The Patent Cliff: What Big Pharma Investors Need to Know

Mar. 11, 2011 10:43 AM ETSNY, MRK, BMY, PFE, GSK, LLY10 Comments
Steven Breazzano profile picture
Steven Breazzano

"For most of the postwar era, the pharmaceutical industry has been the most profitable sector of the U.S. economy by virtually any performance measure (return on equity, return on sales, etc.). This superior performance was based on four structural pillars: (1) latitude to charge relatively high prices, (2) long product life cycles, (3) 'blockbuster' drugs, and (4) relatively high R&D productivity."

The above quote from Prof. Gary Pisano’s book "Science Business" concisely sums up the sector and dives straight into the fundamental issues of the pharmaceutical business. However, as investors in big pharma over the last decade know, this success has not continued. Currently, Pfizer’s (PFE), Eli Lilly’s(LLY), Merck’s(MRK), and Bristol Myers Squibb’s (BMY) stock is trading at half of their value 10 years ago and GlaxoSmithKline (GSK) is faring slightly better at a negative 25%. This is in stark contrast to a 15% increase in the S&P 500 over the same time. Evaluating each of the four points in the quote provides a background for the underperformance of the sector. A New York Time’s piece details some of the pricing issues. Medicare going forward will have the ability to negotiate prices, and while there is significant uncertainty depending on the healthcare overhaul, it is likely pricing power will diminish. Many of the blockbuster products with long product lifecycles are now coming to their anticipated end (detailed below). Furthermore, even though many of these companies have been on acquisition sprees, there is scant evidence to show that this is the most efficient use of cash and thus does not contribute to research productivity. Again, as Prof. Pisano cogently states,

"In pharmaceuticals, M&A may lead to onetime gains in eliminating redundancies (e.g. plants, sales forces, duplicate R&D operations), but once those savings have been made, there is still a growth problem to be solved. Furthermore, being twice as big

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Steven Breazzano profile picture
Steven currently focuses his analyses primarily on the valuation of smaller biotechs (100MM to 1 BB market cap) and utilizes all sources of information, including conversations with management, peer-reviewed publications, SEC filings, and all available primary and secondary research. Steven is currently a consultant for a New York based life science focused consultancy, and brings a strong scientific and financial background to his current position. Previously, Steven earned a Ph.D. from the Scripps Research Institute and an M.A. from Columbia University, with extensive work in the field of synthetic and medicinal chemistry, publishing several papers in prestigious peer-reviewed journals. He is also pursuing the CFA designation, and has completed exam level 2. Please email me with any questions, comments, and investment ideas. (stevenb29 at

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