," Bruce Springsteen (1984).
These phrases, lifted from the mournful Springsteen tune named above, describe succinctly the current status of Big Pharma today. Just a few years ago the pharmaceutical industry, led by a number of large-caps known collectively as Big Pharma, was the world's most profitable business sector. With their top-selling products protected from price competition by patents, with government and insurance companies paying much of the costs for consumers, and with an ability to pump out product almost as cheaply as Microsoft can pump out new Windows CDs, these firms reaped the benefits of a business model that had to be the envy of business leaders everywhere.
Alas, all good things must end, and as we head into the second decade of the 21st century, it has become obvious that Big Pharma is going to be impacted severely by a wave of patent expirations, beginning in 2011 and extending through 2013 and beyond. This development, which has become known as Big Pharma's "patent cliff," has been estimated to put at risk over $50 billion in annual revenue, with the total revenue impact over the 2011-13 time frame being estimated at $150 billion or more. The reason is that once a drug goes off patent, generic versions available at a fraction of the cost of the brand name take over 90% or more of sales. A couple of quotes in a March 6, 2011, New York Times article from Kenneth Kaitin, director of the Center for the Study of Drug Development at Tufts University, describe the situation in stark terms:
This is panic time, this is truly panic time for the industry," and "I don't think there's a company out there that doesn't realize they don't have enough products in the pipeline or the portfolio, don't have enough revenue to sustain their research and development.
There are other factors at work besides the patent expirations, which are exacerbating the situation. An increasingly strict and extended regulatory approval process has slowed down the availability of new drugs, even as the companies have doubled research and development spending over the last decade, a claim tha twas stated in the New York Times article referenced above. Several high-profile problems that surfaced later on, after FDA approval of certain drugs such as Vioxx, to cite one example, showed that increased caution in the approval process was warranted.
While a stricter approval process has resulted in a doubling of the time required to get a new drug to market, and has increased the average development cost to $1 billion, the shortfall in availability of new drugs is not just because of the FDA. The fact is, the historical approach to R&D followed by the drug companies is just not yielding the results that it once did. Perhaps similar to the oil companies' lament that "all of the easy oil has been found," the drug companies can lament that "all of the easy 'blockbuster' drugs -- i.e., drugs that have the potential to significantly affect revenues -- have been discovered." Whether true or not, the fact is that the drug companies have not come up with new blockbuster discoveries to replace those going off patent protection.
Another headwind is that insurers and governments, under increasing cost pressures, may impose price cuts on existing drugs or in some cases may refuse to cover new drugs, claiming they are not cost-effective. I personally believe this will get much worse in the next few years, considering the pressures imposed by governmental deficits and the near-universal desire to rein in healthcare costs.
One could argue that this is all "old news" and is priced into the stocks already. And indeed it is, as the drug company stock prices are now approaching levels that are normally reserved for value stocks, at least in some cases. The question for investors is: Do these stocks truly represent value, or are they value traps?
The answer(s) will likely vary by firm, and won't be known for some time. Still, now that we are well into the patent cliff time frame, the various approaches of these firms in responding to their version of the "new normal" -- to steal the expression made famous by bond guru Bill Gross -- are now becoming apparent. Some are doubling down, focusing ever harder on new drug discoveries, while others are trying to diversify revenue streams to lessen dependence on a few big sellers. Nearly all are looking to acquire and/or partner with smaller firms with promising developmental pipelines, and all are focusing on cost containment, including layoffs in some cases. While picking the clear winners at this point might not be possible, the sheer size of these firms tells me that they aren't going away, as they all have significant resources to deploy in the pursuit of their mitigation strategies. Also, aging populations in the United States and Europe is the one trend still moving in the drug companies' favor, and improving prosperity in emerging markets will add further to the demand for life-saving drug therapies.
I will now list and provide links to several representative articles describing the patent cliff, which I relied on to assemble the preceding summary. An Internet search on the phrase "Big Pharma's patent cliff" will yield these articles and many more, for readers wanting additional detail:
- New York Times, March 6, 2011: "Drug Firms Face Billions in Losses in '11 as Patents End" (Referenced in the opening paragraph above.)
- Swissinfo.ch, Jan. 18, 2012, "Pharma industry braces for some cliff diving"
- Casey Research, Feb. 16, 2012, "Could Big Pharma's Patent Collapse Sink Your Portfolio?"
- Investor Uprising, April 17, 2012, "Big Pharma Teeters on the Patent Cliff"
- The Economist, Dec. 3, 2011, "Big Pharma struggles to protect its blockbusters as they lose patent protection"
- Financial Times, May 6, 2012, "Pharma tries to avoid falling off 'patent cliff'" (Free registration with FT may be required to read the article.)
To get down to specifics, I have identified 10 of the largest drug companies as my subjects for evaluation. I eliminated a couple of firms that I felt were more diversified, such as Johnson & Johnson (NYSE:JNJ), trying to limit the focus to "pure" pharmaceutical companies. The firms are listed below, in descending order by market cap. All are either mega caps, over $100 billion, or large caps, between $10 billion and $100 billion.The countries where each firm is headquartered are also noted.
- Pfizer (NYSE:PFE): $168 billion (mega cap, U.S.)
- Novartis A G ADR (NYSE:NVS), $130 billion (mega cap, Switzerland)
- Roche Holdings LTD ADR (OTCQX:RHHBY), $120 billion (mega cap, Switzerland)
- Merck & Co (NYSE:MRK), $116 billion (mega cap, U.S.)
- GlaxoSmithKline PLC ADR (NYSE:GSK), $116 billion (mega cap, U.K.)
- Abbott Labs (NYSE:ABT), $98 billion (large cap, U.S.)
- Sanofi Sponsored ADR (NYSE:SNY), $95 billion (large cap, France)
- Bristol Myers Squibb (NYSE:BMY), $56 billion (large cap, U.S.)
- AstraZeneca PLC ADR (NYSE:AZN), $55 billion (large cap, U.K.)
- Eli Lilly & Co (NYSE:LLY), $48 billion (large cap, U.S.)
In Part 2 of this article, I will present data comparing these firms on a number of metrics, and will also present some anecdotal information regarding their strategies for coping with the patent losses, with links to articles of interest.