Loss of a Settlement Option

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The Federal Trade Commission is an equal opportunity hater. Earlier this month it came out with a report arguing for limited patent protection for drugs made by biotech companies. Now it's ratcheting up its complaints about pharmaceutical and generic-drug companies as well.

In a speech by FTC Chairman Jon Leibowitz, the agency claims that it costs Americans roughly $3.5 billion a year when pharmaceutical companies pay generic-drug companies to stay off the market. You can see how a lack of competition doesn't sit well with an agency that's supposed to encourage it, but the FTC continuing to fight against it isn't a good sign for either side -- or their investors.

The pay-for-delay deals are a win for both pharma and generic-drug companies, as it allows them to avoid court and both get something out of the deal. The FTC has investigated deals to delay generics, including Bristol-Myers Squibb's (NYSE: BMY) Plavix and Cephalon's (Nasdaq: CEPH) Provigil, but courts have generally sided with the companies' right to include payments in the settlements. In fact, earlier this week, the Supreme Court refused to hear a case involving Bayer paying Barr Pharmaceuticals (before Teva Pharmaceuticals (Nasdaq: TEVA) bought it) to not launch a generic version of Bayer's Cipro. The lower courts had upheld the deal.

I'm not sure the FTC's methodology for calculating the $3.5 billion savings is correct; it seems to assume that pay-for-delay deals would have the same results as current deals that don't involve payments. That seems like a big assumption. After all, if the payment option to settle isn’t available, it's possible that generic-drug companies might choose not to challenge some patents, leaving the branded drug alone.

But whether or not the calculation is correct doesn't really matter. What's important for investors is that the FTC isn't backing down and Congress seems to be listening. There's a bill currently making its way through Congress that might outlaw the payments, overriding the court's current opinion of the law.

Fortunately, pharmaceutical and generic-drug companies do have other avenues to settle patent disputes that don't involve payments. To avoid court, companies compromise and the generic-drug maker is allowed to launch at a later date, but before the challenged patent expires. Teva is the king of this, recently settling with AstraZeneca (NYSE: AZN) and Medicis Pharmaceutical (NYSE: MRX), but other generic-drug makers have used this trick, too, including Mylan's (Nadsaq: MYL) recent settlement of patents over Novartis' (NYSE: NVS) Femara.

If you're invested in branded pharma, keep an eye on this, as generic competition might come sooner than hoped. And, if you're invested in generics, know that a revenue stream can always dry up. Both possibilities are bad for those companies and their investors.

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