How Big of a Deal Are Gilead Sciences Patent Woes?

A California District Court jury has found Gilead Sciences (GILD 0.91%) guilty of infringing upon patents co-owned by Merck & Co. (MRK 0.44%) and Ionis Pharmaceuticals (IONS -0.32%). The jury awarded Merck and Ionis Pharmaceuticals $200 million for past sales, and Gilead Sciences could end up paying as much as $500 million per year in royalties too. Are these potential payments significant enough to warrant investor attention? Find out in this clip of the Motley Fool's Industry Focus: Healthcare podcast.

A full transcript follows the video.

This podcast was recorded on March 30, 2016. 

Kristine Harjes: Our next topic that we wanted to talk about is also something that we saw a lot of news headlines on last week. This one involves Gilead Sciences, another favorite stock of Todd and me, hope you guys aren't sick of hearing us talk about Portola and Gilead. This one also involves Merck and Ionis Pharmaceuticals. Todd, do you want to take it from here?

Todd Campbell: Absolutely. Essentially, what we've got here is something that we don't talk a lot about, which is a patent infringement battle. Often times, we'll talk about patent expiration and how shareholders need to be aware that there are patent risks associated with that, but we don't often talk about what happens when one company is found to infringe upon another company's patents. That's what happened in the case of Gilead, Merck and Ionis last week. A Northern California district court found that Gilead's Sovaldi, which is the backbone drug used in its various hepatitis C drugs, did indeed infringe on some patents that Merck and Ionis co-own that stem back to 2001.

Harjes: Yeah. Merck was asking for a 10% royalty on previous sales of Harvoni and Sovaldi, as well as 10% going forward. I believe, right now, they've only decided about what will happen to the past sales, but what the jury decided was that they were going to back out the research cost that Gilead had spent on developing these drugs, in order to arrive at a sum. They arrived there at $5 billion, as their number they're going to use in the calculation. Instead of opting for a 10% royalty rate, they decided on a 4% royalty rate. If you take 4% of $5 billion, then the jury decides $200 million is the appropriate amount of money to compensate for this infringement on a historical basis.

Campbell: Yeah. Essentially what we're talking about here is, we're talking about patents that are based on, how does the drug work. Sovaldi is a prodrug, which means that you ingest it and it turns into the active ingredient, and that active ingredient inhibits the activity of an enzyme that helps hepatitis C replicate. Research that Merck and Ionis did back in the late 1990s into using drugs basically to inhibit the replication of hepatitis C was found to be infringed upon by Sovaldi. That means that any drug that includes Sovaldi, including Gilead Sciences' Harvoni, which is an other mega blockbuster -- we're talking about billions of dollars in sales here, people -- any drug that includes Sovaldi will thereby infringe upon it.

What the jury also said though is, "OK, listen we understand that a patent is only part of what goes into making a drug work, and the costs that are associated with getting a drug actually to the market. Therefore, we're going to allow you to back out the cost that you had associated with developing Sovaldi in the first place. That's how we came to those numbers."

It's kind of a rounding number, if you will, for Gilead and Merck. Gilead and Merck are huge companies. Since launching in 2013, Sovaldi-based drugs have raked in, in the U.S., about $23 billion for Gilead. For Gilead to be on the hook potentially for $500 million for future sales, and for $200 million or so on the past sales, we're not talking about a huge amount of money to those two companies. It is, however, more of a needle-mover for Ionis.

Harjes: Yeah, this is a lot smaller of a company. Gilead, they've got $14.6 billion in cash and equivalents on their balance sheet, but Ionis is only a $4.8 billion market cap company. Clearly they have a lot more at stake here. To me, it seems like the past-looking historical payment is not going to be quite as important to them. It looks like that should come out to a little less than $40 million depending on what Merck's legal fees were. But going forward, you could have a pretty big needle-mover for Ionis since, as the co-owner of the patents, they get 20% of whatever Merck winds up getting here. If the jury sticks with this 4% royalty rate, and you apply that to Gilead, last year's $12.4 billion in sales, assuming that that's going to remain steady going forward, which is obviously not exactly the case, but we're estimating here. That would mean that Gilead would owe around $500 million going forward and that Ionis would get $100 million of that annually going forward maybe indefinitely. That's pretty huge for this company.

Campbell: That's a big deal. Ionis has been around for a long time. They've got a great patent portfolio, but they don't have a lot of revenue other than collaboration revenue. It's not like they've been able to commercialize blockbuster drugs yet. Last year, they lost $88 million. So right there, by getting $100 million a year, theoretically, from Gilead, you've got a company that could go right into the black. Yes, it's a much bigger needle-mover for them than it is for Gilead and Merck. But you know investors shouldn't be investing one way or the other on this decision, because Gilead -- surprise, surprise -- is going to appeal.

Harjes: I'm shocked. Yeah, this is definitely not settled.

Campbell: Did anybody see that coming? Yeah, of course. It may be a rounding error for Gilead, but we are still talking about hundreds of millions of dollars, so they're not going to just give that up willingly.

Harjes: Yeah, exactly. This is really just one battle in a long war.

Campbell: Right, stay tuned. It could be that this gets upheld and Ionis at some point gets a nice big fat check for Christmas that it can cash, but that could be years from now. We just don't know.