Big Pharma Pipeline: Why So Dry?

Pharmaceutical companies are trading well below their historical P/E levels. To anyone who follows the industry, this comes as no surprise. After a slew of blockbuster drugs that hit the market several years ago, the R&D departments of the largest companies have been coming up empty as of late. As a result, investors are concerned that revenues currently yielded from drugs that will soon undergo patent expiration are not being replaced.

So why haven't there been any new blockbuster drugs to replace the ones currently in the market? The problem is not a lack of trying on the part of the industry. Here's a look at the R&D spend (as a percentage of revenue) for three of the largest US pharmaceuticals over the last couple of decades: With the R&D spend where it is, it's surprising to see that the industry can't keep pace with its aging pipeline. So what's going on here? There will always be media airtime for pundits and experts to offer theories as fact to help decipher a phenomenon whose occurrence is difficult to explain. The common arguments are that big pharma is inefficient, has morale problems, and doesn't have the entrepreneurial spirit conducive to innovation.

It's entirely possible that one or more of these arguments is correct. But they rely on anecdotal evidence, and are more likely applicable to a few departments or perhaps one or two entire firms. But it seems far-fetched that these explanations describe an entire industry that spans countless research labs and several companies which have undertaken high-profile upper management changes with the goal of driving innovation.

It's possible that many of the factors resulting in the current weak drug pipelines are out of the realm of human control. The process of discovery relies to a certain extent on luck. Scientists perform experiments with the hope of seeing results, but the slim chances of success for the next big blockbuster drug can result in high volatility in the degree of success: we have good times (like in the 90s when there were blockbusters a-plenty) and bad times.

When we met with Francis Chou last week, famed value investor and founder of billion dollar Chou Associates, he told us that pharmaceutical stocks have been too beaten down by investors. He said with R&D budgets where they are, investors are getting stable cash flows from drugs still on patent, and getting access to drug pipelines that are bound to turn up a share of successes. To spread out risk, Chou recommended buying a basket of these stocks, since it's unclear which of these companies will hit the home runs.

Disclosure: None

Comments

[turd furgeson]

Lack of innovation among 'big pharma' is nothing new. Virtually all of the major blockbusters of today were discovered at the laboratories of small companies that were picked up on the cheap from these monstrous waste baskets. Who is to blame? Short term fund managers pressuring great small companies into deals. Who pays the price? Everyone.

[redbaron]

Please take a look at the ratio of drug company marketing spending, to research spending. I maintain that when they started spending more on advertising, than on research, the number of new drugs discovered, tanked. The last article I saw on this subject says that they are now spending in the neighborhood of 2-3 times as much on marketing, as on research. Perhaps, if they just did the research (and did it right), and forgot the advertising, they could produce a few more new drugs.

Then there is the use of questionable statistics in analyzing the data. The experts in the various medical fields cannot even agree that some of these new drugs are safe and effective for their intended uses. Given their recent record of producing drugs with so many questionable results, one has to wonder why they didn't discover that these drugs were not safe and effective until they were already on the market. Very poor science, it seems to me, and also very poor statistical analysis. And, I might add, very poor oversight by the regulators.

Some return to basic good science, is perhaps all that is needed. That, and a little less marketing.

[Tom B]

I know the industry. There are several problems:

1) The "D" in R&D is MUCH bigger than the "R". Big Pharma has been slashing research.
2) The FDA is full of cronies. They are too slow to approve, and WAY to quick to panic over extremely miniscule risks. Look at the whole Vioxx thing.

[Kend I]

I totally agree with the second point by Tom B, the FDA is reacting to the liberal congressional committees and also a few "scientist's"... that seem to have an agenda other than science. Add to that the scandelous liberal media that plays up non-issues like horrific events. I also think the New England Journal of Medicine is way out on some radical limb.

[Tom B]

"Add to that the scandelous liberal media that plays up non-issues like horrific events."

Both parties are screwed up on this. I'm underwhelmed with Bush's appointees to the FDA.