Novartis AG Seeks to Pump More Value into its R&D

Investments in R&D are in need of an overhaul, according to one Big Pharma chairman.

Novartis AG's (NYSE: NVS  ) new chairman Joerg Reinhardt sees many challenges in the pharmaceutical sector, as branded drugs face ever-increasing competition from generics. Reinhardt sees a critical need to invest in research that delivers value, in terms of prolonging life or improving the quality of life. He told The Wall Street Journal, "with every new product coming off patent, the benchmark comes up."

And Novartis is certainly going after that benchmark, with 10 planned filings for 2014, including five new molecules and five new indications. One of them, LCZ696, is generating buzz about its potential to become a mainstay therapy for heart failure, and analysts predict it could add an additional $3 billion to revenue by 2026. Novartis' pipeline has about 144 pharmaceutical products under development and three have received FDA Breakthrough Therapy designations. This should expedite the development and review of LDK378 for lung cancer, RLX030 for acute heart failure, and BYM338 for a muscle wasting disease. BYM338 is the type of rare disease treatment many pharmaceutical companies are interested in developing due to their market potential. Analysts predict the drug could have peak sales of $300 million.

As the company retools its R&D scope, Novartis' top pharmaceutical products such as Lucentis, Gilenya, Tasigna, Galvus, Afinitor, and Xolair should deliver healthy revenues over the medium term. Combined 2017 worldwide sales for these products are estimated to reach $11.5 billion. Novartis' sky-high 2013 R&D budget of $9.85 billion is expected to hold steady going into 2014, and the company is looking for ways to better optimize that expense.

Centralizing research effort
For example, Novartis is consolidating its research centers to four cities – Shanghai, Basel, Boston, and La Jolla, California – known for their academic centers. The move is intended to encourage more teamwork among researchers and facilitate more brainstorming of new ideas. Reinhardt's commitment to R&D was evident upon his arrival at Novartis when he created a board subcommittee to stay on top of Novartis' R&D strategy and organization and advise the board on the latest research updates.

Reinhardt's comments and proposed strategy resonate through out an industry where its biggest players are reshuffling their businesses and partnering with outside labs to develop experimental drugs with greater market potential. Companies like Merck & Co. (NYSE: MRK  ) and Roche Holding AG (NASDAQOTH: RHHBY  ) are engaging in this type of strategy.

Merck and Roche's R&D focus
During fiscal 2013, Merck's R&D expenses were $7.1 billion, a decrease from $7.9 billion in 2012. The decrease in spending is part of the company's increased focus on select therapies, while reductions are implemented and clinical development is decreased in other research areas of lower priority.

R&D spending targets for 2014 are expected to be below 2013 levels due to the continuation of spending on specific core and upcoming products. Merck has 12 therapies undergoing Phase III testing and 10 treatments under FDA review. Analysts are predicting that two key treatments – cancer drug MK-3475 and an all-oral hepatitis C cocktail drug – may add as much as $5 billion to revenue in 2020. It's important for investors to keep in mind that these estimates are highly variable and Merck also faces stiff competition in the hep C market.

Meanwhile, Roche reported higher 2013 R&D expenses in its three core business groups:

Business

R&D expenditure growth (CER)

R&D as a percentage of sales

Roche Group

+5%

18.6%

Pharmaceuticals

+5%

21.2%

Diagnostics

+7%

9.7%

Source: Roche Business Report 2013 

The company is investing heavily in the areas of oncology, immunology, ophthalmology, infectious diseases, and neuroscience, and has 66 new molecular entities under development, with 15 in late-stage trials. Roche is known for its oncology product line; however, CEO Severin Schwan noted recently that the company is also focusing on inflammation and ophthalmology. One of its cancer drugs, Kadcyla, currently under further study after receiving early FDA approval for its ability to treat breast cancer, is having favorable results so far. Analysts are guiding for between $2 billion and $5 billion in peak sales for the drug.

Roche places a high reliance on collaboration within their in-house research teams, which are supported by its Japanese subsidiary Chugai and other external partners, which include more than 150 outside companies. The company is also looking into new ways to improve R&D productivity to contain the costs of turning their research into viable products. Some of these cost-saving measures include engaging in data-sharing of clinical trial results and decreasing its number of clinical trails to 2,184, a 6.5% reduction from 2011 to 2013 .

My Foolish conclusion
As giant pharmaceutical companies work to keep up with their generic and other branded competitors, their focus on improving the R&D process is a step in the right direction for shareholders. I urge investors to watch this issue to see how changes unfold and impact these companies in the next few years. In the short term, Novartis may show some weakness but over the long haul I like the opportunity presented by its current and prospective pipeline.

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