High-Margin Generic Drugmakers -- An Oxymoron?

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There's big money to be made by generic-drug companies -- and therefore investors -- but it's not in selling low-margin pills for pennies. No, the big profits come when a generic-drug maker doesn't have any competition.

To manage that feat, a generic-drug maker challenges a patent of a branded drug company -- called a paragraph IV certification -- and the Food and Drug Administration awards the company 180 days of exclusive sales after a 30-month stay is concluded. The stay is to allow time for the usual resulting patent-infringement lawsuit, filed by the challenged company, to be heard. That six-month virtual monopoly allows the generic company to sell the drug at close to the branded price and reap the similarly high margins that branded-drug makers fetch. It's not until the second or third generic enters the market that the price really drops.

The 180-day clock doesn't start ticking until the court makes its decision, but some generic drugmakers don't wait for the courts to decide. They start the clock -- after receiving FDA approval -- by making at-risk launches before the infringement case has concluded. This puts those drugmakers at risk of having to pay the branded-drug company triple damages should the court keep the patent intact -- thus the "at-risk" name for this move.

No one seems to be better with "at-risk" launches than Teva Pharmaceuticals (Nasdaq: TEVA). According to Bloomberg, Teva has pulled off the stunt 13 times since 2004.

Why would a company risk having to pay triple damages for willfully ignoring a patent? It seems to come down to leverage. For instance, Teva made an at-risk launch of AstraZeneca's (NYSE: AZN) asthma treatment Pulmicort Respules last month and, before a court could make a decision, AstraZeneca settled with Teva and allowed Teva to launch next year, well ahead of the 2019 patent expiration.

But it doesn't always work out as planned. For instance, last December's launch of Wyeth's (NYSE: WYE) Protonix apparently ended with Teva not selling any more beyond that launch.

Even the threat of an at-risk launch probably factors into branded drugmakers' decisions to settle. Just yesterday Mylan (NYSE: MYL) announced that it will be able to launch generic versions of Novartis' (NYSE: NVS) Femara before the challenged patent expires.

But bluffing is only half of it. If the company is confident that the patents are invalid, it might as well launch as early as possible. That's what Mylan did with its 2003 launch of Omeprazole, the generic version of AstraZeneca's Prilosec. Just last summer, the U.S. Court of Appeals upheld an earlier ruling that it did not violate AstraZeneca's patents. And there's the case of Apotex's generic version of Sanofi Aventis' (NYSE:  SNY) and Bristol-Myers Squibb's (NYSE: BMY) blood-thinner Plavix in which Apotex was found to have violated the patents, but didn't have to pay extra damages because Bristol-Myers agreed not to ask for them before the ruling.

Generic drugmakers are in a sweet spot right now with so many blockbuster drugs going off patent in the next few years, but investors would be wise to note how many paragraph IV patent suits the companies have. That's where the big bucks lie.