<THE DRIP PORTFOLIO>
J&J's Procrit Hit
Thoughts on yesterday's "big news"

by Brian Graney (TMFPanic@aol.com)

ALEXANDRIA, VA (Dec. 22, 1998) -- Today, we're going to put our ongoing study of the oil and gas industry on hold and take a look at some recent developments out of the Drip Port's healthcare sweetheart, Johnson & Johnson (NYSE: JNJ).
I'm assuming most Fools have already heard about yesterday's "big news" concerning J&J. In case you haven't, here's a quick recap. The FDA approved J&J's Levaquin drug for the treatment of uncomplicated urinary tract infection. What great news! Previously, Levaquin was approved to only treat complicated urinary tract infections. Now, the FDA is saying that the drug can treat uncomplicated conditions as well, opening up a whole new short-therapy option for patients afflicted with this terrible ailment!

Oh, wait. Wasn't there some more news yesterday, something concerning recent Rule Breaker addition Amgen (Nasdaq: AMGN) and J&J's powerhouse Procrit drug? Um... yeah. And that's the story shareholders and the media grabbed onto, ignoring the Levaquin approval. Sometimes you just can't figure out the ways of Mr. Market.

Late Friday, an arbitration panel in Chicago ruled that Amgen should retain all of the marketing rights for a forthcoming once-a-week dosing version of its erythropoietin treatment, known as NESP. For Amgen, the decision was pretty much a home run. For J&J, which sells three-times-a-week erythropoietin under the Procrit brand name, the legal loss was akin to leaving a trio of runners on base in the middle innings of a close ball game. It's not the outcome J&J would have preferred, but it's not the end of the drug development pennant chase either.

As the Rule Breakers whoop it up over Amgen's big win, the Drippers and other J&J shareholders are left to ponder the fate of our beloved long-term holding (Remember, J&J is the second-oldest holding for this portfolio, dating all the way back to October of 1997. Where has the time gone?)

So, what does this arbitration ruling mean? Is it time to sell J&J, perhaps for another healthcare company? Does Amgen have a Drip? And what the heck is Jeff doing in France at a time like this, anyway?

Trust, dear Fools, that we will attempt to answer these questions today, except for that last one.

First, a little background on the drug in question. Amgen developed erythropoietin (or EPO) in the 1980s as a treatment for anemia, which occurs when there is the lack of red blood cells. A lower red blood cell count reduces the amount of oxygen that can be carried by the blood, which is certainly not a good thing. The condition often afflicts patients with kidney trouble and those undergoing chemotherapy treatments for cancer. Amgen's EPO is actually a recombinant version of the naturally occurring human hormone erythropoietin, which is produced by the kidneys and tells bone marrow to keep those red blood cells coming. If there is a problem with the kidneys, Amgen's EPO can be injected to do the kidneys' red blood cell stimulation job. Ain't science neat?

EPO has many uses as a treatment, often referred to as indications. Currently, Amgen's EPO, called Epogen, is only "indicated" to treat the anemia associated with chronic renal failure in patients undergoing kidney dialysis. Under a 1985 licensing agreement, J&J pays Amgen 8% to 10% royalties to market EPO under the Procrit brand name to treat anemia in patients not on dialysis or those undergoing chemotherapy. Procrit is also used to give patients undergoing heavy blood-loss surgical procedures a pre-surgery red blood cell "boost." Moreover, J&J owns the European rights to market Procrit for all of the above indications, including kidney dialysis.

When Amgen changed the amino acid make-up of EPO to cut the needed injections to once a week from the current three times a week, J&J argued that the existing licensing agreement should also cover the new mutant EPO, called NESP. Amgen cried foul, and everyone went to court. With Friday's decision, Amgen will be able to market NESP for all possible indications, not just the dialysis market. Thus, NESP could potentially eat away at Procrit's sales when (and if) the two are pitted in head-to-head competition one day.

The "if" in that last sentence is important. J&J is not exactly standing still on the EPO front and is working with biotech Alkermes (Nasdaq: ALKS) on reduced dosing versions of Procrit. In fact, Procrit has already been approved for once-a-week dosing in surgery patients. A once-a-week version of Procrit for the oncology, or cancer, indication is expected to be filed with the FDA sometime next year. So, while Friday's ruling is a bummer, it does not mean that the $1.45 billion in sales Procrit is expected to bring to J&J's topline this year is going to up and disappear anytime soon.

Sell J&J? We say "no way."

Total EPO sales are expected to come in at around $3.7 billion this year, and rise to $7 billion in five years or so, according to Merrill Lynch. Since NESP has a different chemical make-up than plain-vanilla EPO (think of it as vanilla with a longer-lasting flavor), Amgen will have to finish a current round of clinical trials before submitting the whole shebang to the FDA for review. NESP may get the FDA stamp of approval by 2001. But based on Procrit's estimated 25% annual growth rate in the coming years, J&J's annual EPO sales will likely be reaching the $2.5 billion mark by then.

Given those numbers, we strongly doubt that NESP will make a huge dent in Procrit sales in the few years following 2001, due in part to J&J's ability to market and entrench Procrit as an effective anemia treatment in the minds of doctors the world over during the past 13 years or so. Besides, J&J will likely have once-a-day, if not once-a-month versions of Procrit ready to go shortly after NESP's launch.

So, to sum up, J&J's Procrit sales may suffer a little bit at the hands of NESP a few years from now, but the damage will likely be short-lived provided J&J can innovate new versions of Procrit. J&J's main challenge today is to keep the (currently small) gap between its future anemia products and Amgen's future offerings from becoming too wide, or do away with the gap altogether.

If we are at all concerned with J&J's future, that concern is based on the innovation question hanging over the company. We have been monitoring this situation closely for a few months now, or at least since I hit Jeff over the head with it again and again in the bear argument of our recent J&J Dueling Fools feature. Innovation is what long-term J&J Drippers like ourselves need to keep an eye on. That will determine J&J's ultimate long-term performance, in our opinions.

J&J Drippers must remember the company's past record for building revenues and shareholder value over the better part of this century. With such past performance in mind, we feel J&J deserves the benefit of the doubt when a not-so-great year like 1998 rolls along. There will be other bad stretches mixed among the next 20 years, but we expect them to be far outnumbered by periods of growth and prosperity. As Jeff pointed out in the just-released 1999 Industry Focus, J&J is "likely to crush the market averages over time."

Other Fools may disagree, of course. We invite everyone to share their views about J&J's future on the Drip Companies message board.


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12/22/98 Close
Stock Close Change JNJ 77 +1/8 INTC 119 1/16 -3 5/8 CPB 54 1/8 +1/8 MEL 68 1/8 +3/8
Day Month Year History Drip (1.29%) 2.20% 30.44% 11.08% S&P 500 0.06% 3.43% 24.02% 26.51% Nasdaq (0.80%) 8.79% 35.06% 33.08% Last Rec'd Total # Security In At Current 11/02/98 8.055 CPB $52.880 $54.125 09/01/98 9.727 INTC $80.238 $119.063 11/09/98 8.578 JNJ $74.090 $77.000 10/07/98 1.000 MEL $48.560 $68.125 Last Rec'd Total # Security In At Value Change 11/02/98 8.055 CPB $425.95 $435.98 $10.03 09/01/98 9.727 INTC $780.50 $1158.16 $377.66 11/09/98 8.578 JNJ $635.55 $660.51 $24.96 10/07/98 1.000 MEL $48.56 $68.13 $19.57 Base: $2200.00 Cash: $262.88** Total: $2585.65

The Drip Portfolio has been divided into 93.111 shares with an average purchase price of $23.628 per share.

The portfolio began with $500 on July 28, 1997, adds $100 on the 1st of every month, and the goal is to have $150,000 in stock by August of the year 2017.

**Transactions in progress:
10/24/98: Sent $40 to buy more INTC.
11/24/98: Sent $100 to buy more MEL.
12/19/98: Sent $100 to buy more MEL.


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