Surprising Claims About Orphan Drugs?

It's no secret that pharma companies are investing heavily in drugs for rare diseases, aka 'orphan drugs', these days. Because orphan drugs offer extended market exclusivity, faster regulatory times, and numerous cost-saving benefits, they have become a focal point in the industry lately.

And the interest has only grown stronger as multiple orphan drugs have now achieved megablockbuster status, such as Roche' s (NASDAQOTH: RHHBY  ) Rituxan and Celgene's (NASDAQ: CELG  ) Revlimid, to name a few. Consequently, we've seen a buyout frenzy take place over the last few years, many of which have come at astonishingly high premiums.

Shire plc, for example, gobbled up several orphan drugmakers recently, paying 30-40% premiums in the process. Amgen recently paid over $10 billion to acquire Onyx Pharmaceuticals, primarily for their orphan drug indicated for multiple myeloma.

Although the regulatory and marketing benefits for orphan drugs have undoubtedly spurred innovation for diseases that otherwise would go unnoticed due to profitability issues, the eye-popping price tags for most of these drugs have garnered a fair amount of criticism. From the industry's viewpoint, prices need to be high to warrant developing drugs for diseases with small target populations. On the flip side, critics point to the fact that orphan drugmakers already receive a good deal in terms of reduced regulatory costs and tax benefits, so price tags that average several hundred thousand  in U.S. dollars are controversial.

Are orphan drug prices too high?
As the debate over drug pricing continues, insurance companies, for the most part, have been willing to pay these high prices because of the small patient population sizes. Nonetheless, orphan drugs are starting to face pressure on the pricing front. As the Affordable Care Act comes into effect, experts believe there will be more debate on the benefit of paying billions of dollars for diseases that affect only a few hundred, or thousand, people worldwide.

That's certainly a tough question to tackle. From a pure dollars and cents perspective, some believe these high price tags are hard to justify in a time of rising health care costs. But that view removes the human element altogether. Who wants to be viewed as withholding life-saving treatment for patients simply because of cost? This is why so little debate has occurred over orphan drug pricing schemes, until now.

Are orphan drugs less profitable?
Last month, an article appeared in Nature Reviews Drug Discovery that starkly contrasted prevailing notions about orphan drugs, suggesting that orphan drugs are, in fact, less profitable than their non-orphan peers. Put simply, the study's authors suggest that orphan drugs tend to have lower gross profit margins on the whole, after accounting for research and development costs. As such, orphan drug prices would appear to be largely justified. In a nutshell, the authors believe the high prices are the cost of innovation for unmet medical needs, and are not the result of profiteering.

When I first read the article, I was quite literally dumbfounded. Why would so many pharmas covet orphan drugs if they are less profitable? That's certainly counterintuitive.

What's important to understand is that because this study was published in a top journal, it's likely to get a fair amount of attention from policymakers going forward. So it's key to understand if the conclusions are indeed sound.

After digging a bit deeper, however, I believe the study missed some key data points that might paint a different picture altogether. Because the study didn't include drug revenues from dates past 2011, some of the biggest revenue generators among orphan drugs were excluded in the analysis.

Questcor's Acthar Gel is a prime example. Questcor acquired Acthar for all of $100k, and it now generates over a billion a year in sales. And because of the study's 2011 cutoff, Jazz Pharmaceuticals was also not included, and the bulk of BioMarin's revenues relative to costs were skewed in favor of costs. In short, I am not sure the study's main takeaway holds water in light of these critical omissions. 

Foolish final thoughts
There is clearly going to be increasing debate over orphan drug pricing going forward. In the current fiscal environment, lawmakers have little choice but to think in terms of getting the biggest bang for the buck. And investors jumping into the orphan drug game now should be aware of this issue. With that said, I think there is ample evidence that orphan drug specialists are some of the most profitable in the industry, and will remain so for the foreseeable future.

 

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