A Ripple In Generics?

by: BioTrench

Hospital drug shortages and rising prices have led to the development of Civica RX.

Civica is a new not-for-profit that looks to source/manufacture generics and provides it to its member hospitals (~750 so far).

With many more hospitals looking to join Civica RX, generics manufacturers may suffer over the long term as Civica starts up its engine.

This may encourage generic producers to pursue biosimilars more aggressively, but time will be required to solve a number of challenges.

With yet another US Senate hearing having been held in late February, prescription drug prices have been continuously receiving a lot of attention. While an eventual solution to brand name pricing may take a number of years, changes to the generic industry may be coming quicker. Over the past few months, the name Civica RX (Civica) has been showing up in the news on occasion. Civica is a not-for-profit organization that aims to provide affordable generics for a collective of US hospitals. As it is, the generic pharmaceutical manufacturing industry's growth has been fairly slow in recent years, with a 5-year average sitting at around 0.69%. The advent of Civica could add pressure to the generic drugs industry over the coming years as it gradually ramps up operation. While still in its infancy, Civica should be on the radar for anyone invested in the generics industry.

How much do hospitals spend on generic drugs?

Hospitals can account for a fairly generous portion of generics spending. A report from the American Hospital Association suggested that in 2017, the average drug spending was $522 per outpatient adjusted admission and $756 per admission in US community hospitals (5262/6120 hospitals in the US are community hospitals). Adjusted admission is defined as "an aggregate measure of workload reflecting the sum of admissions and equivalent admissions attributed to outpatient services". Around 35 million hospital admissions occur per year, which suggests drug spending of $25-30 billion for this group. In contrast, while 125 million outpatient visits occur, it is unclear as to how many would be classified as "adjusted admission". However, between admissions and adjusted admissions, aggregate spending is likely in excess of $40-50 billion.

Unfortunately, the aggregate value does not differentiate between brand name and generics spending, which will require additional guesswork. One estimate from Blue Cross Blue Shield indicates that while generics account for 83% of prescriptions (vs. 17% branded), they only account for 21% of spending. If the same applies to hospitals, then generics spending would likely be in the range of $5-10B, if not more. As a point of reference, TEVA had global revenues of $18.9B in 2018, while MYL had revenues of $11.4B. Essentially, US hospitals, unsurprisingly, spend a lot of money on generic medications and are a nice source of revenue.

Shortages as a revenue boost?

Drug shortages can lead to an increase in drug prices and some companies seek to exploit this. Before going further, it's important to note that drug shortages do not necessarily affect low volume medications. As an example, between 2016-2017, shortage of Ringer's solution (IV fluid similar to saline) has led to a 30% increase in price. Likewise, a look through the shortage list shows that supplies for some common medications such as heparin, lidocaine, various antibiotics, and chemotherapies are lacking.

While the nature of the shortages can be fairly variable (e.g. manufacturing, discontinuations, few suppliers, etc), companies have been known or suspected to try and exploit shortages for additional revenue. For example, a Financial Times article stated that they "found that Baxter has been probed by US authorities over allegations that it had taken advantage of the shortages in 2014 to boost its revenues". Likewise, there was an investigation into Valeant for Nitropress and Isuprel price exploitation in 2016. Whether intentional or due to a Force Majeure (e.g. Puerto Rico factories being disrupted by hurricanes), shortages have been associated with a spike in price increase, which can likely help improve margins on generics.

Civica RX and its implications

Civica is a not-for-profit organization that seeks to ensure sustainable access to hospital-administered medications for its members. The initiative was established in 2018 and is already seeking to launch its first medication in 2019. As of early 2019, they have approximately 750 hospitals participating in their collective. In terms of absolute numbers, this accounts for over 10% of the hospitals in the US - note that this does not distinguish between large and small hospitals. Moreover, they have stated previously that health organizations representing more than a third of US hospitals have reached out and expressed an interest in participating.

While Civica has not openly stated what drugs they intend to produce or who they will be partnering with, they have provided some other details via an FAQ. Of note is that they intend to eventually own the abbreviated new drug applications for the generics they will be providing. Moreover, in order to ensure supplies, Civica intends to enter into long-term contracts with multiple manufacturing partners, although they plan to eventually build out their own manufacturing site. Likewise, they will be setting up minimum viable volume contracts with their member hospitals. Overall, Civica appears to be an enhanced group purchasing organization.

It is currently difficult to predict how Civica will affect current generic providers, as it is not fully functional yet and many aspects are undisclosed. Having said that, we can hazard some guesses. Civica will likely target both high volume high cost drugs and low volume low margin drugs on the shortage list. This way, the savings from the high volume drugs can be used to offset the cost associated with providing lower volume generic medications. Additionally, as Civica will be standardizing pricing for all network members (i.e. same price for everyone regardless of size), generics may be forced to reduce prices on targeted generics - assuming that they will be competing. Lastly, as Civica will be sourcing and (eventually) manufacturing some of the drugs, some generics may end up losing a revenue stream.

The start of a ripple?

If Civica does manage to erode away some of the better margins in generics, then generic manufacturers may push even harder for biosimilars, which is far more lucrative and difficult to break into. The challenge, however, is not only getting an FDA approval but also figuring out how to make biosimilars interchangeable with the reference product. If deemed interchangeable, then a biosimilar may be substituted for the reference product without needing the original health care provider to rewrite the prescription. Unfortunately, there does not appear to be any interchangeable biosimilars that is recognized by the FDA to date, which is one of the barriers to biosimilar adoption. Beyond interchangeability, legal maneuvering/contracts by biologics manufacturers have been known to throw in a wrench or two. Overall, the adoption of biosimilars in the US has been lagging significantly behind the European market, and time will be required to resolve a lot of the issues at hand.

Concluding Remarks

How the drug pricing hearings will change the industry is unclear, but, in the meantime, the generic drug industry will likely undergo some changes. Hospitals spend a lot on drugs, and between drug shortages and rising prices, they are not happy. As a result of this, Civica was born. Although there are still a number of uncertainties as to how it will work, it will likely be important to pay attention to Civica, given its potential impact on the industry. As a not-for-profit organization that will be sourcing/manufacturing and distributing generics for a large number of US hospitals, Civica has the potential to cut into generic margins in the long term. Compounded by additional barriers in the US biosimilar arena, generics companies with a heavy focus on hospital-administered medications may have some rough waters to navigate over the course of the next few years, depending on how things play out.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. 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.