$20 Billion Market: What’s the Best Stock to Buy?

Modern drugs, known as "biologics," are harder to develop and harder to replicate than the conventional small molecule medications we all grew up with. As a result, competitors have to work harder to develop generic approximations of them, known as "biosimilars."

The companies that manage to develop viable biosimilars and win FDA approval, especially those who get there first, could dominate what is estimated to be a $20 billion market by 2020 as biologics begin to come off patent. Find out who's in the running on this health care edition of Industry Focus.

A full transcript follows the video.

Michael Douglass: $20 billion potential market in health care. This is Industry Focus.

[INTRO]

Hi Fools, health care analyst Michael Douglass, and I'm on the phone with one of our contributors, Todd Campbell, today. Todd, how sick are you of the snow at this point?

Todd Campbell: I am so sick of shoveling! I'm going to be in fantastic shape, come spring. That's the upside!

Douglass: Since we're in health care, being healthy is an important part of that, so I'm glad to hear at least there is a silver lining here, in this playbook, as it were -- there, let me go ahead and just make the movie reference as well!

All right. Today we really wanted to talk about biosimilars and the biosimilar market, which I think is being estimated to be worth as much as $20 billion in, what is it, 2017, 2018, 2020, something like that?

Campbell: Yes. It's a moving target right now because no one really knows how much of the market these biosimilars are going to capture, but Pfizer (PFE 2.40%) estimates this is a $20 billion market by 2020, then growing exponentially from there as more biologic drugs come off patent.

Douglass: Sure. I definitely want to delve into this market and talk winners and losers, but first let's define "biologic drugs" and "biosimilar drugs." Let's talk a little bit about that. A biologic drug; Todd, go ahead and lead us off.

Campbell: I think the most important thing for investors to understand is that the first wave of medications that won approval from the FDA were small molecule drugs. Small molecule drugs were top-selling drugs. They were easy to manufacture. They were easy to copy.

The next wave were biologics. Biologics are more complex. They're harder to duplicate, and as a result they were harder to bring to market. Generic drugs for small molecules basically are about a 10-year head start on where the generic alternatives are for these new biologics, which will be called "biosimilars."

We're about to see that explode, because so many biologics are going to start coming off patent in the next 5-10 years. The estimate right now is that we're talking about $70 billion in sales for biologic drugs that are going to be coming off patent over the course of the next 5-6 years.

It's a tremendous opportunity that is akin to what we saw with the creation of the generic drug marketplace for small molecule drugs. That's a market that has been a boon to companies like Teva Pharmaceuticals (TEVA 0.63%) and Mylan (MYL), for example.

Douglass: Sure. Let's unpack that even a little bit further because one of the things with small molecule generics is that they were easy to manufacture, they were easy to get approved, so you would see markdowns as high as 90% off the sticker price for that original small molecule drug, for the generic.

But with biosimilars because it's more complex, it's more difficult to get approved, for these generics -- these biosimilars -- the estimates that we're getting from analysts are that it's going to be more like a 20, 30, 40% haircut instead of that 90% haircut.

Which means sure, more R&D costs to get them approved and get them ready and prove that they are sufficiently similar to the biologic drugs -- but also greater potential revenue and markup on the biosimilars, with only that 20, 30, or 40% haircut instead of an 80 or 90% haircut for a small molecule.

Campbell: Absolutely. Obviously there's more headaches in development. They're "biosmilar" for a reason, right? They're similar. They're not exact copies.

Douglass: Right.

Campbell: That creates a lot of questions. The FDA has been slower than regulators in Europe to approve biosimilars so far because they're just not so sure what the pathway should be for approving drugs that aren't exactly the same, as the small molecule generics were.

They're ironing that out, and I think that we're getting closer to the point where we're going to start seeing biosimilars on the market here in the U.S., but your point is a valid one.

It's going to cost a little bit more money up front to show that these drugs have the same clinical efficacy; basically, this drug works "as well as." It may not be designed exactly the same as, but it works as well as these drugs.

Because those costs are going to be a little bit higher, and because the cost of biologics in the marketplace are far higher than traditional small molecule drugs, you're right. These could be very, very profitable drugs for companies like Hospira (NYSE: HSP), which just got bought in the $17 billion deal from Pfizer.

Douglass: Yes, let's talk about that a little bit. You're seeing a number of big pharmas starting to want to play in this space.

Of course, their pipelines are threatened, potentially, by these biosimilars. But by the same token, if it's somebody else's pipeline that they're getting into with that biosimilar, then there's an opportunity for them to have a generic drug that could be a blockbuster in its own right.

Let's talk about Hospira. They've got a biosimilar for Remicade, the blockbuster autoimmune drug, that they are beginning to launch in Europe and hoping to get approval for in the U.S. as well. This drug could be really big, and certainly was part of the argument for Pfizer to go ahead and buy up Hospira.

Campbell: Right. Europe has been on the cutting edge of biosimilars. There have been drugs approved for use over there for years and Hospira already has a three, including a biosimilar for Neupogen, a biosimilar for Epogen, and now they've got the biosimilar for Remicade which is a multi-billion dollar drug.

I think that Merck (MRK 0.44%) reported $2.4 billion in sales in Europe, Russia, and Turkey for the drug in 2014 or 2013, so we're talking a lot of money at stake.

Yes, Pfizer is looking at this and saying, "This could be how we jump-start our growth." To your point earlier, there's two advantages. One, I can cannibalize a competitor's sales. Two, I can protect my own franchise. That's why you have a lot of different drug makers, like you said, out there who are building up their pipelines.

Amgen (AMGN 2.35%) is on the hot seat because it's the manufacturer of Neupogen. It doesn't want to lose that market share, so what does it do? It takes all of that experience it has in developing biologics, creates a biosimilars program, and that way it can keep that market share. It doesn't have to give it up to a competitor who develops a biosimilar.

So, you've got companies out there like Pfizer obviously, with this big splash, is basically telling everyone, "Biosimilars are going to be the real deal, and it's going to be worth a lot of money."

Douglass: Yes, $17 billion isn't exactly chump change.

Campbell: Yes. And Amgen, they've just increased from six biosimilars in development to nine biosimilars -- and one of those just put up great numbers showing that it has the same clinical efficacy as Humira, which of course is the granddaddy of biologic drugs.

That's AbbVie's (ABBV 1.06%) drug for rheumatoid arthritis and psoriasis. It's got $12 billion in annual sales, and it's losing patent protection at the end of 2016.

This is going to be a huge play for these companies. If you can come up with an equivalent efficacy for Humira and launch that, get FDA approval and European approval to market those products in 2017, you're talking about billions of dollars out of the gate. Blockbuster drugs, to your point, for a biosimilar; for a generic drug. That's pretty remarkable.

Douglass: Yes. One of the things that's really driving governments toward biosimilars, and it's been felt even more strongly in Europe than in the U.S., is this drive to reduce health care spending without reducing the quality of care, if at all possible.

That's why you've seen a lot of companies need to give substantially increased ... what's the word I'm thinking of?

Campbell: Pharmacy benefit managers -- this could be toward your point -- pharmacy benefit managers, they've been going gangbusters because they're being hired by health care payers to control the cost of drug spending, and drug spending is going through the roof.

Douglass: Right.

Campbell: Biologics is going to be a $200 billion a year market in the next five years, for biologic drugs alone. You're looking at biosimilars capturing 10% of that. Well, go back in time a little bit, and small molecule generics only had about 40% of the market in '03, and now they have about 80% of the market, so there's a tremendous opportunity here.

What's behind that is the health care payers are going to say, "Listen, we need to control the spending," so they're going to be embracing pharmacy benefit managers like CVS Health (CVS 1.49%), like Express Scripts (ESRX), and telling them, "See what you can do about making sure that these drugs are getting out in front of current patients that are taking these more expensive alternatives."

There's a lot of opportunity for market share growth, just tied to there being so many people with a vested interest in biosimilars' success.

Douglass: Right, and that's particularly true I think in Europe, where the government payers have been demanding greater discounts -- that was the word I was looking for earlier, discounts! -- from big pharma, big biotech, small biotech; all these health care drug makers, for years.

In the U.S. we're starting to feel that more and more as Medicare and, to your point, our private insurers, are trying to find ways to save money. I think this is a trend that could really benefit biosimilars.

In wrapping this up, let's talk about the best stock, potentially, to buy in this biosimilar market. As you've mentioned, there may be not so many pure plays at this point, but several big pharmas are in this market.

What is the one that's most attractive to you, or what would make one the most attractive to you?

Campbell: I think there are three right now that are really on my radar. Again, because Hospira has been bought by Pfizer, one of them is Pfizer.

Douglass: Right!

Campbell: I had been nervous about Pfizer because I couldn't figure out where their growth was going to come from. Now I have a much better understanding, "Okay, great. This could be billions of additional dollars. This could be what helps them turn the corner back to revenue growth, year over year." I think Pfizer has to be back on people's radar because of this deal.

Amgen is another one that I think people now have to look at and say, "Jeez, there could be a good opportunity here."

Where before I was worried that they were going to start to see their market share fall away as their patents expired, now I'm starting to think, "Wow, they could actually hold onto a lot of the market share for their own patents that are going to expire," but they could also go out now and grab market share away from AbbVie's Humira and other drugs as they advance it, so I think Amgen is another one to consider.

Then I would wrap that up with Novartis (NVS 1.93%). Novartis is also a huge player in biosimilars. They've got five biosimilars already in the market in Europe. They're doing more than $400 million in sales from those biosimilars in Europe already, and they just got the nod from the FDA Advisory Panel that would support potential approval of their biosimilar to Neupogen, possibly as early as this year.

Those would be the big three that investors should be considering.

Douglass: Yes, and I would add to that. I think the initial big winner probably will be whoever is able to get the data and the generic ready first, for Humira.

I think that's the one that I'm going to be watching most closely and thinking most hard about because you've got what was in 2013 the best-selling drug in the world, going off patent soon. Whoever can wrap that up and really start stealing a lot of that market share could have a really impressive opportunity ahead.

Todd, thank you for your thoughts. Folks, as always here at The Motley Fool, we're all about helping the world invest better. One of the ways we do that is through our premium services, which are paid services. Although, as a former premium service subscriber before I came on staff, they're pretty cheap! I certainly found that I had a really good return on my investment.

We're always looking at what the next big growth opportunities could be, whether they're biosimilars or elsewhere. If you're interested in learning more about that, shoot us an email at [email protected]. We'll have a special offer to David Gardner's Rule Breakers service, that really is all about trying to find that next big thing; smart group of analysts, and really pretty impressive returns over the lifetime of the service.

Todd, thank you as always. Folks check back to the Industry Focus podcast at Fool.com for all of your health care and other investing needs, and Fool on!