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Global Pharmaceutical Industry: Trends, Observations, Investment Implications

Big Changes In the Global Pharmaceutical Industry

  • There is a shift from traditional small molecule “white pill” drugs to biologics. Main effect of this is a change in the economics of these drugs’ lifecycles – “white pills” are easy to copy cheaply and at scale, so patent expiries result in an instant 90% drop in sales, but the next generation of biological drugs has a different lifecycle. This is broadly because generic “biosimilars” still need $2.5-5m in R&D spend and generic manufacturers are obliged to test them in the same way as a patented drug, so prices can’t be slashed as dramatically as before
  • Companies are now focusing on a much smaller range of diseases. In the past, pharmaceutical industry functioned like a movie studio where the blockbusters paid for the flops. However, the “low hanging fruit” of diseases with large patient populations have largely all been addressed, and the industry focus is now on developing smaller, specialized products with much smaller patient populations and therefore much higher price tags. One example is Merck’s immune-oncology offering Keytruda, which costs $150,000 per patient per year. Compare this to Pfizer’s statin Lipitor, launched in 1996 and by some margin still the best-selling drug in the history of pharmaceuticals, despite the presence of other statins such as AstraZeneca’s Crestor, itself a blockbuster. In the USA, the population of patients on statins is an enormous 15 million, meaning that volumes more than offset its comparatively low price of $2,000 per patient per year

Further Observations / Investment Implications

  • Conducted a broad survey involving conversations with pharmaceutical companies
  • Most fundamental question put to each company was, what exactly is the core asset which allows the company to keep coming up with patentable intellectual property?
    • This question didn’t yield many concrete answers or even consistency
  • First observation is that all the companies which have done well recently credited their early identification of the need for specialization and targeted R&D into just a few therapeutic areas
    • Given the shift from small molecule to biologics, companies which haven’t narrowed their R&D target range down to a core list of competencies and set themselves up as a leader in specific spaces definitely seem to be at a disadvantage
    • Suspect it’s no accident that the highest valued company looked at (Novo Nordisk, currently on 6.4x sales) is almost a pure diabetes specialist with 80% revenues from this therapeutic area and that the second highest valued company (Bristol-Myers Squibb, on 5x sales) targets an extremely narrow range of diseases with a distinct emphasis on biologic oncology; Sanofi, by contrast, actively promotes itself as diversified and is on a much lower 3x sales
  • Second observation is more of a caution. While attaining a strong position in one therapeutic area is important for pharmaceutical companies, that position doesn’t then function like a successful consumer goods franchise which benefits from a durable brand and consumer loyalty
    • While it’s possible for drugs to have a great deal of physician and patient loyalty, ultimately efficacy and value is king and a trusted name alone is no defense against a more effective or cheaper offering
    • It’s rare that brand value as a concept is applicable to individual drugs, although on the rare occasions when a drug is successful enough to spawn line extensions and more indications, these can be valuable
    • Some drugs do gain consumer recognition but the boost or protection this affords is likely to be temporary
  • Stronghold in a key area is the result of years of investment which has resulted in expertise and hopefully a stable of drug “intellectual property.” This acts as a moat, as would-be new entrants have to catch up with spending, but more importantly it makes the company a magnet for talent and early stage biotech drugs
  • Price regulation is a fact of life for the pharmaceutical industry and we see no indication that this will change. Pricing will always be constrained in some way – historically, the US has been the most profitable region for drugs companies, but increasing consolidation amongst insurance payers in the US means they are growing more powerful every year
    • It would be foolish to disregard the impact this will have on drug pricing, especially as pharmaceutical companies target even smaller patient populations with ever more expensive drugs. Despite these pressures, we do think that in the long run, efficacy will win out and drugs offering genuine advances in treatment will always be rewarded
  • 90% fall in Valeant’s share price since 2015 is a cautionary tale which fundamentally highlights the risks of its strategy of growth via acquiring “mispriced” drugs and hiking prices. Ideally, pharma companies would love to grow via a steady stream of in-house new drugs but arguably that strategy may now be harder to follow
    • “Growth via acquisition” model is a continuum. A model of judicious acquisition can be productive but at its extremes, risks of political pushback and payer price intolerance make the model demonstrably unworkable
  • Even more interesting than pure pharmaceutical is the over the counter (OTC) healthcare industry, which enjoys more consumer good-like qualities such as a lack of patent expiries and a strong element of brand loyalty amongst customers
    • Exceptionally fragmented market that is ripe for consolidation, with only 25% of total sales coming from top 10 companies
    • This fragmentation is largely due to localized nature of the business – consumers trust brands they know well and since these are often local brand names, it can be difficult to truly globalize a product. Also, countries differ in their approach to self-care – Chinese traditional medicine is very different to Western – and there is the widespread issue of OTC healthcare departments often being part of a larger pharmaceutical company, which means there is a risk they are run for cash but chronically under-nurtured
  • Despite the fragmentation and difficulties with globalizing products, the OTC market is an attractive space
    • Consumer trust and loyalty are crucial, with doctor and dentist recommendations being a key differentiator for many products, and strict governmental regulation in all regions means higher barriers to entry and therefore better margins for existing competitors
    • Structural growth will come from cash-strapped governments increasingly encouraging people to self-medicate, as well as aging populations and more obesity, which all tend to be treated with more drugs
    • In some locations such as UK, deregulation means that some OTC preparations are available in supermarkets and convenience stores as well as chemists, all of which encourages consumers to opt for OTC preparations as a first line treatment
  • We sense that pharmaceutical industry is at a crossroads. The shift from small molecule drugs to biologics is genuinely revolutionary and the different pricing mechanics of biologics and biosimilars to small molecule and traditional generics may result in some respite from the patent cliff model
    • Companies which have grasped the importance of the shift could have 10 or more years to do really well, with little competition for expensive, effective products and their initial investments paying off handsomely as others struggle to catch up

Lindsell Train: Just What The Doctor Ordered, October 2017

Image Source: International Research Report

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