Big Pharma Abandons Antibiotics: An Opening For Small Biotech

Includes: MRK
by: Deborah Gouge

The Problem with Antibiotics

To understand the financial markets for companies that make antibiotics, it helps to understand, at least in general terms, what they are and how we use them.

Antibiotics are drugs designed to kill or slow the growth of bacteria. Streptomycin and penicillin, the first antibiotic drugs, were introduced about 70 years ago. Since then, antibiotics have transformed the practice of medicine. In the early 1900s, infection was the leading cause of death in the United States. Antibiotics enabled people to recover from diseases - such as TB, typhoid fever, and bubonic plague - that were once a death sentence. They also diminished the dangers of surgery, became integral to cancer treatment, and made organ transplants possible.

But like any innovation that becomes commonplace, we've taken antibiotics for granted. Like kids in a candy store, we consumed too much. There are now over one hundred antibiotic drugs on the market, and experts have been warning us for years that antibiotics are being overprescribed and overused. Doctors sometimes accommodate demanding patients by prescribing antibiotics for conditions that the drugs have no ability to impact - such as colds (which are caused by viruses) and fungal infections. Even worse, an estimated seventy percent of the antibiotics used in the U.S. are fed to livestock for non-therapeutic uses, primarily to keep animals that are raised in unnatural conditions alive and healthy looking until they go to slaughter. Those antibiotics are then passed on to you when you eat meat from the animals that consumed the drugs or vegetables fertilized with their manure.

The consequences of overusing antibiotics are serious - a lot more serious than the bellyache a kid in a candy store might get. Like all living organisms, bacteria evolve. When you take an antibiotic, the bacteria in you that are not wiped out develop resistance to that particular drug. Over time, individual antibiotics become ineffective in treating diseases they were once able to cure. Dr. Kenneth Todar estimates that "about 70 percent of the bacteria that cause infections in hospitals are resistant to at least one of the drugs most commonly used for treatment" and some are impervious to all the antibacterial drugs approved for use. The list of antibiotic-resistant bacteria includes strains of anthrax, gonorrhea, Group B streptococcus, some forms of tuberculosis, typhoid fever, and Methicillin-resistant Staphylococcus aureus (MRSA). In his newsletter, Dr. Joseph Mercola reports that more people die from antibiotic-resistant infections every year than from AIDS. He writes that antibiotics "literally are becoming increasingly ineffective with each passing day."

People are dying from infections that were once treatable, and experts in the pathology of contagion express fears that human populations may once again be decimated by pandemics. Globally, the second leading cause of death is bacterial and parasitic disease. There's a real need for new and more effective antibiotics. Big Pharma is not meeting that need.

The Financial Market for Antibiotics

In recent years, the major pharmaceutical companies have been getting out of the antibacterial business. There were 36 companies in the U.S. and Europe that produced antibiotics in 1980. That number dwindled to no more than seven large companies by 2010. Companies that have closed their antibacterial-development departments include Roche (OTCQX:RHHBY) in 1999 and Pfizer (NYSE:PFE) in 2011.

Why the rush to abandon pharmaceuticals that were once considered miracle drugs and are still essential to the practice of medicine? The short answer is that antibiotics are simply not as profitable as many other drugs. In part, that's because the course of treatment tends to be short - usually about 10 to 14 days. Compare that with a blockbuster drug like Lipitor, which an average patient may take for many years, and it's easy to see which is more profitable. Every antibiotic faces the additional handicap that the bacteria it is designed to eliminate will one day likely become resistant to its effects. If and when that happens, the drug is discontinued - and it stops generating earnings for the company that developed it.

Drug companies face the same increasing research-and-development costs and regulatory hurdles with antibiotics as they do with other drugs. It can cost more than $800 million and take about 15 years to develop and get approvals for a new antibiotic. For about the same investment of capital and time, a big pharmaceutical company has a choice: try to develop the next Lipitor or a blockbuster antibacterial drug. Lipitor generated worldwide sales for Pfizer of $10.7 billion in 2010. A blockbuster antibiotic typically has annual sales of about $1 billion. In 2001, there were six blockbuster antibiotics. By 2008, there were only two. So it's not surprising that fewer and fewer antibiotics are being developed in favor of drugs with the possibility of a greater ROI. The shift away from antibiotic development can be seen in these numbers: in the 1980s, 29 antibiotics received FDA approval; in the 10 years beginning in 2000, that number dropped to nine.

An Opportunity for Small Biotech Firms

Big Pharma's exit from antibiotic development has proved to be an opportunity for small biotech firms. In recent years, companies with antibacterial drugs in development have included Advanced Life Systems, Arpida Ltd. (OTC:APDAF), Basilea Pharmaceutica Ltd. (OTC:BPMUF), Cerexa, Cubist Pharmaceuticals (CBST), King Pharmaceuticals, and Trius Therapeutics (TSRX). All receive funding from or have become subsidiaries of large pharmaceutical companies. Let's look at two of these firms: Cubist and Trius.

Founded in 1992, Cubist Pharmaceuticals was listed in 2010 and 2011 among Fortune's 100 Fastest-Growing Companies and as one of the Deloitte Technology Fast 500. The company has two products on the market: Cubicin, an injectable form of daptomycin, which is the first in a new class of antibiotics called lipopeptides; and Entereg (alvimopan), which facilitates gastrointestinal recovery following bowel resection surgery. Cubicin was developed and abandoned by Eli Lilly & Co. (NYSE:LLY), which sold the anti-infective to Cubist in 1997. It targets difficult-to-treat skin and blood infections, including MRSA. Products in development include remedies for gram-negative bacterial infections, clostridium difficile-associated diarrhea, and opiod-induced constipation.

The company has received major funding from Lilly. Cubist is headquartered in Lexington, Massachusetts, and is valued at $2.65 billion. Its stock closed yesterday at 41.80, near the top of its 52-week range (28.82-44.95).

Trius Therapeutics (TSRX) was formed in 2004 to create, develop, and market innovative antibacterial drugs for the treatment of life-threatening infections. Trius recently announced positive, top-line results for its first phase-three clinical trial for tedizolid phosphate (TR-701), a second-generation oxazolidinone that can be administered orally or via IV for the treatment of serious gram-positive bacterial infections, including those caused by MRSA. Bayer is investing $69 million in the development of tedizolid.

One feature that sets Trius apart from most other biotech startups is that the company has substantial revenues ($60 million) from government contracts, including a $28 million five-year contract from the National Institute of Allergy and Infectious Diseases (NIAID). These revenues fully fund three pre-clinical programs through phase-one clinical development. The most advanced is the Gyrase-B program, which is expected to enter clinical trials in the first part of next year. Another government agency, the Biomedical Advanced Research and Development Authority, has expressed interest in funding the program through phase three. Gyrase could be the first new class of broad-spectrum antibiotics to enter the clinic in the last 50 years.

Based in San Diego, California, Trius is currently trading at 5.25, with a 52-week range of 4.71-9.00. It has a market cap of $203.02 million. In 2011, Trius was named one of the Deloitte Technology Fast 500.

Is it possible for small biotech companies like these to thrive in a market that most of the big pharmaceutical companies have abandoned? It looks as though they can.

Small biotech firms are taking advantage of government incentives to encourage antibiotic development. These incentives include R-and-D funding (such as the contract Trius has the NIAID) and faster approval from the FDA. An anti-infective drug is more likely to receive approval at any phase of development than almost any other type of drug. To offset the typically lower returns expected from antibiotics, companies are using premium pricing for the drugs they are bringing to market.

There is no indication that the market for new antibiotics will soften. Small biotech firms are taking the lead in developing the products that are needed to treat bacterial infections. Companies such as Trius and Cubist that have solid products, facilities, teams, and management in place should be positioned to prosper.

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