In the healthcare space, 2014 was the year of hepatitis C. April saw the biotechnology industry take heavy losses as investors began to view stocks as overvalued following strong performance throughout 2013. But the launch of hepatitis C cure, Harvoni, by Gilead Sciences (GILD) seemed to force the realization that mega-blockbusters addressing big unmet needs could still generate game-changing profits. Then came controversy over the cure’s pricing, and fear of pushback from regulators. When those fears didn’t materialize, the biotech stocks resumed their climb. But later in 2014, the arrival of a competitive hepatitis C product from AbbVie (ABBV) presented an opening to pharmacy benefit managers (PBMs) such as Express Scripts (ESRX) to negotiate aggressively for lower prices. Biotech stocks reacted with a shudder.
ESRX also noted that it intends to apply the same aggressive negotiation to other drug categories, including oncology drugs. This is happening just as some promising next-generation cancer treatments -- so-called “immuno-oncology” drugs -- are nearing the market, with potential blockbuster status and likely blockbuster prices. Wherever there is competition -- and GILD has shown us that it is very difficult to build a moat in the biotech industry -- there will be scope for PBMs to cut deals, use biotech competition to their advantage, and drive prices down for the consumer.
Profits May Be Under Pressure -- But They Could Still Be Very Large
However, the market may overreact to fears of price wars and competition. We see two spaces within the biotech industry where, for different reasons, profits may still be robust.
One is the orphan drug space. Orphan indications are rare diseases, frequently genetic, where the patient population is typically very small. During the initial promulgation and roll-out of the Affordable Care Act (ACA), we feared that orphan indications would come under pressure and that budgets for their development would begin to dry up. That prospect made companies that focus on orphan indications seem problematic. However, the ACA has not yet had this effect -- and if competition is the key to new price pressures in the biotech industries, orphan drugs may be one place where biotech profits can be preserved. Alexion Pharmaceuticals (ALXN) is one such company; they manufacture a blockbuster drug called Soliris which treats two rare genetic disorders and costs more than $500,000 a year -- the world’s most expensive pharmaceutical. This year they will likely launch another such drug, asfotase alfa, which could also reach blockbuster status (more than $1 billion in sales per year) in spite of the small patient population.
Large, Complex Molecules (Such As Monoclonal Antibodies) Are the New Cutting Edge Biotech Products For Many Diseases
Another possible haven in biotech where profits may still be robust is in areas of significant unmet need. Hepatitis C itself may fall under this category. The pie of available patients is huge -- since until now there has simply been no cure at all. It will take many years to work through the existing population of hep C patients. GILD analysts may have to revise their revenue projections downward -- but we think those revenues will still be robust.
One area where unmet needs may be big enough to support several entrants is the next generation of anti-cholesterol drugs. Amgen (AMGN) and a team of Sanofi (SNY) and Regeneron (REGN) are nearing commercialization of drugs which inhibit an enzyme called PCSK9. Data that came from Merck (MRK) in November bolstered the claim that lower cholesterol actually leads to lowered rates of death from heart disease. The new PCSK9 inhibitors face competition from one another as well as from generics, as current anti-cholesterol blockbusters go off patent. (There are also unresolved legal issues between the competitors.). Should their efficacy prove high enough, though, they could become blockbusters themselves even in the face of all that competition.
Investment implications: Pricing pushback from PBMs may crimp biotechnology companies’ profits, and the industry may not fly as high as it did in 2013 and 2014. However, orphan indications and new treatments for widespread chronic conditions could both continue to generate good profits for biotechs, even in the face of pricing pressures and payer pushback. In the first, competition will be muted; and in the second, the pie may be big enough for all competitors to profit. Nonetheless this is a very exciting sector with opportunities for investors.
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