Valuation and Other Biotech Mysteries – Part 11: Changes in Pharmaceutical Industry Product Portfolios and Strategies
August 23, 2011
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[Ed. This is the eleventh part in Wayne's series. You can access the whole thing by clicking here. Please leave comments or questions on the blog and Wayne will address them in future posts in this series.]
As described in the prior post, the modern pharmaceutical industry has evolved from the patent medicine companies selling herb and alcohol combinations into an industry developing complex and personalized medicines such as gene and cell therapy. The first blockbuster drug, Tagamet (cimetidine), developed by Smith, Kline & French (SK&F) is a great base for a case study of various industry strategies.
- There is room for more than one drug in each drug class. Tagamet was followed by Zantac (ranitidine) from Glaxo Labs and two other members of the H2-antagonist drug class. From a valuation perspective, focus on first-in-class (important when drugs have similar safety and efficacy) and potential to be best-in-class.
- There is room for more than one drug class to treat each medical condition. The H2-antagonist drug class was followed by the proton pump inhibitors (PPIs), including Prilosec (omeprazole) by AstraZeneca. From a valuation perspective, focus on whether the new drug class will become the new first-line therapy, first-line co-therapy, or second-line or salvage therapy.
- Line extensions can prolong the market life of a drug. Eventually, the 4 branded drugs of the H2-antagonist drug class all lost patent protection and were replaced by generics. Because these drugs had such a good safety profile and self-treatment of this medical condition was medically acceptable, OTC versions have been approved in the U.S., along with an OTC version of Prilosec. For OTC products, you can also get other brand, generic and house-brand competition. Very few prescription drugs have made the transition to OTC status. Low-dose statins are available in the U.K. but Merck’s proposed Mevacor OTC has been rejected by the U.S. FDA.
Three other types of line extensions have been popular in the last two decades.
- The first line extension was once-daily products to replace oral products taken several times daily, with the presumed benefit being patient compliance. For the brand pharma company, the key was to get the once-daily products to market prior to generic competition and change physician prescribing to the once-daily products. Specialty pharma companies must wait until the patents expire and need to consider whether their once-daily product can compete on price with the generics or convince physicians and payers that their product has a clinical benefit which justifies a price premium to the generics.
- The second was a combination of two drugs in a single tablet, such as the combination of the diuretic HCTZ (hydrochlorothiazide) with certain hypertension drugs and the combination of two pain drugs such as tramadol and acetaminophen. The presumed benefit could be patient compliance or a superior clinical benefit. Timing, comparative benefits and pricing are again critical for the success of this type of line extension.
- A third was the use of single-isomer drugs to replace isomeric mixtures, such as the replacement of Prilosec by Nexium (esomeprazole). Sepracor, acquired by Dainippon Sumitomo Pharma in 2009, was the pioneer of this approach based on its chemistry expertise in chiral synthesis.
Scientific discoveries can change treatment regimens. It was discovered that ulcers were triggered by an infection (H. pylori) and the treatment regimen was changed to include antibiotics.
M&A is a major growth strategy in the pharmaceutical industry. In our case study, SK&F was unable to develop new blockbusters to follow-up Tagamet and ended up being acquired by Glaxo, now GlaxoSmithKline or GSK. Look at any of the larger pharmas and you will see numerous M&A transactions. Pfizer alone has made 3 major acquisitions starting with Warner Lambert in 2000 for US$90 billion, Pharmacia for US$60 billion in 2003 and Wyeth in a US$68 billion deal in 2009. Interestingly, the total cost of these three acquisitions is US$218 billion – the current market cap of Pfizer is about $142 billion.
Brand, human prescription drugs is the core business of the pharmaceutical industry. Operating in a small number of therapeutic areas may help focus operations and expenses but it increases risk if the key drug candidates fail or growth is slower than expected. Critical mass and diversification of risk is attained by having drugs in multiple therapeutic areas. However, the impact of a single new drug on growth is diluted in the larger company.
At any given time, there will be different growth rates for the various therapeutic areas. The first approvals in a new class of drugs may trigger extraordinary growth in a given therapeutic area. Conversely, when an entire class of drugs loses patent protection over a period of a few years, such as the statins for lowering cholesterol levels, growth measured by prescriptions may still be rising but dollar sales may be decreasing.
Diversification can involve other types of drug products and healthcare activities, which I will cover in the next post.