Do Orphan Drug Developers Belong in Your Portfolio?

According to the U.S. National Institutes of Health, their site lists 138,691 ongoing studies and trials throughout the world. That's an incredible amount of research being undertaken, and it underscores just how many billions of dollars are being spent on understating and curing the world's many diseases.

Of particular interest, we've seen a surge in biotech research geared toward orphan drugs. Orphan drugs target rare diseases -- those that would affect 200,000 people or less -- and, based on recent figures from Thomson Reuters (link opens PDF), they've far outpaced non-orphan drugs in revenue growth (25.8% versus 20.1%) over the past decade.

Source: Thomson Reuters Cortellis.

With that being said, let's examine some of the pros and cons of investing in orphan drug developers and highlight one or two examples of promising orphan drug developers.

Why invest in orphan drugs?

  • Lack of competition: The primary reason to develop orphan drugs is that most large pharmaceutical companies are disincentivized from spending huge resources to market to such a small group of patients. A lack of competition is a key component to success for smaller biotech firms like Aegerion Pharmaceuticals, (NASDAQ: AEGR  ) which recently received approval for Juxtapid for the treatment of homozygous familial hypercholesterolemia.
  • Long periods of patent protection: Understanding that bringing an orphan drug to market involves considerable investment dollars, the Food and Drug Administration grants orphan drugs seven years of exclusivity from the date of approval. This means that NPS Pharmaceuticals' (UNKNOWN: NPSP.DL  ) orphan drug Gattex for the treatment of short bowel syndrome, which was approved in December, is protected through at least December 2019.
  • High price tag: With big investment dollars being spent on a small population, orphan drugs often carry very high price tags given their rare nature and lack of competition. BioMarin Pharmaceutical (NASDAQ: BMRN  ) , for example, offers Elaprase to treat Hunter syndrome, and Naglazyme for Maroteaux-Lamy syndrome, at a rough cost of $375,000 and $365,000, respectively -- per patient, per year!  
  • Faster approval time: Perhaps the biggest advantage to gaining orphan drug status is that drugmakers and the FDA work side by side to bring these life-changing treatments to market faster and with far fewer fees than non-orphan treatments.

Why you should think twice before investing in orphan drugs

  • High price tags disincentivize insurance coverage: On the flip side, carrying a top-tier price point for an ultra-rare orphan drug can often dissuade insurers from absorbing the high costs of a drug, or simply cause them to place numerous qualifying factors on a drug in order for members to be approved for reimbursement. Consider Aetna (NYSE: AET  ) , for instance, which recently dropped coverage on all but one indication of Questcor Pharmaceuticals' (UNKNOWN: QCOR.DL  ) Acthar gel, which it prices at $23,000 per vial regardless of the indication.
  • Limited target and profit potential: The upside to targeting a small group of patients is the lack of competition. However, targeting rare diseases often leaves biotechs with a limited upside in terms of profit potential. Case in point, Exelixis (NASDAQ: EXEL  ) received approval for Cometriq in November, but noted in its presentation at the JPMorgan Healthcare Conference that its drug will only target 500 to 700 patients within the U.S.
  • It requires an incredible level of specialization: Perhaps this is a terrible generalization, but general physicians are a dime a dozen compared to a doctor or scientist who specializes in an ultra-rare disease. Sanofi's (NYSE: SNY  ) Fabrazyme is a targeted treatment for Fabry disease, which only affects an estimated 5,000 to 10,000 people worldwide, but it must invest quite a lot of time and research with Fabry disease specialists in collaborating on the drug development process.

The $64,000 question: Should you invest in orphan drug developers?
After reviewing the pros and cons, I can definitely see the advantage of owning orphan drug manufacturers in your portfolio. However, I also prefer to see the potential for pipeline diversification and insurance coverage before jumping on board, and definitely prefer to buy into companies where the valuation somewhat makes sense.

Alexion Pharmaceuticals (NASDAQ: ALXN  ) is one of the best examples of a successful orphan drug developer with Soliris, its drug for paroxysmal nocturnal hemoglobinuria, or PNH. Soliris alone generates better than $1 billion a year in revenue for Alexion (even though only 10,000 people are suffering from this blood disease) thanks to its $409,500 per-year price tag! While this may sound attractive, Alexion's remaining pipeline is wholly dependent on newer indications for Soliris -- it did receive approval to treat atypical hemolytic uremic syndrome in 2012 -- and it's currently valued at a frothy 19 times annual sales, which dissuades me from buying the stock.

Instead, two orphan drug developers I'd suggest taking a closer look at would be Exelixis, a name I've been high on for months, and Aeterna Zentaris (NASDAQ: AEZS  ) , a microcap I personally own.

Both of these companies may be small in size, but don't let that fool you. Exelixis has more than 30 ongoing trials just for Cometriq, and it has more than a handful of out-licensed collaborative partnerships with some of pharma's biggest names. Having performed so well in clinical trials with regard to progression-free survival, I have a hard time believing that Cometriq is a one-indication wonder drug.

Similarly, Aeterna Zentaris has a pipeline geared toward rare diseases. Although perifosine failed to meet its endpoint in a colon cancer trial, it currently has a late-stage trial ongoing for perifosine with regard to multiple myeloma, and has multiple other orphan drugs mixed in with its seven ongoing clinical trials and four pre-clinical possibilities. With $33 million in cash on the books, and this expansive of a pipeline, $69 million in market cap seems a small price to pay for Aeterna's potential for one or two successful trials.

What about you? What are your opinions on orphan drugs, and, if you do support buying orphan drug developers, which one is your favorite? Share your opinions with your fellow Fools in the comments section below.

Will this orphan drug maker turn things around?
Questcor is one of the most debated names in all of biotech. Its premium priced drug, Acthar, is growing at a torrid pace -- and minting money in the process. However, recent events have created significant doubts about Questcor's future. Will insurance companies continue to cover the drug? Will a government investigation lead to huge fines? We highlight these high-profile issues inside our brand new premium research report on Questcor. In it, you'll learn about the key opportunities and threats facing the company, as well as multiple reasons to buy and sell the stock. We're providing a full year of analyst updates as key news hits, so make sure to claim a copy today by clicking here now.

Read/Post Comments (2) | Recommend This Article (6)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On January 17, 2013, at 10:09 PM, drdonrs wrote:

    It appears MF takes every opportunity to present a negative read on everything when it comes to Questcor. You fail to mention that Aetna has grandfathered in patients already receiving Acthar. Also you never mention that there is an appeals process in place (external appeal) in most states and that the medication can be requested in a pre-authorization process. So your statement that coverage was dropped is so typical of the ploy used by short sellers...what are you?

  • Report this Comment On January 18, 2013, at 8:24 PM, earthunit wrote:

    I agree, this is another example of MF slanted reporting for the benefit of someone and that someone is not the readers here.

    You guys at MF are on the exact same level as Lance Armstrong. What's it feel like to have no conscience?

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