Why Drugmakers Are Shaking in Their Boots

The Motley Fool highlights potential winners and losers in Hillary Clinton's proposed plan to curb soaring drug prices.

Social media recently took up proverbial arms against drug companies like Turing Pharmaceuticals for causing an insane jump in cost for medications that have been on the market for ages. As political season gears up, we expect to hear from each hopeful on how they plan to tackle this offense, but some companies are fearful this could affect their bottom line. Should we hold steady on our healthcare stocks?

A full transcript follows the video.

 

Kristine Harjes: Why drugmakers are shaking in their boots. This is Industry Focus.

Hey, everyone. Welcome to Industry Focus healthcare edition. I'm your host Kristine Harjes and joining me on Skype is Motley Fool's healthcare contributor, Todd Campbell. Thanks for being here, Todd. How's it going up there in New Hampshire?

Todd Campbell: It's going great. It's a beautiful fall day. Fall has arrived in New England. The leaves will be turning soon.

Harjes: I bet it's going to be beautiful. If you guys have been following the news lately, or even just watching the healthcare portion of your portfolio slowly trickle downward, you know that something has happened out there to threaten healthcare companies. Today, we're going to dig into the news to unpack for everybody what this all means for patients, insurers, drugmakers, investors; this conversation has been ongoing.

Let's start this story... yesterday on Twitter. Todd?

Campbell: Wow. I tell you. What a crazy weekend and week it's been for healthcare investors. There's a lot to digest so I'm not going to spend too much time talking about what got it all started so we can dive into the meat of it, but I think what's interesting and important for investors to know is that there has been a trend in the healthcare industry for companies to go out and find drugs that have been on the market for a long time, but are no longer marketed and "forgotten," buy those on the cheap and hike the prices and relaunch them with a big marketing sales force in order to make a lot of money.

This has been happening for a while, but it kind of came to a head over the weekend when a lot of patients were able to attract the attention of The New York Times. The New York Times ran with a story, basically calling out Turing Pharmaceuticals, which is a recent start-up that was founded by a hedge fund manager with one of the major purposes being to go out, buy an old drug for $55 million, jack up the price -- which they then did by almost 5,000% -- taking the cost from $13.50 per pill to $750 per pill.

Obviously, that caught a lot of people's attention and New York Times ran with the story and, sure enough, presidential hopeful, Hillary Clinton, read that story and saw a great opportunity to dovetail that story in with her plans to try and curb drug spending.

Harjes: Yeah. As a reaction to this New York Times article, Hillary tweets: "Price gouging like this in the specialty drug market is outrageous. Tomorrow I'll lay out a plan to take it on." So she comes out with this plan yesterday and there are quite a few different parts to this plan. Let's start with Medicare.

One of the things Hillary said in reaction is, if we give Medicare more power to negotiate, that could help bring the cost of drugs down. Todd, how exactly would that work?

Campbell: People are probably surprised by this, but Medicare, with 55 million members doesn't have the ability to go to a drug company and say, "We've got so many members and they're all seniors and they're all going to demand medication, or need more medication. Why don't you give us a sweetheart price and we'll make sure all that volume comes your way?" They're not allowed to do that.

A bill was passed in 2003 that prevented them from being able to negotiate pricing. It's very different than what happened at other government-funded healthcare programs like the VA or even Medicaid. Medicaid can get some reimbursements back from the drugmaker. Medicare is kind of hamstrung. They basically end up paying whatever health insurance companies negotiate in the private market.

That's probably more than they have to pay, especially when you look at some of the prices that are being paid by large, single payer systems in other countries.

Harjes: Exactly. There's such a difference in what goes on in the United States versus other countries. The U.K., for example, runs their bargaining through the National Institute for Clinical Evaluation and these guys' whole existence is to determine what price the drugs should be set at. It uses its research that does all this analysis on when a treatment is essentially going to be cost effective, and when it will save money on preventing further continuation of the disease and save the healthcare system money.

They come up with a price and say, "This is what our country will pay you for this drug." Then we get over to the United States and that's the job of private insurers who can negotiate and they're really good at negotiating, but their voice isn't as loud as Medicare because there's so many of them. Any one individual company doesn't have as big of the bargaining power as Medicare would.

Campbell: Absolutely. Medicare is a Goliath, and it's only getting bigger because there are 10,000 baby boomers who are turning 65 every day. This is not a new idea. Hillary can't claim that she's the one who birthed it. It's been kicked around a couple times this year alone. President Obama mentioned it in February, Bernie Sanders mentioned it in early September. There's definitely a ground swell of support for giving Medicare the ability to negotiate.

A study by Kaiser Family Foundation last month found that an overwhelming majority of Americans are OK with that because it's as free market as you can get.

Harjes: Exactly. Pivoting over to the other side of government healthcare; if you look at Medicaid, what's her plan there?

Campbell: Essentially, because Medicaid can negotiate out rebates from drug manufacturers, the average drug cost for a medicine that is paid for by Medicaid is lower than the cost of the same medication that is paid for by Medicare.

Harjes: Isn't there a federal law requiring a discount from sticker prices for Medicaid?

Campbell: I'm not sure what that discount is, but it's definitely lower and I think what Hillary is saying she wants to do -- according to her plan -- is to be able to say if we have low-income people on Medicare that might not qualify for Medicaid in certain states because their income is possibly a level above the qualifying rate, but they're still below the federal poverty level; let's go ahead and let them get their drugs through the Medicaid program.

According to studies that she's cited, that could theoretically save up to $100 billion over time. Again, these are seniors who use a lot of drugs and it seems silly for you to be on Medicare and paying more money than your neighbor is paying for the same medicine because they're maybe on Medicaid.

Harjes: Right. Another large aspect of this plan that she laid out had to do with research and development spending. How exactly does this plan intend on combatting any issues that are surrounding R&D spending?

Campbell: What's interesting is that I don't think this part of the plan is targeting Pfizer, or some of the large drugmakers. It's calling out Turing Pharmaceuticals and these companies that are in the business of buying existing drugs and not spending a dime on research and development for their own drugs.

Essentially, my opinion is that this is a shot across the bow to people who are in the business of rebranding and repricing existing therapies with exorbitant prices tags, yet not going forward in taking some of the profit that's being generated and putting it back into R&D for other drugs.

My opinion is that this isn't necessarily a big part of the plan, as far as curbing prices, but on the margins it could result in more money being spent in the science end of things. That could theoretically could lead to new medicines.

Harjes: Essentially, what the plan wants to do is take a given percentage and demand that percentage of your revenue goes back into R&D?

Campbell: I don't believe she's gone on record and cited exactly what the percentage would be. My feeling is that it's going to be a percentage that's lower than what most drug biopharma companies are spending already, today.

Harjes: It might not actually affect too much R&D spending of most of the pharmaceutical and biotech companies that we talk about. One thing that really could affect these companies, though, is getting rid of the tax breaks that allow drugmakers to deduct their spending on marketing as a business expense.

Campbell: Yeah. One of the things we've seen in the last 10 years, a huge uptick in the amount of direct to consumer advertising from the biopharma industry. You can't turn on a TV and not see and ad for some of these drugs. You listen to this list of side effects and it almost makes you wonder if it's better to have the disease than the treatment.

I think that there's a lot of concern that direct to consumer advertising, even if it has all these disclaimers, can influence a patient to go after a medicine that may not be the best medicine for their condition. People who would believe that would then say that it's really the doctor who should be engaging with the patient.

Now, the other argument could be that maybe this sparks some people who are suffering from conditions to go visit a doctor and begin that conversation. There is some debate. However, should the taxpayer be collecting less in tax revenue because of this direct to consumer advertising? I think that's the crux of what she's saying.

If we get rid of the ability for them to write that off as a business expense, in theory, more money is collected in taxes that could then be doled back out to the National Institute of Health's research budget, which is used to fund promising research at educators, and private institutions.

Harjes: She's estimated that billions of additional dollars would end up being paid in taxes by these big companies if you were to get rid of this tax advantage. That could really be pretty huge.

Let's talk about another aspect of the plan that has to do with drug exclusivity. Todd, what's the deal here?

Campbell: I don't think exclusivity is a big-needle mover. There are two ways that drugmakers have market protection for the drugs that they launch. You have patents, which are usually filed pretty early in the development cycle before these drugs reach the FDA and eventually reach the market. Then you have exclusivity, which is the number of years that you're guaranteed not to have to fight out with generic competitors.

Usually patents last longer than exclusivity, so changing exclusivity from the 12 years that it is now for biologics down to seven years may or may not impact a couple companies. On balance, I think this is one that's probably not going to have a huge impact or even go very far.

Harjes: That seems like a non-item. Let's pivot to something that I think could totally be an issue, particularly for health insurers. One other aspect of Clinton's plan would be to limit the amount of money that patients pay out of pocket for medicines to $250 per month. That's a good bit less than many people are paying now.

Campbell: Insurers have made the decision to increase the out of pocket expenses and the copays associated with a lot of drugs. They do that because drug prices have, indeed, skyrocketed. This is one of the ways they try to limit their exposure and maintain their margins. The margins are actually relatively thin around 3% to 5% for most insurers.

The incentive is big for them to try and find innovative ways to share the costs with patients. The problem is that you reach a certain point and now you're making choices like "Do I pay for this medicine, or do I pay my electric bill?" That's an untenable situation. What she wants to do is reduce it to $250 per month, maximum out of pocket for patients, or cap it at $3000 per year.

That's not an unreasonable number. You see plans offered in the marketplace that use similar numbers to that, and there is some precedent. The ACA plans that are available on the Obamacare exchanges also have out of pocket limits on total healthcare spending and such. I think this is one that could actually have some legs and could make a huge impact for patients, while squeezing insurers in the process. We're going to have to watch that dynamic pretty closely.

Harjes: We see insurers potentially being squeezed here. We see drugmakers potentially finding their wiggle room in negotiations decreasing. It seems like there are a lot of losers in the healthcare sector due to this proposal. Who could be a winner?

Campbell: There are definitely winners. We'll get to losers in a second, too. There's an important takeaway to take there as well. In my personal opinion the winners are going to be generic drugmakers -- those that are making generic small molecule, and generic biosimilars to biologic drugs. They have a huge potential, especially since one of the things that was outlined in her plan was to boost the FDA budget to expedite the approval on drugs.

You could end up with these generic drugmakers getting more drugs to the market more quickly to help sales and profit. You could also see a benefit for pharmacy benefit managers like Express Scripts and companies that manage drug programs for healthcare payers with an eye on saving money by increasing adherence rates and converting people over to generic drugs from branded drugs.

Those are two of the winners. A third winner could be pharmacy companies. Think about it; one of the things we've seen with the falling prices for Gilead Sciences' hepatitis C drugs has been increased utilization and script growth. If prices fall and more people can afford them, pharmacies may benefit by seeing more volume.

Harjes: I can absolutely see that. You said you wanted to talk a bit about some of the losers.

Campbell: Yeah. There's an economy out here that I think all investors should consider before pressing the "sell" button on their healthcare stocks. It's very difficult to look into the future and figure out what the unintended consequences of any policy changes could be. If you go back in time to when Obamacare was first talked about, everyone felt that every single healthcare company was going to end up seeing their profit fall into the toilet.

That's not what happened. It ended up being an incredibly profitable program for most of the players in healthcare. I'm going to urge investors to, instead of worrying about the short term political maneuvering that's associated with election year cycle; I want them to look at what the long term trend for healthcare demand is instead.

With so many seniors and aging, larger and insured population in America, demand for healthcare services and products is going to grow over the next 20 years; it won't shrink. I think that's the thing most investors should be focused on today.

Harjes: I think that's the biggest takeaway. This is not something to freak out over yet. Historically, politically driven drug price scares haven't amounted to much and there's also a huge difference between a presidential hopeful's unveiled plans and actual legislation. You referenced the passage of the Affordable Care Act. Investors who sold of their healthcare holdings back then missed out on huge gains over the last five years.

Even after giving back some of those gains recently, the iShares Biotechnology ETF is up an incredible 290% over the past five years, and that's compare to 70%for the S&P 500. Of course, you can't invest by looking backward, but to me it seems like all signs point to continued profitability in the sector.

As always, do your research when you're picking out different stocks. Todd and I could have interests in the stocks we've talked about today. The Motley Fool could have formal recommendations for, or against, but I would really encourage all of our listeners to dig in. The heightened emotion right now that's causing a lot of these companies to drop could present a really awesome buying opportunity.

As long-term investors, we want to remind you to keep a cool head and focus on finding the most profitable companies in the sector and other sectors as well. Hold on to them. Todd, thank you so much for being here today. Folks, thanks for listening and Fool on!