Big Pharma's Not-So-Hidden Secret to Success

The past week may have been a bit of a bumpy ride for the pharmaceutical and biotech sector following congressional testimony that highlighted the rising cost of branded drugs, but it represents nothing more than a tiny hurdle in what's been an incredible run for health care stocks.

Traditionally slow-growing and less volatile, big pharmaceutical companies have discovered the fountain of youth since the recession. For example, shares of Bristol-Myers Squibb (NYSE: BMY  ) and Pfizer (NYSE: PFE  )  have galloped higher by 217% and 178%, respectively.

Some of these gains can be attributed to the overall rebound in the U.S. economy, which has propped up growth in practically all industries. Internal pipeline innovation is another reason that the biopharmaceutical sector has outperformed. More drugs than ever are shuffling through the Food and Drug Administration's review process, which is yielding tangible revenue results for big and small biopharmaceutical companies. We've also seen acquisitions play their part in encouraging top and bottom-line growth.

Big Pharma's secret weapon
But none of these pathways represent what I believe to be Big Pharma's not-so-hidden secret to success since the recession: its propensity to form collaborations.

As Foolish health care bureau chief Max Macaluso pointed out at the beginning of the year, biopharmaceutical companies are often very secretive about their pipelines and drug discovery processes. However, it's becoming more apparent with each passing year that biotech companies need Big Pharma funding to take their drug ideas from the concept stage to clinical testing, while Big Pharma needs different treatment pathway ideas to expand somewhat stagnant top-line growth caused by the patent cliff.

The drug collaboration process also spreads the risk around for Big Pharma companies and the smaller biotechs. Up-front funding, milestone payments, and royalty rights delivered by pharmaceutical majors allow small and midsized biotechs to fund new studies, while Big Pharma gets the opportunity to swing at more pitches in an effort to hit a home run.

Lately we haven't had to look very far to find how collaborations are changing the biopharmaceutical investment landscape.

Deals-a-plenty
Bristol-Myers Squibb earlier this month signed a collaborative deal giving it access to Five Prime Therapeutics' (NASDAQ: FPRX  )  proprietary drug discovery platform targeted at immuno-oncology drugs designed to retrain the body's immune system to recognize and attack cancer cells. The deal specifically targets two unidentified immune checkpoint pathways and entitles Five Prime to a $20 million up-front payment, $9.5 million in research funding, and a $21 million common equity investment from Bristol-Myers. Five Prime receives valuable cash to continue its research, Bristol-Myers gets marketing control over what gets developed, and both companies have a vested interest in the success of the other.

Source: GlaxoSmithKline.

If you're more interested in tangible results, you needn't look further than the collaboration between GlaxoSmithKline (NYSE: GSK  ) and Theravance  (NASDAQ: THRX  )  to develop a number of therapies for treating chronic obstructive pulmonary disorder, or COPD. Thus far this collaboration has produced two FDA-approved therapies: Breo Ellipta, a long-term, once-daily, maintenance therapy of airflow obstruction for COPD patients using umeclidinium and vilanterol inhalation powder, and Anoro Ellipta, which is also a once-daily long-term maintenance therapy comprised of fluticasone furoate and vilanterol. Each therapy has blockbuster potential in its own right, and the two companies have two additional therapies in development. Furthermore, this collaboration put Theravance on the map by moving its valuation from small-cap to mid-cap territory, while allowing GlaxoSmithKline a fresh revenue stream to help cancel out eventual generic competition to Advair in a few years.

Were that not enough, big pharmaceutical companies are also collaborating with each other. Just last month, Pfizer and Merck announced an anti-cancer collaboration that will combine Merck's experimental anti-PD-1 immunotherapy with two of Pfizer's oncology therapies (Inlyta and PF-2566) to test their effectiveness in renal cell carcinoma. With the patent cliff hitting certain companies harder than others, and branded drugs having only a finite patent life, Big Pharma is learning that two heads are often better than one.

When Big Pharma collaborates, everyone wins
This isn't the easiest logic to follow, but I firmly believe that when Big Pharma collaborates, everyone wins.

Realistically, a good chunk of collaborative deals will end with a therapy not being approved by the FDA or simply not making it through clinical trials. Still, these collaborative deals provide the funding needed to keep the biotech cog lubricated, and even failures help teach pharmaceutical majors and biotechs which pathways do and don't work when treating varying diseases and disorders.

This doesn't mean that every biotech and Big Pharma that make deals will come out a winner. Your investment could very well lose money. However, the end result of consistent collaboration is that these companies have (to return to my favorite baseball metaphor) more pitches to swing at and more chances to knock one out of the park. This is why we see highly collaborative and deep pipelines from companies such as ImmunoGen and Isis Pharmaceuticals performing so well, and why thinner, noncollaborative pipelines have often struggled to keep pace.

Whether you're a biotech-investing novice or a seasoned vet, keeping your eyes peeled for collaborative deals of all forms could ultimately make you a better investor.

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