Expiring Patents Ignite Biotech Boom

It’s tough to find anything positive to talk about in this market. The U.S. Government stepped in and assigned Fannie Mae (FNM) and Freddie Mac (FRE) a value of zero through governmental decree. Even a cutback in oil production from OPEC can’t stop oil prices from falling. Gold, silver, and fertilizer stocks are falling too. Even Brazil’s stock market, the top-performing BRIC nation of 2008, is starting to fall.  

It’s bad out there for most industries. But there’s no sector worse off than the pharmaceutical sector. Big Pharma stocks like Pfizer (PFE), Merck (MRK), and Glaxosmithkline (GSK) are having a rough time and it looks like more stormy weather ahead. And these companies are giants headed for a fall.   

 

But here’s the thing about the drug industry: Bad times for the big guys can mean good times for the little guys. And that means great profits for savvy investors. Right now, Big Pharma is searching for new revenue streams, and that is good news for the shareholders of smaller innovative drug makers. 

CNN summed Big Pharma’s problems up best when it said, “[The industry is] like rearranging chairs on the Titanic.” 

Frankly, the situation is bad …real bad. Even 9-digit lobbying budgets and their hundreds of Ivy League-educated lawyers aren’t going to be able to stop it. 

The cause of the problem is complacency. You see, Big Pharma is lives on “blockbuster” drugs. A blockbuster drug is simply any drug that generates at least $1 billion in sales each year. And it’s those drugs that make the big profits for the multibillion-dollar pharma companies like Pfizer, Merck, and GlaxoSmithKline. 

On average, it takes about $800 million to develop a drug. That takes a moment to digest.  It’s an astronomical price tag for a product that is difficult to “market test”.   The $800 million covers everything from early pre-clinical trials to the three phases of FDA approvals and marketing costs. As a result, it takes a big success to make any money in the drug industry. 

 Keep in mind, that’s not including the costs to manufacture each pill …and the costs of any lawsuits, production delays, competition, patent disputes, and everything else that seem to pile up. So for these big drug companies, $1 billion is basically the break-even point.

There’s another significant challenge the big pharma companies have to deal with: the length of the patent.  New drugs are only patented for 20 years. That sounds like a generous amount of time. If they had 20 years, a drug company would have to sell only about $40 million of a drug to recoup those costs of developing a new one. But investors are not typically patient enough to operate on that time-line. 

At the 20 year point, the patent expires and anyone can make the drug and sell it. The generic drug industry is founded on manufacturing drugs after the patent runs out. Generic drug makers wait for the patents to expire, take the formula that costs hundreds of millions of dollars to develop, and reproduce it.  

Since they have none of the $800 million in research costs to recover, they can easily undercut the prices original developer of the drug. The generics can cost as much as 80% to 90% less than brand name drugs. Consumers inevitably turn to the cheaper version. 

But we’re discounting one technicality. According to U.S. patent law, patented drugs are protected from competition for 20 years. In reality, drug companies don’t have nearly that long. 

The clock starts ticking when the patent is filed. That’s before the safety and development process even begins.  

Since that process usually takes at least a decade, drug companies don’t have anything close to 20 years ... they usually have only seven to 10 years to sell their drugs at top prices. They’re protected from competition by patents for a very short time. And once the patents expire, the generic manufacturers move in and take sales away. 

In the next few years, the worst possible thing is going to happen to Big Pharma. The industry that needs vast amount of cash to fund high-risk projects knowing any payoff is 10 years away (at the earliest), is going to get cut off from its lifeblood.

The number of drugs  going “off patent” in the next few years is alarming. According to IMH Health, more than $60 billion worth of drugs are going “off patent” by 2011. 

Take Fosamax for example. Fosamax is Merck’s current top selling drug. It’s designed to help treat osteoperoasis by making bones stronger. It brings in more than $3 billion in sales to the company each year.  It WAS a huge success for Merck … Emphasis on WAS. The Forsamax patent expired in February of 2008. 

Fosamax accounted for more than 12% of one of the largest pharmaceutical companies in the world! Now, it’s all gone. Anybody can take the secret formula that made Fosamax a success, directly copy, and resell it for as cheap as possible. 

Fosamax is just one example of the huge impact of a drug going “off patent.” It’s happening all across Big Pharma.  

GlaxoSmithKline’s Advair came off patent in February, 2008. Advair accounted for 15% of annual sales for GSK. 

Top selling anti-depressant Effexor, which accounts for $3.7 billion in annual sales for Wyeth (WYE), has gone off patent too. Last June, when the patented expired, 6% of Wyeth’s business was eliminiated. 

Johnson & Johnson’s (JNJ) Topamax, which racks up $2.5 billion in annual sales, is going off patent in September. AstraZeneca’s $1.2 billion loses patent protection in October…. 

You get the picture. It’s happening now, and more and more drugs are going to go “off patent” in the next two years.  

Big Pharma is going to be forced to buy small biotech companies just to survive, and the buyout frenzy could spark a very bull market in biotech.  

In fact, it has already started. Earlier this week a rumor of an “imminent” takeover by Pfizer of Bayer sent shares of the German drug maker climbing 5%. Forbes reports the top cause of the buyout is Bayer’s extensive pipeline of new drugs in development. 

Although any Pfizer/Bayer combo is unlikely and far from a perfect fit, the excitement surrounding it proves how desperate Big Pharma is becoming. 

At the end of the day, the investing principals we stick to are pretty simple. You buy something (a stock) at a low price and hope to sell it at a higher price. And right now, you can buy small biotech stocks at a low price that are good candidates to be bought out by deep-pocketed buyers at a higher price. 

Disclosure: No positions in any of the stocks mentioned.

Comments

[wow!:]

NO WAY! thanks for your insight Andrew, you really know your way around pharma. I'm off now to put your prescient words to good use and make some sound investments based on the leads you provided here. Thanks! Again!

2008 Sep 14 08:43 AM

[point:]

I have never read this guy's work before, but I will tell you that at least in one case, he has no idea what he is talking about. His comments about Advair being off patent may be true, but there will not be a generic for several years because there are multiple other patents in force regarding the drug. His advice is flat out wrong regarding Advair. It worries me that it appears he has a baseline, rudimentary (at best) understanding of patents and intellecual property and how they apply commericially.

2008 Sep 14 09:35 AM

[Shiv139:]

Point - good catch. There are too many bloggers who really have no clue, but do have an opinion. If you ask me, blogs are very dangerous places to use as a source for investment ideas, but a great place to look for sentiment.

2008 Sep 14 11:35 AM

[onthecliff:]

Not sure that one could charterize Bayer as a small biotech.

2008 Sep 14 11:59 AM

[mcj96:]

Andrew: Big pharma has to replace an estimated 60B in revs starting in 2011. They are presently cutting personnel, down-sizing R&D depts and out-sourcing more of the leg-work to identify new and promising investigational drugs. It is clear that big pharma will mainly pursue partnerships or mergers with small to mid-sized bio companies that have very promising mid to late-stage biologic drugs with blockbuster potential. One small biotech company that fits this profile is Savient Pharmaceuticals (SVNT). Full disclosure: I currently own over 125k shares of the company and have been long since late 2004. SVNT has completed their Pegloticase P3 and 6 month OLE study and topline results were robust. 5 of 6 study endpoints were met with statistical significance. Pegloticase has orphan status and is expected to receive priority review next month when SVNT files its US BLA. Pegloticase will have zero competition once it is approved in late 2Q09 and in the EU approximately 6 months later. The orphan US gout mkt is estimated to have up to 100k patients with similar estimates in the EU,Asia and Latin America. In addition, the US tophi mkt which is estimated to be 5 times larger than the orphan mkt (approx 500k patients) will be an easy gout indication for SVNT to add to the label given the fact P2, P3 and the 6 month OLE study demonstrated tophi elimination. No gout drug in the world has ever shown disease modification in a phase study. Analysts and industry thought leaders estimate that Pegloticase will be priced similar to Remicade and Elitek (15-25k/yr). Palo Alto, Oppenheimer and others estimate that peak US revenues alone could be 1B. SVNT has zero debt, over 100M in cash and has guidedthat they will announce either a partnership deal or M&A deal at the end of this month (Sept. 08). If SVNT is acquired by big pharma, a multiple of 4-5 times peak revenue estimates is expected, similar to what GILD paid for MYOG when it sought Ambrisentan. Finally, if biosimilar legislation is passed in 2009 or 2010, biotech companies will be given an additional 5-7 years of market exclusivity on top of existing patents. In conclusion,SVNT is the right stock at the right time.

2008 Sep 14 03:31 PM

[PeteK:]

To mcj96 : Thanks, will take a look into SVNT.
After spending 10 minutes to read your lonnnng comment,
it better be worthwhile.

2008 Sep 14 03:50 PM

[in4thelonghaul:]

Another factor involved in the motivation of BP to acquire smaller developmental biotechs, besides existing drugs and the pipeline, is the repatriation of huge amounts of cash currently being held overseas as well as the debt which these biotechs have accrued over the years...these can be directly applied as tax deductions to BP.

A few examples of likely acquisitions are BIIG & ELN for the Tysabri franchise and the attractive pipeline.

Dendreon (DNDN) is another independent biotech which BP has been closely watching; their lead candidate 'Provenge', for the treatment of end-stage prostate cancer, has multi-billion dollar potential not to mention the incredible value of their cassette technology which may hold promise for multiple types of cancer. Results of the interim evaluation for Provenge are expected in October...if sufficiently positive, Provenge could receive an FDA decision by 1Q09. Considering DNDN's SPA with FDA, seems highly likely that numerous BP players will be tripping over one another to either cinch a ROW partnership with Dendreon or make an outright acquisition upon very positive interim results. Upon positive interim, DNDN's sh/pr could easily reach $25.00 as it did once before following the FDA's Advisory Committee results in 2007. In the event of interim results only sufficient to guarantee trial continuation to its likely 2009 conclusion, the high short interest, stable financial base (for a bio-tech), healthy inst. support, plus incredible prior efficacy indications are likely to insure a sh/pr floor of approx. $3.00...where it will be the opportunity of a lifetime.

GNVC is another small biotech whose upcoming results with TNFerade could create an overnight 5-bagger or trigger a buyout offer...at $1.35sh the risk/reward seems highly favorable considering the pipeline and past preliminary indications of efficacy.

2008 Sep 14 03:54 PM

[in4thelonghaul:]

That was supposed to read BIIB & ELN....NOT "BIIG"....Biogen and Elan.

2008 Sep 14 04:14 PM

[Daniel Henn...:]

I am going to have to agree with Point here. While there are some truths to this article, there are also some overgeneralizations and key points missing. It is true that big pharma is definitely facing major headwinds, and patent expiration will lead to large revenue losses for many big pharma players. This article indicates that the only way to replace these lost revenues is to buy biotechs. It should be noted that big pharma employs ~80,000 research scientists and spent $56.1 billion in R&D in 2007. Historical data indicates that return on invested R&D exceeds the cost of capital. The author makes a case for acquisitions of small biotechs to meet the external growth needs of big pharma, but entirely disregards the value of internal development. Big Pharma has maintained large R&D investments for decades; not all of them will be able to make up for revenue losses from patent expiration (such as Pfizer's Lipitor), but to dismiss the returns on tax-free R&D investments and to assume that the only path to growth is via external acquisitions of small biotechs greatly undervalues the potential of big pharma, and overvalues the potential for small biotech. The more gloom and doom I hear on the web about big pharma and its impending demise, the more I realize that there are tremendous values that arise from such sentiment.

2008 Sep 15 10:36 AM

[Carousel:]

What you don't know is that the third world, led by India, China, Thailand, etc are already copying patented drugs, for rich or poor people. So yes, effectively 5 out of 6.7 billion people worldwide already don't pay patent price for patented drugs. In my opinion, this has a far greater effect than legal expirations.

2008 Dec 05 07:39 AM

[roxyrohit:]

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On 2008 Sep 15 10:36 AM Daniel Hennessy wrote:

> I am going to have to agree with Point here. While there are some
> truths to this article, there are also some overgeneralizations and
> key points missing. It is true that big pharma is definitely facing
> major headwinds, and patent expiration will lead to large revenue
> losses for many big pharma players. This article indicates that the
> only way to replace these lost revenues is to buy biotechs. It should
> be noted that big pharma employs ~80,000 research scientists and
> spent $56.1 billion in R&D in 2007. Historical data indicates
> that return on invested R&D exceeds the cost of capital. The
> author makes a case for acquisitions of small biotechs to meet the
> external growth needs of big pharma, but entirely disregards the
> value of internal development. Big Pharma has maintained large R&D
> investments for decades; not all of them will be able to make up
> for revenue losses from patent expiration (such as Pfizer's Lipitor),
> but to dismiss the returns on tax-free R&D investments and to
> assume that the only path to growth is via external acquisitions
> of small biotechs greatly undervalues the potential of big pharma,
> and overvalues the potential for small biotech. The more gloom and
> doom I hear on the web about big pharma and its impending demise,
> the more I realize that there are tremendous values that arise from
> such sentiment.

Sep 04 01:08 PM