Rocky Outlook for Pharmaceuticals

The pharmaceutical industry performed reasonably well in 2007, but analysts point to weak fundamentals in the sector. A dearth of new drug approvals, some major clinical setbacks, lower financing into the biotechnology sector, and a new wave of patent expirations negatively affected the financial performance of the pharmaceutical sector. For 2008, analysts are evaluating whether the eroding macroeconomic conditions will put further pressure on the sector, whether the pace of drug approvals will improve, and the impact of more generic-drug entries.

Mixed financial performance in 2007

Despite volatility, the healthcare sector performed reasonably well in 2007, but there were important changes in investor confidence in the pharmaceutical and biotechnology sectors. "Generally, there has been a shift away from the traditional healthcare favorites (Big Pharma and Big Biotech) to smaller, niche players (medical technology and services)," says Jeff Shacket, vice-president of corporate advisory services with Thomson Financial. Shacket spoke at an educational program organized by the Drug, Chemical, and Associated Technologies Association last month.

Overall, the 10 most active US investors with the most money invested in healthcare held steady during 2007, representing $395 billion or 11.5% of equity assets, according to data from Thomson Financial. Among the largest investors, holdings in the pharmaceutical sector increased 6% in 2007 to $207.9 billion, holdings in the biotechnology sector decreased 3% to $69.6 billion, and holdings in medical technology firms increased 15% to $57.5 billion. "Collectively, these firms bought pharmaceutical and medical technology stocks, but sold biotechnology stocks despite some gains in this sector," says Shacket. "Five of the largest investors increased their healthcare exposure, but five trimmed their holdings."

In evaluating the corporate performance of Big Pharma in 2007, Shacket pointed out there were few significant clinical developments. The sector was marked by cost-savings efforts in cutting sales forces and trimming research and development (R&D) expenses, small-acquisitions aimed at specific therapies or technology, and companies repurchasing stock and raising dividends.

Stock price and earnings (P/E) multiples for Big Pharma dropped in 2007. "A couple of years ago, most of pharma was expected to deliver double-digit earnings growth," says Shacket. "Current three- to five-year forecasts for many are in single digits and are falling. It is not surprising 2007 stock price performance was correlated."

Although Big Biotech turned to traditional financing vehicles in 2007, there was an more of an emphasis on raising capital by partnering with Big Pharma accompanied by relatively low levels of financing through public and private markets. Shacket pointed out that there were 53 private placements in the US in the biotechnology sector in 2007 that raised an average of only $20.6 million per deal. There were 40 deals for follow-on offerings with an average of $71.1 million in 2007, but which averaged a loss of 7% after the announcement of the offering. There were 22 initial public offerings in 2007, and 19 deals in convertible debt that raised an average of $114.9 million. In contrast, some of the larger partnering deals with Big Pharma included GlaxoSmithKline's (London) $1-billion deal with Synta Pharmaceuticals (Lexington, MA), Merck & Co.'s (Whitehouse Station, NJ) $452-million pact with Ariad Pharmaceuticals (Cambridge, MA), and Schering-Plough's (Kenilworth, NJ) $380-million agreement with Novacea (South San Francisco, CA).

Although the healthcare sector has historically been bolstered by investors selecting the sector as a defensive strategy when macroeconomic conditions decline, there is a question as to how investors will react this year. "One of the key issues facing the sector is whether clinical setbacks and patent expirations erased the downside protection,"says Shacket. "Also, on the regulatory and political landscape, key factors to consider are the rate of regulatory approvals in 2008, the threat of generic biologics, and the impact of the Presidential campaign in moving investors to stay on the sidelines as debates over healthcare continue."

Generics loom large

As innovator companies struggle, opportunities for generic-drug companies are fairly strong. Over 150 products, including 20 blockbusters, with $77 billion in total branded drug sales in the US are coming off patent through 2012, outlined David Harding, sales support specialist of API intelligence for pharmaceutical and chemical markets with Thomson Scientific at the DCAT program. In 2007, the US led all countries with approvals for abbreviated new drug applications (ANDAs) with 169, or 38%, of the total final ANDA approvals. India followed with 132 or 29%. Israel followed with 40 or 9%, then Germany with 25, or 5%, Canada with 24 or 5%, and Switzerland with 19, or 4%. The rising influence of India in the generic-drug market is further underscored by its leading position on the supply of active pharmaceutical ingredients (APIs). India, alone, accounted for 274 US drug-master filings between 1998-2007, according to Thomson Scientific. The rest of the world accounted for 292 and China, 90.

Of the 29 products that had first ANDA approval in 2007, 15 drugs were considered blockblusters, pointed out Harding. Some major new generic launches in 2007 included: ceterizine hydrogen chloride (HCl), carvediol, pantoprazole sodium, zolpidem tartrate, risedronate sodium, and valacyclovir HCl.

In 2008, 25 products will lose patent protection in the US, notes Harding. Some anticipated generic launches of 2008 include memantine HCl, topiramate, risperidone, levetiracetam, ropinirole HCl, alfuzolin HCl, eplerenone, and rocuronium bromide. For 2009, there are 29 molecules with new chemical entity exclusivity expiring and therefore exposed to Paragraph IV patent challenge in 2008, explains Harding. Some major products that are likely to see a patent challenge in 2008 are duloxetine HCL, pregabalin, and tiotropium bromide.

Despite the opportunities in the generics market, the low-margin and cost-competitive nature of the business continues to drive consolidation, some positioning in novel R&D by generic-drug companies, and tactical acquisitions by major generic companies in biogenerics. Between 2005 and 2008, the top generic-drug companies spent approximately $40 billion in mergers and acquisitions (M&A), says Mike Chace-Ortiz, director of product strategy with Thomson's API intelligence business. He also spoke at the DCAT conference last month. M&A among second-tier generic drug companies has also increased. Some noteworthy deals include the pending $450-million acquisition of Taro Pharmaceutical Industries (Hawthorne, NY) by Sun Pharmaceutical Industries (Mumbai, India); the estimated $200-million acquisition of Biosintetica by Ache (Guarulhos, Brazil); and the combined $450-million purchases of Morton Grove, Pinewood, and Negma by Wockhardt (Mumba).

This M&A activity has also spread to biogenerics."Behind the big deals, biogenerics have been quietly pursued by some of the major generic-drug companies such as Teva, Hospira, Stada, Barr Laboratories, and Apotex,"says Chace-Ortiz. These deals include: Teva's (Jerusalem) acquisition of Cogenesys (Rockville, MD) and Tianjin Hualida; Hospira's (Lake Forest, ILL) acquisition of Bresagen and its alliance with Stada (Stadastrasse, Germany); the creation of Bioceuticals by Stada; Barr's (Montvale, NJ) acquisition of Pliva; and continued investment by Apotex (Toronto) in Cangene (Toronto). "A key question is how will other major players such as Mylan and Watson react in position in biogenerics," he says. "To date, they have not made major moves in biogenerics."

The major generic-drug companies are also tactically investing in innovator R&D as means to offset cost competition and low margins. Teva leads with innovative R&D spending at $500 million, which accounts for roughly 51 development programs, notes Chace-Ortiz. Other estimates include: Hospira at $161 million, Barr at $140 million, Ranbaxy (Gurgaon, India) with $110 million, Dr. Reddy's Laboratories (Hyderabad, India) at $65 million, Geoden Ritcher (Budapest) at $65 million, Apotex at $50 million, and Watson (Corona, CA) at $47 million. Apart from Teva, the other companies are developing a relatively small number of novel drugs: either in the single digits or up to 18 for Barr or 16 for Gedeon Richter.

"Given typical attrition rates for drug development, an important question for these innovative R&D programs is whether pipelines of less than 10 molecules, most of which are in preclinical phases, are really sustainable," says Chace-Ortiz. "We see top and mid-tier Indian generic drug companies investing in novel R&D with some success. Most notably, Dr. Reddy's and Glenmark, both of whom attracted some healthy attention from major brand companies. "