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When You Need More Than Just a Low-Margin Business

The corollary to the loss of revenue by pharmaceutical companies as their drugs go off patent is an increase in revenue by generic-drug makers that sell knockoffs of the brand-name drugs.

Unfortunately those are cheap knockoffs. After six or seven manufacturers move into the space, the price drops to 25% or less of the brand name drug. It's a cutthroat business where volume is just as important as price, because the margins are nothing compared to brand-name products.

Some generic-drug makers seem to have figured that out. Teva Pharmaceuticals (Nasdaq: TEVA  ) , arguably the largest generic-drug maker, can use economies of scale more easily than smaller companies like Watson Pharmaceuticals (NYSE: WPI  ) or Par Pharmaceutical, but it's still pushing further into branded drugs.

The company has sold Copaxone for years. Last quarter the multiple sclerosis treatment made up 23% of sales thanks to both price and volume increases. Like most companies, Teva doesn't break out margins on individual products, but one can only guess that higher net margins on sales of Copaxone mean it's contributing a lot more than 23% of the bottom line.

Getting another Copaxone might be difficult; the drug sells nearly $1 billion each quarter, but Teva has established partnerships to try to boost its take from brand-name drugs. Earlier this month, the company boosted its stake in privately held CureTech to 75% and it still has the option of acquiring the CureTech outright. CureTech is developing CT-011, a treatment for lymphoma and other types of cancer. It's not Teva's only hurrah into oncology; the company also has a partnership with OncoGenex Pharmaceuticals to develop a prostate cancer drug called OGX-011.

In May, Teva outbid Valeant Pharmaceutical for specialty pharma Cephalon. The purchase was mostly for Cephalon's pipeline of drugs. Teva is also focusing on over-the-counter medications through a partnership with Procter & Gamble (NYSE: PG  ) .

More diversity
Taking the idea further, there's Novartis (NYSE: NVS  ) , which has a fairly large generic drug business called Sandoz, but still gets much of its revenue from brand-name drugs and diagnostics.

Even Pfizer (NYSE: PFE  ) and Sanofi (NYSE: SNY  ) have dabbled in generic drugs, although those are more branded with a side of generic than the other way around.

If you want to stick with generics that are dabbling in branded drugs, there's also Mylan (Nasdaq: MYL  ) , which has a specialty pharma subsidiary called Dey. The company considered selling Dey a few years ago, but decided to hold onto the branded products. In the second quarter, branded products grew at 6.2% year over year. That's not nearly as fast as the 17% year-over-year growth that generics experienced, but it's a reasonable addition that might help growth in quarters when Mylan isn't able to launch any new generic drug.

Losing focus?
The biggest worry for companies trying to sell both generic and branded drugs is that trying to do both will cause the company to get distracted. They really are two entirely different animals, and generic drugs especially require a commitment, since margins can be expanded through economies of scale. In my opinion, investors would be better off looking for a company that focuses on generics but dabbles in branded drugs, rather than one that's more mixed.

The dual role can also put the companies in a weird predicament. Teva, for example, has argued that Sanofi's (NYSE: SNY  ) Lovenox isn't that complex and the company should be given an approval for its generic version. But it's also argued that other generic drugmakers, specifically Novartis, Momenta Pharmaceuticals (Nasdaq: MNTA  ) , and Mylan shouldn't be allowed to sell generic Copaxone because of the complexity of the active ingredient.

For now, I like the moves Teva has made, but investors should keep a close eye on the company and be willing to cut it loose if the push toward branded drugs doesn't seem to be panning out.

Fool contributor Brian Orelli holds no position in any company mentioned. Click here to see his holdings and a short bio. The Motley Fool owns shares of Teva Pharmaceutical Industries and Momenta Pharmaceuticals. Motley Fool newsletter services have recommended buying shares of Teva Pharmaceutical Industries, Momenta Pharmaceuticals, Procter & Gamble, Pfizer, and Novartis. 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.

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