HamletsMill: How do we factor in the chance that a drug in development will be obsolete by the time it is approved? You raise a very important question.
Let's use some real life examples. ImClone Systems has been very popular over the last six months because of the success of their drug C225 in pivotal phase 2 trials for colorectal cancer. C225 is a monoclonal antibody that targets the EGF receptor, which is a very popular target in the development of cancer therapeutics.
Now C225 is pegged as a blockbuster drug. It will be the first drug to this large market that is better than chemotherapy alone. So it stands to do well with no real competition. And it is also in trials for 2 other indications that I won't go into here. All in all predicted to be a big seller (over $1 billion.)
But, there is some potential future competition waiting in the wings. Genentech and OSI are collaborating on the development of a small molecule drug, Tarceva, that is an inhibitor of the EGF receptor. Will a small molecule drug work better than ImClone's monoclonal? I don't think we know until we see some efficacy data. But it may or may not. In addition to Tarceva, there are numerous other EGFR drugs in development, some monoclonals and some small molecules.
To move to other colorectal cancer drugs, ImmunoGen has one of their TAP drugs in phase I/II for colorectal cancer. A lot of people, myself included, think this is the hottest anti-cancer platform around. But it is a long way from the market (several years) and solid efficacy data from a pivotal trial isn't out and won't be until at least 2003.
So I think this addresses your point. We have C225 pegged as the blockbuster, but we can easily see that there are some potentially serious competitors waiting a few years back. So what to do?
One approach is to buy IMCL and keep an eye on the progress of the clinical trials of the other drugs. If one of them presents efficacy data that is superior to what IMCL presented, it may be time to bail out. But if a few of them stumble, you'll have been sitting on the success of C225 the whole time while they're fighting through trials.
Another approach is to view IMCL as a whole company. What would happen if one of these competitors comes along and crushes C225? Does IMCL have other products or developmental drugs that will boost the top line?
I think this stresses the importance of finding drugs that have a competitive advantage in terms of efficacy and safety. With the long duration of clinical trials it is easy to find out who the potential competitors are and follow their progress. There are no "surprise" product launches in biotech.
I think is also stresses the importance of companies with a broad pipeline. In your models, knock out a few of the drugs for the inevitable failures, run the #'s and they may still be ok.
Build in a safety margin. If the company forecasts $2 billion in sales growth by 2005, do they have to hit the entire $2 billion to make a good investment based upon current and anticipated valuations? If so that's too close and stay out. Instead, figure out how low the anticipated revenue can drop and still produce the return you want. This accounts for unforseen disappointments and helps keep your investment return from being killed. This lowball approach can remove a lot of the downside risk while keeping the upside.
Just some ideas......
HamletsMill: How do we factor in the chance that a drug in development will be obsolete by the time it is approved?
You raise a very important question.