Developing a new drug costs hundreds of millions of dollars, but for every five drugs that reach the market, another 95 end up in the trash bin.
That makes finding the next big thing in biotech particularly hit or miss. Frankly, the odds are stacked against biotech investors, because the odds are stacked against the biotech industry.
Small biotech companies generally have just one or two compelling ideas under development, which means that if one fails, the stock will take a substantial hit. That doesn't mean, however, that investors can't benefit from billion-dollar biotech blockbusters; it simply means they may want to develop a better strategy.
Rather than focusing on fly by night, unproven therapies, investors may want to look for opportunities to capture the billions of dollars in sales that are already being generated by the largest drugmakers in the world.
That leads me to what I believe may be one of the biggest coming long-term trends in biotech: biosimilars. These are generic, copycat versions of biologic drugs such as AbbVie's (NYSE:ABBV) blockbuster autoimmune drug Humira.
Although hurdles remain for advancing biosimilars to market, the opportunity to take market share from from megablockbuster biologics is potentially game changing for generic specialists including Mylan (NASDAQ:MYL), Novartis' Sandoz unit (NYSE:NVS), and Hospira (NYSE:HSP). Given that backdrop, let's learn more about biosimilars and how these companies hope to benefit from them.
At the cusp of a wave
As patents expire for top-selling, small-molecule drugs, including blockbusters Lipitor, Plavix, and Diovan, billions in revenue are being transferred from big pharmaceutical companies to generic-drug makers including Mylan and Teva Pharmaceutical (NYSE:TEVA).
Overall, roughly $290 billion worth of branded drug sales face off against generic competitors between 2012 and 2018, and that's already providing a windfall for the generics industry.
In 2003, generics represented about 48% of all prescriptions filled, but today they account for more than 70%. At the same time, Mylan's revenue has spiked from $1.4 billion to nearly $7 billion, and Teva's sales have more than quintupled from $3.3 billion to more than $20 billion.
Clearly, the small-molecule patent cliff has been a boon for generics, and the biosimilar opportunity may provide another boost.
According to Express Scripts, sales of specialty drugs increased 14% as biologics like Humira and high-priced cancer drugs have gained market share. As a result, spending on specialty drugs per member per year -- a measure used by health payers to gauge costs -- hit $240.57 in 2013.
Over the next three years, Express Scripts expects that spending growth on specialty drugs will advance an average 17.5% per year, versus just 2% per year for traditional counterparts.
Driving that growth are developers increasingly investing in biologics due to their higher prices and thicker margins. Over time that boost in development will mean more biologics losing patent protection and an increasingly larger market for biosimilars.
A more profit-friendly knock off
While traditional drug spending exceeds specialty spending, the high cost of biologics and the difficulty associated with creating biosimilars suggest that biosimilars could prove far more profit-friendly to generic manufacturers.
So far, only a few biosimilars have been approved, but they've been priced at a discount of roughly 30% to their branded peers. That's far better than the 80% discount for small-molecule generic equivalents.
While generic manufacturers will need to spend far more to usher biosimilars to market, less competition due to the complexity of making those drugs should allow for higher prices and more money dropping to earnings than prior-generation generics. For example, Hospira cited biosimilar margin as one reason for its gross margin improving from 36.4% a year ago to 40% in the first quarter.
Leading the pack
However, Hospira is not alone at the forefront of the biosimilars opportunity. Mylan and Novartis have made big investments, too.
Mylan has five biosimilars under development, and hopes for an FDA approval for its Copaxone alternative soon. Teva's Copaxone multiple sclerosis drug has $4 billion in annual sales and loses patent protection this year.
Mylan has since 2008 been working with Indian pharmaceutical company NATCO to bring its version of Copaxone to the U.S. market, While Copaxone is more a hybrid than a pure biologic, many are watching the FDA closely given its implication for future biosimilar approvals.
Novartis' Sandoz generic unit has six biosimilars in phase 3, including one for Abbvie's Humira, which loses U.S. patent protection in 2016, and another for Roche's Rituxan, which lost patent expiration in the European Union late last year but maintains exclusivity in the U.S. until 2018.
AbbVie notched more than $10 billion in Humira sales last year, and the drug's sales totaled $2.6 billion in the first quarter, up 18% year over year. Meanwhile, Roche's Rituxan sales were north of $7 billion last year.
In addition to those programs, Sandoz already markets three biosimilars that had combined sales of $420 million last year, up 23% from 2012, including Binocrit, Sandoz's alternative to Amgen's Epogen.
Hospira also markets three biosimilars, including an Enbrel alternative in Europe named Retacrit, that generate more than $100 million in annual sales.
Hospira's biosimilars pipeline includes a copy of Roche's soon-to-expire breast cancer drug Herceptin. The Roche drug, which costs $4,500 per month had sales of nearly $7 billion last year; it loses exclusivity in Europe in 2014 and in the United States in 2019.
Additionally, Hospira launched Inflectra in Eastern Europe in February. Inflectra is a biosimilar to Johnson & Johnson's $6 billion a year Remicade. Hospira priced its drug at about a 40% discount to Remicade, and the company plans to roll out the product throughout Europe when Remicade's patent expires in 2015.
Fool-worthy final thoughts
Express Scripts estimates that the health-care system would save $250 billion between 2014 and 2024 if just 11 biosimilars for popular biologics losing patent protection are approved.
However, that assumes that those biosimilars do win approval, and that's not a certainty. Europe has been far more welcoming to biosimilars than the U.S. While Europe is a big market, the U.S. remains the crown jewel of global drug spending.
That said, Frost & Sullivan estimates that biosimilar industry sales will jump from just $172 million in 2010 to more $4 billion in 2017. That revenue should continue to climb even higher given that 12 blockbuster biologics with $67 billion in annual sales lose patent protection by 2020.
Given the money at stake and the size of the market opportunity, the advent of widespread biosimilars is more likely a certainty than a pipe dream. It's just a matter of time. That suggests generic-drug makers should have plenty of profit-friendly tailwinds coming over the next decade.
Warren Buffett just bought nearly 9 million shares of this company
Imagine a company that rents a very specific and valuable piece of machinery for $41,000... per hour (that's almost as much as the average American makes in a year!). And Warren Buffett is so confident in this company's can't-live-without-it business model, he just loaded up on 8.8 million shares. An exclusive, brand-new Motley Fool report details this company that already has over 50% market share. Just click HERE to discover more about this industry-leading stock... and join Buffett in his quest for a veritable landslide of profits!
Todd Campbell has no position in any stocks mentioned. The Motley Fool recommends Express Scripts, Johnson & Johnson, and Teva Pharmaceutical Industries. The Motley Fool owns shares of Express Scripts and Johnson & Johnson. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.