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Wall Street BioBeat : Jan 1, 2007 ( )
Biotech's Changing Competitive Landscape
Next-generation Innovations and a Smoother Path for Follow-ons Will Play a Key Role
Biotechnology companies, especially those profitable today, face a coming decade that may be even more painful than the past decade was for global pharma, when many saw their valuations cut in half, not to mention all the restructurings and management havoc. A couple of dozen companies accounted for over 95% of the sector valuation in the early 1990s. Today, that figure is down to 70% as their multiples have been halved, exceeding even the most bearish predictions. This is despite the fact that their contribution to industry sales is still at the same level, or around 84% (down from 89%). The cashflow share also has eroded only modestly from 90% to 86%.
It is fair to ask how and why the biotech managers who were supposed to be creating an industry of and for the future find themselves in this pickle, and if they have learned useful lessons from the last decade.
Why have these very profitable biotech company managers not been bolder in investing in the new science that would build a pipeline for the next round of innovations? Why does the industry feel compelled to justify life-cycle management strategies that gave global pharma such a black eye? Why are there few models of true and successful collaborations that can enhance R&D productivity? Why do we see acquisition sprees only when valuations seem to be peaking? Why are biologic prices at a level that contributes the majority of the inflation in drug costs? Why is there a desire to preserve a perpetual monopoly rather than help pave a path for follow on biologics (FOB) that would help society accept the next round of innovations more readily?
Most biotech companies achieved their success behind just one or two block-buster drugs that were priced boldly and marketed aggressively. Unfortunately, as happened with large pharma, billions in R&D have failed to produce much in the way of a next round of innovations.
Managers of these companies have successfully put into practice two lessons from the large pharma textbook—well-timed life-cycle management strategies, a la Neupogen and Aranesp, and escalation of fears about FOB safety as was done by large pharma against small molecule generics in the 1980s.
Amgen’s(www.amgen.com) two-drug franchise has had a monopoly in Epogen for 17 years and in Neupogen for 15 years. Not since the 1980s heyday have drug companies had that sort of license to print money with absolutely zero competition.
However, things are about to change on two fronts: Next-generation competitive innovations are in late stages of development and the FOB pathway is being defined, which will begin the flow of lower cost biogenerics by the end of this decade, first in Europe and soon thereafter in the U.S. European patents on many of the big biologic blockbusters have expired or will expire over the next several years, whereas the U.S. patents begin to lapse into the next decade. Safety fearmongering may hold back the adoption initially but quite likely for a much shorter time than it took small molecule generics to be accepted in the early 1980s, as most regulators and payors have seen this play before.
Likely to be facing competition from next-generation innovations, and soon, are Epogen (from Roche’s(www.roche.com) CERA, Fibrogen’s(www.fibrogen.com) FG 22-16, and Affymax'(www.affymax.com) Hematide), Herceptin (from GSK’s(www.gsk.com) Tykerb), and Avastin (from Sanofi’s(www.sanofipasteur.com) VEGF-Trap). Even a modest improvement destroys the first mover advantage, as Lucentis did to Macugen in AMD sales; Macugen went from $50 million in quarterly sales to $9 million in just two quarters.
Another development that is only slightly less painful is the aggressive price competition that was just ushered in by Amgen when it launched Vectibix, a superior next-generation innovation to Erbitux at a 20–30% discount. This move shows why the widely held view that FOBs are unlikely to be discounted much is wrong. In fact, most Asian biogeneric competitors are confident of selling biologics at half the brand price and still achieving 30% operating margins.
Other Cost Control Efforts
It is likely now that the political rhetoric is going to heat up as the Democrat-controlled U.S. Congress tries to catch up on lost time and bring the industry’s pricing practices under a bright spotlight. Five years ago, most biotech products cost $10–20k per year. While definitely higher than what people were used to, such prices were still in the ballpark considering the high cost of goods, high risk of development, and the appeal of the new biotech tools that were going to make us all 21 years old again.
As it became clear that payors were unable to say no, no matter what the price, a race got under way as to who could price their product higher. Today, a cancer cocktail can cost over $250,000.
U.S. healthcare expenditures as a percent of GDP will increase from 16.5% in 2006 to 18.8% in 2012. Federal government spending on prescription drugs as part of the Medicare program is expected to rise from $58 billion today to $108 billion by 2012 (Figure).
The Medicare Part D drug benefit program has given new powers to Managed Care Organizations (MCO) that are increasingly focusing on evidence-based reimbursement. Arrival of the next generation of innovations at a 20–30% lower price, followed by half-priced biosimilars, will fit right into their formulary and co-pay systems. This is the market at work, and no price controls may be needed, even though the Democrats in the U.S. Congress are surely going to give that a good try and may even win on that front.
MCOs are already rapidly expanding their reach into cost-benefit driven reimbursement, limiting off-label use, which has contributed to rapid growth of new products, and successfully controlling costs better than even their more loyal supporters had expected.
Moreover, MCOs, government regulators, payors, and a host of intermediaries are taking the lead on integrating sophisticated information and analysis to single out products with questionable value even before they reach the market. In that setting, the glory days for Epogen and even Aranesp may be numbered. Most of the major biologics face a similar fate. Sadly, few of these second-generation products are coming from pioneering companies.
Filling Up the Larders
The competitive landscape is about to change, and the cupboard is pretty much empty. If the current high valuations are anything to go by, however, many investors have not noticed yet. Other than Amgen’s Denosumab, there really isn’t anything in the entire industry pipeline that looks like it can even begin to make up the lost sales. And even Denosumab is hardly the standard biotech blockbuster, it will be entering a market currently dominated by Merck(www.merck.com) and Novartis(www.novartis.com).
It seems increasingly clear that once a biotechnology company reaches a certain size, it, like its larger pharma brethren, becomes unable to get much out of its heavy R&D spending. Other than Genentech(www.gene.com), no other large and profitable biotechnology company has a productive internal R&D engine. And even Genentech’s is now dependent on new indications for its recently launched products. At least Biogen Idec(www.biogen.com)came clean and began to set aside a large part of its R&D budget for external sourcing, although it has found meager pickings so far.
Everyone is looking for ways to fill their empty larders, as the new science is taking longer to mature and needs another decade or more. So, for the time being, it is a zero-sum game, and only a lucky few are able to overpay and bring in one of the few exciting late-stage products.
The new science will bring innovative therapeutics with predictable productivity within a generation. Their impact on the quality of our lives is going to be even greater than the impact IT has had over the last generation. Such targeted products aimed at well-diagnosed subpatient populations will need much smaller trials of short duration (supported by extensive on-market monitoring with IT tools), requiring focused marketing with little sales effort.
First, however, we will have to survive another decade of painful transition, where our analysis of the industry pipeline shows only incremental life-cycle management types of new products.
M&As may be the only effective near-term answer. Unfortunately, there are few companies with truly innovative products. Hence, good deals are hard to find, with competition keen and bidding wars bringing final prices well above fair value. Still, it may be better to swallow hard and take the hit now for longer term benefit. Luckily, these profitable biotech companies have high valuations that helps make the dilution more palatable. Amgen could spend over $4 billion on acquisitions and still only dilute shareholders by 5% (assuming an all-stock transaction). This may not be the case for long.
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