The pharmaceutical industry is in the midst of one of the biggest patent cliffs with Pfizer’s (PFE) multi-billion-dollar blockbuster drug Lipitor losing patent protection in the US in late November 2011. Besides Lipitor, other major branded drugs that lost patent protection in the past few months include Forest Laboratories’ (FRX) Lexapro, Sanofi/Bristol-Myers’ (SNY/BMY) Plavix and Eli Lilly’s (LLY) Zyprexa.
These products alone represented branded sales worth more than $15 billion. Another product that will start facing generic competition shortly is Merck’s (MRK) blockbuster Singulair.
The effect of the genericization of these products will be felt mostly in 2012, which will be a challenging year for several companies. While generics will eat into sales, new products are not expected to generate the same level of sales as products losing patent protection. The next few years are expected to reflect a significant imbalance between new product introductions and patent losses.
Generic competition and insufficient new product sales are not the only factors impacting performance in 2012. Other headwinds include EU and Japan pricing pressure as well as negative currency movement. In fact, results of several companies including Johnson & Johnson (JNJ) were hit by negative currency movement in the June quarter.
Meanwhile, the US government is exploring options which will help increase the availability of generics. The Obama administration announced that it is looking to implement a proposal under which the exclusivity period for biologics will be cut down by 5 years, thereby allowing generics to enter the market sooner.
The government is also seeking to increase the availability of generics by preventing companies from entering into anti-competitive or “pay for delay” agreements which push out the availability of generics. These initiatives, if implemented, would result in additional pricing competition and genericization in the pharma industry. Moreover, the FDA is working on establishing a biosimilar pathway so that cheaper versions of biologics will be available.
With revenue growth stalling or slowing down, pharma companies have been resorting to cost-cutting and share buybacks to drive bottom-line growth. Mergers & acquisitions (M&As), licensing deals, restructuring, share buybacks and monetization of non-core assets have become recurring events in the pharma and biotech sector over the past few quarters.
The M&A activity witnessed in the pharma sector in the last couple of years has continued in 2012, in-line with expectations. With most of the big pharma companies already facing or likely to face patent challenges for their blockbuster products, the companies have been looking toward M&A and in-licensing activities to make up for the loss of revenues resulting from the loss of patent exclusivity of key products.
Major deals so far in 2012 include Johnson & Johnson’s acquisition of Synthes, which should help strengthen its medical device portfolio, Bristol-Myers Squibbs’ upcoming acquisition of Amylin Pharmaceuticals, Inc. (AMLN), GlaxoSmithKline’s (GSK) upcoming acquisition of Human Genome Sciences (HGSI).
Bristol-Myers has been pretty active on the acquisition front. The company has been looking to expand via acquisitions and partnerships to counter the loss of revenues arising from the genericization of blockbuster blood thinner Plavix. The Amylin acquisition should allow the company to expand its presence in the lucrative diabetes market.
The Amylin deal is the second major deal for Bristol-Myers this year, with the company having purchased Inhibitex, Inc., for $2.5 billion in February, thereby targeting the lucrative hepatitis C virus (HCV) market.
Oncology also remains a much sought-after therapeutic area, with companies like Sanofi and Celgene (CELG) strengthening their presence in this market through acquisitions. Meanwhile, generic players are not far behind in the acquisition game. While Teva (TEVA) acquired Cephalon, Inc., Watson Pharmaceuticals (WPI) acquired generic company Specifar Pharmaceuticals to expand and strengthen its presence in Europe. Watson recently announced its intention to acquire generic player, Actavis.
Elsewhere, companies have been looking toward biotech firms to build their product portfolios. A prime example is French pharma giant Sanofi’s acquisition of biotech company Genzyme Corp. The Genzyme acquisition has boosted Sanofi’s revenues as well as its pipeline. Meanwhile, AstraZeneca (AZN) acquired biotech company Ardea Biosciences. Another acquisition deal announced in April 2012 is Spectrum Pharma’s (SPPI) upcoming acquisition of biopharma company Allos Therapeutics (ALTH).
Going forward, we expect the M&A trend to continue. We also expect a significant pickup in in-licensing activities and collaborations for the development of pipeline candidates. Instead of developing a product from scratch, which involves a lot of funds and time, pharma companies are shopping for mid-to-late stage pipeline candidates that look promising.
Small biotech companies are also game for in-licensing activities and collaborations. Most of these companies find it challenging to raise cash, thereby making it difficult for them to survive and continue with the development of promising pipeline candidates. Therefore, it makes sense for them to seek deals with pharma companies that are sitting on huge piles of cash.
We would recommend investors put their money in biotech stocks that have attractive pipeline candidates or technology that can be used for the development of novel therapeutics. Therapeutic areas which could see a lot of in-licensing activity include oncology, central nervous system disorders, diabetes and immunology/inflammation. The HCV market is also attracting a lot of attention.
Another trend that we are seeing lately is the divestment of non-core business segments. Pfizer sold its Capsugel unit in August 2011 and signed a deal for the divestment of its Nutrition business in April 2012. The company intends to spin-off its Animal Health business as well.
Meanwhile, GlaxoSmithKline is divesting non-core brands from its Consumer Healthcare segment. In August 2011, AstraZeneca sold its Astra Tech business to DENTSPLY (XRAY). The monetization of non-core assets will allow the pharma/biotech companies to focus on their areas of expertise.
2012 will see Abbott Labs splitting into two separate publicly traded companies. While one company will deal in diversified medical products, the other (AbbVie) will focus on research-based pharmaceuticals.
A major event that will have a significant impact pharma and biotech stocks is the upholding of the Patient Protection and Affordable Care Act (ACA) by the Supreme Court in late June 2012. The Act, popularly referred to as “Obamacare,” passed through Congress in 2010, represents major changes in the nation’s healthcare sector.
The Act will provide coverage to 32 million uninsured Americans, make healthcare facilities more affordable, expand coverage for customers with pre-existing health conditions and keep a check on health insurers. The healthcare reform aims to end the discrimination policy of insurance companies, create competition amongst insurers through the establishment of health insurance exchanges, add value to the overall healthcare system and reduce premiums.
The upholding of the Act is a big win for pharma companies as the coverage base will increase.
Meanwhile, the signing of the Gaining Antiobiotic Incentives Now (GAIN) Act should benefit companies pursuing the development of novel antibiotics. Once approved, these products will enjoy an additional five years of marketing exclusivity. Companies that should benefit from this Act include The Medicines Company (MDCO), Optimer Pharma (OPTR) and Cubist Pharma (CBST) among others.
Another important event in the past few weeks was the signing of the Food and Drug Administration Safety and Innovation Act (FDASIA) of 2012. This new law includes the reauthorization of the Prescription Drug User Fee Act (PDUFA), under which the FDA is provided with funds and resources needed to ensure the smooth and timely review of drugs.
Another recent trend seen in the pharmaceutical sector is a focus on emerging markets. Companies like Mylan (MYL), Pfizer, Merck, Eli Lilly, Glaxo and Sanofi are all looking to expand their presence in India, China, Brazil and other emerging markets. Until recently, most of the commercialization efforts were focused on the US — the largest pharmaceutical market — along with Europe and Japan.
Emerging markets are slowly and steadily gaining more importance and several companies are now shifting their focus to these areas. According to the IMS Institute, spending on medicines in “pharmerging” markets will almost double to $345 billion – $375 billion in five years from $194 billion in 2011.
However, while higher demand for medicines, government initiatives for healthcare, new patient population, and increasing use of generics should help drive demand, we point out that emerging markets are also not immune from genericization.
Meanwhile, according to the IMS Institute, annual growth in the branded medicines market will remain flat or increase up to 3% to $615 billion – $645 billion through 2016 from $596 billion in 2011.
As far as developed nations are concerned, the IMS Institute expects US spending to go up by $35 billion – $45 billion (1-4%) in the next five years. The introduction of medicines targeting unmet needs and higher patient access resulting from Obamacare are expected to drive growth.
However, growth in Europe will continue to be pressurized by austerity and cost-containment measures. According to the IMS Institute, growth in Europe will range from negative 1% to positive 2%. The Japanese market is expected to grow at a slower pace annually (1-4%) through 2016 compared to the last five years.
We continue to have a Neutral outlook on large-cap pharma stocks. While the companies will continue to face challenges like pricing pressure and genericization, growth in emerging markets and product approvals could help reduce the impact.
A few years down the line, the pharma industry should demonstrate signs of recovery. The industry should be out of the major patent cliff period, and new products should be contributing significantly to results. Increased pipeline visibility and appropriate utilization of cash should increase confidence in the sector.
In the biotech space, we are positive on Biogen Idec (BIIB). We are optimistic on BG-12, the company’s oral multiple sclerosis candidate. Key products Avonex and Tysabri should continue contributing significantly to sales. Biogen’s second quarter results were impressive and the company increased its guidance for 2012.
We are also positive on Amgen (AMGN). We are encouraged by the company’s first half 2012 performance. Enbrel should continue performing well and Xgeva/Prolia should continue responding positively to the company’s increased marketing efforts like DTC advertising. Amgen’s late-stage pipeline is also moving along.
Another company that delivered a solid performance in the June quarter is Auxilium Pharma (AUXL). In addition to reporting a profit for the first time, the company increased its guidance. We expect the company’s hypogonadism product, Testim, to continue performing well especially with the additional promotional effort from Glaxo.
Among generic companies, both Watson Pharma (WPI) and Mylan (MYL) carry a Zacks #2 Rank (short-term Buy rating). While Watson should benefit from its upcoming acquisition of Actavis, which should be immediately accretive, we are encouraged by Mylan’s geographic reach and product depth along with a robust generic product pipeline.
We recommend avoiding names that offer little growth or opportunity for a take-out. These include companies which are developing drugs that are likely to face regulatory hurdles. The FDA has been exercising more caution in granting approval to new products and several candidates are facing delays in receiving final approval.
Elan Corp (ELN) carries a Zacks #5 Rank (short-term Strong Sell rating). The company’s second quarter loss per share was wider than expected mainly due to revenues coming in below expectations. Moreover, expectations from pipeline candidate bapineuzumab (Alzheimer’s) are pretty low, with the candidate failing to meet its primary endpoint in one of four phase III studies.
Companies that currently carry a Zacks #4 Rank (short-term Sell rating) include Glaxo (GSK) and AstraZeneca (AZN). Both Glaxo and AstraZeneca presented weak second quarter results. Factors like generic competition, EU pricing pressure and negative currency movement will continue impacting the performances of these companies.
We are also concerned about the prospects of Cardiome Pharma Corp. (CRME) which carries a Zacks #4 Rank (short-term Sell rating). The company recently announced a major reduction in its workforce following Merck’s decision to discontinue the development of an oral formulation of vernakalant. Merck and Cardiome were studying the candidate as a maintenance therapy for the long term prevention of atrial fibrillation recurrence.
The discontinuation of the development of oral vernakalant is a huge setback for Cardiome. The company has a weak pipeline consisting of a few early stage projects. We expect the shares to remain under pressure until the company provides a strategic update.
The FDA has some major decisions coming up in the next few months. Some of the most interesting candidates currently under review include Medivation’s (MDVN) enzalutamide (oncology), Biogen Idec’s BG-12 (multiple sclerosis), United Therapeutic’s (UTHR) oral Remodulin (treatment of pulmonary arterial hypertension), Gilead’s (GILD) Quad pill (HIV), and Forest Labs’ linaclotide (constipation-predominant irritable bowel syndrome and chronic constipation), Onyx Pharma (ONXX) and Bayer’s (BAYRY) regorafenib (oncology) among others.
Important product approvals in the last few quarters include Johnson & Johnson’s prostate cancer therapy Zytiga, Merck’s HCV treatment Victrelis, Bristol-Myers’ melanoma treatment Yervoy, AstraZeneca’s Brilinta, Vertex Pharma’s (VRTX) HCV treatment Incivek, Pfizer’s lung cancer treatment Xalkori, and Glaxo/Human Genome’s lupus drug Benlysta, among others. Potential blockbusters include Benlysta, Yervoy, Zytiga, Incivek and Xarelto.
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