Catching Hepatitis: Why Merck (MRK) Was Willing to Break the Bank for Idenix (IDIX)

Joel Anderson  |

Monday saw a major tectonic shift in the market for biotech companies. Or, rather, the tectonic shift happened some time ago; Monday was the day a major earthquake finally rippled across the stock markets as a result.

The earthquake in question? The announcement that Merck (MRK) is purchasing Idenix Pharmaceuticals  (IDIX) .

At first blush, this doesn’t seem like it should be news. Major pharma companies absorb smaller biotech firms to acquire promising treatments and product pipelines all the time. But in this case, it was the price paid that raised eyebrows. Merck is shelling out $3.85 billion for Idenix, a staggering 240-percent premium on the closing price from Friday.

All told, this comes back to a single, central issue that’s been a fixation of the entire health care industry for months whether the general public realizes it or not: the cost of treating hepatitis C.

Sovaldi Has Demonstrated Treating Hepatitis C is a Good Business to Be In

Idenix has zero, count ‘em, zero therapies that are currently commercially available and had zero, count ‘em, zero dollars in revenue last year. So why the massive price tag for a company whose most-advanced therapy has only reached Phase II clinical trials? Because the company’s primary focus is treating hepatitis C, a market that has grown astonishingly lucrative and is getting astonishingly competitive as a result. ISI Group analyst Mark Schoenebaum said in a research note the price paid by Merck would place the global hepatitis C market at $20 billion by 2018, and everyone's now fighting to secure their piece.

The first inklings that this would be the case came when Gilead Sciences (GILD) announced that Sovaldi, the first truly effective hepatitis C treatment to hit the market, would cost $84,000 for a round of treatment, better than $1,000 a pill.

This created waves. Big ones. Henry Waxman fired off a strongly-worded letter to Gilead CEO Dr. John C. Martin that essentially reminded Martin, in a rather pointed fashion, that his company should potentially factor the help it got from the federal government into its pricing considerations.

The next potential aftershock came as earnings reports started to roll in for Q1 2014, the first quarter where the drug was commercially available. Gilead tallied $2.3 billion in sales for Sovaldi, helping it spike revenue and profits through the roof as a result. Gilead had fell just short of doubling revenues, year-over-year, and boosted them over 60 percent from Q4 2013 alone.

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But it didn’t stop there. Gilead’s gain was also major insurers’ loss. Even as major insurers like UnitedHealth Group (UNH) were getting their Q1 reports combed over for signs of what the effects of Obamacare might end up being, industry watchers also noted something else: the cost of Sovaldi was eating into profit margins for insurers in a big way. While the first quarter saw higher costs as patients long in need of a treatment finally had a new option, the $100 million the insurance company spent on the treatment seemed to imply that the price tag was going to be steep.

Effects of Sovaldi Pricing Still Settling In

Today, though, represents the next wave of changes brought on by the massive cost of Sovaldi. It doesn’t take a rocket scientist to look at Gilead’s massive Q1 and realize it would send other pharma companies scrambling to get their own drug into the space. In fact, part of the reason the price for Idenix got so high was a bidding war between Merck, Johnson & Johnson (JNJ) , and AbbVie (ABBV) , each desperate to get their hands on what appears to be the next best hope to create a competitor for Sovaldi. It’s also probably a big part of the reason why Novartis (NVS) already owned 22 percent of Idenix.

But, in maybe one of the craziest offshoots, Achillon Pharmaceuticals (ACHN) , a company which also doesn’t have any drugs out of Phase II and also didn’t have any revenue in 2013, shot up nearly 50 percent on Monday. Not because of any specific buyout rumors, but because the company, as The Street’s Adam Feurerstein observed, would appear to be the next-best option for acquisition by the losers in the race for Idenix.

Gilead, meanwhile, plunged over 4.25 percent on the news, which has as much to do with the role intellectual property owned by Idenix may play in the ongoing patent dispute between Merck and Gilead as anything. However, on the whole, it was a big day for the biotech sector, with the SPDR Biotech ETF (XBI) climbing 6.16 percent.

Biotech Industry Shifting Due to Hepatitis C Drugs

So what does this mean moving forward?

Well, for starters, it’s likely to mean any and all small-cap biotechs with even a sniff of hepatitis C to their product pipeline are probably going to see their valuation bolstered. In much the same way that the Dodgers and Clippers each getting sold for more than $2 billion in the last year is probably making the owners of any and every major sports franchise in America seriously reconsider what their asset is worth, Idenix’s huge price tag will probably have shareholders of biotech companies working on hepatitis C treatments realizing they’ve got more on their hands than they appeared to on Friday afternoon.

It’s also another sign that Waxman’s letter wasn’t out of line. The pricing of Sovaldi is clearly a game-changer in the industry and even now, months later, its effects are still being felt. Even though Sovaldi can make a strong argument that the price tag is justified (expensive as it is, it costs a lot less than treating liver damage), the combination of market factors their decision has unleashed can’t go unnoticed.

Given how much money Gilead is making, it’s not hard to imagine the next company that can corner the market on a massive pharmaceutical need ahead of its competitors may decide to gouge their customers in similar fashion. And the ripple effects of this sort of pricing strategy if multiplied a few times over could mean big changes in the entire health care sector over time.

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