First half of 2006 roundup: Big Pharma trumps biotech

03 Jul First half of 2006 roundup: Big Pharma trumps biotech

Here we are at the midpoint of 2006 already. The first half stock market doesn’t look pretty! The Dow is up a modest 4%. Two months ago, the Dow was up twice that level but took a tumble in May falling sharply in June and beginning to bounce back in July. The NASDAQ has really taken a hit in these first 6 months, having dropped 2%.
We all know about continued oil price increases, once again surpassing the $3/gallon level. This time, surprisingly, American consumers seem not be fazed as there has been no sharp downtick in SUV sales and no parallel up tick in hybrid car sales. And the Fed has continued to increase interest rates to control its concern about inflation! The housing price bubble burst and while there has been a significant decline in prices in places like Florida and Boston, it seems prices in places like New York City and San Francisco and L.A. continue to maintain their upward rate.
So what does this mean to the world of pharmaceuticals and biotechnology?
Big Pharma continues to be face substantial sales and profit (an estimated $80 billion in cumulative sales over the next 4-6 years) declines with drugs losing patent protection. There is a new twist on how Big Pharma will manage the loss of patent exclusivity.
Traditionally, Big Pharma has jacked up the prices aggressively in the two to three years before a drug loses exclusivity knowing that the price discounting by the first set of generics will be about 30% for the first 6 months (for those generic companies that were first to file an Abbreviated New Drug Application or ANDA), followed by further price erosion of another 40-50% after this period. Big Pharma is lucky if it is left with 10-20% of its original sales.
So if you have a $3 billion drug, that means that one year after losing patent protection, your sales have dropped most likely to $300 million to $600 million/year, or a sales (and profit) loss of $2.4 billion to $2.7 billion. Imagine what will happen with Pfizer’s Lipitor with last year’s sales of $13 billion (granted this is worldwide and Pfizer’s patent expiration in different parts of the world varies).
More recently, during the last 3 years, Big Pharma has experimented with a different formula called “authorized generics”. Under this scenario, in advance of patent expiration, Big Pharma has agreed to start selling a generic version of its drug through a generic drug company with which it has established an agreement. Under this scenario, the Big Pharma usually sources the generic company with finished product or at a minimum drug raw material, thus retaining some control of the market situation and some profits. During this period, it has allowed the authorized generic company/product to establish market position with pharmacies and thus fortify a position in advance of the generic onslaught when patent exclusivity occurs. This is somewhat of a controlled decline.
Market leader Pfizer has decided to take a much more aggressive stance against generic companies. It has created a new marketing arm and company to market its own generic products in advance of patent expiration with the goal of sending a shot across the bow of generic companies that it will not readily or easily give-up its long-held franchise.
This strategy will commence with the antidepressant drug Zoloft, but with annual sales over $3 billion/year, but this is a warm-up act to see what will happen with Lipitor. How successful this strategy will be is not clear, but at least one other major Big Pharma, J&J, seems to be following suit. Novartis, the second largest generic company in the world, has already been doing this with its own branded research-based products for some time.
As I have mentioned in other articles, M&A activity has been light in the first half of the year with the exception of Bayer’s acquisition of Schering AG (not to be confused with Schering-Plough), and the completion of the Boston Scientific/Abbott Lab’s acquisition of Guidant (with Abbott acquiring an equity chunk of Boston Scientific in the process). Of note, in the last week was the disposal by Pfizer of its consumer products business to J&J for over $7 billion. This includes products like Listerine and other products Pfizer had obtained in the Warner-Lambert acquisition along with Pfizer’s own consumer products. Pfizer is now a pure-play ethical pharmaceutical business. Pfizer has said that it will use a good part of this cash to buy back shares in the open market.
J&J, on the other hand, has taken a different tack by creating a diversified business portfolio including ethical pharmaceuticals, consumer products, and medical devices. The market seems to be rewarding J&J for this strategy as J&J’s market cap continues to beat Pfizer’s, as can be seen below.
Let’s see how Big Pharma fared:
Big Pharma stock performance, first half 2006

Source: Yahoo Financial Page: 06/30/06
Note: Does not include Hoffman LaRoche which trades on the U.S. Pink Sheets
Six of the Top Ten Big Pharmas showed stock price increases versus four showing stock price declines (including both Pfizer and J&J, and our two Midwest giants Abbott Labs and Eli Lilly). In Pfizer’s case, it is surely due to investor concern about Pfizer’s product portfolio and the impact of generics and few new blockbusters on the horizon. Pfizer has just announced that it has a war chest of $17 billion to acquire new products that will generate in excess of $1 billion each.
The case of Abbott Labs’ stock price is a little strange as its new drug Humira continues to grow beyond original expectations and has achieved additional FDA labeling approval. Furthermore, Abbott’s move to aid Boston Scientific in the acquisition of Guidant pleasantly surprised many!
Nevertheless, six of the 10 Big Pharmas had outstanding stock growth, equaling or bettering the Dow Jones, including Merck (which continues to battle the Vioxx lawsuits) and AstraZeneca. Merck received FDA approval for several new vaccines, and has gone on biotech deal spree, which ran contrary to Merck’s prior historical strategy which dictated that all new products must come from within Merck’s own research efforts.
In biotech land, the reverse situation took place with only 4 of the top Ten Big Biotechs showing stock price increases versus six showing stock price declines, all of which were worse than the NASDAQ and AMEX Biotech indices. Not a pretty first half!
Big biotech stock performance 2006

Source: Yahoo Financial Page: 6/30/06
Genentech continues to outpace Amgen in market valuation. Genentech’s market cap would rank it as the 7^th largest Big Pharma, while Amgen’s would rank it in 9^th place, ahead of Abbott Labs and Eli Lilly.
The biotech IPO market continues to be open although slow. This IPO market dynamic has changed substantially: in the past, the IPO window would open for a 3-6 month period and shut for 1-2 years. The current IPO window has lingered open since the 4^th quarter of 2004; however it has not been a strong market, with low initial pricings and valuations. Nevertheless, it continues to remain open! We will look at this further in weeks to come!
One issue that both Big Pharma and biotech companies face: increasing resistance to high pricing on new products. There will be further pushback in the future on this as consumers and their insurance companies, buying groups, and hospitals, further these prices, even for life-threatening diseases! How the industry deals with this still remains up in the air!
In my next article, we will take a closer look at the Midwest’s role in the market for the first half of 2006. I suspect not well!
See you soon and Happy July 4^th!

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