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Pharma Pipeline Anxiety - Crisis or Cycle?

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By TMFRoZany
November 10, 2004

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Throughout its modern history, the pharmaceutical industry has faced scrutiny from critics claiming the industry reaps excessive profits at the expense of the health of the general public. Since the Kefauver Congressional hearings of the 1950's, the industry has defended itself with the argument that the high profit margins are necessary to support the massive capital outlay required to develop new treatments. Leaving aside the merits of the argument, the pharmaceutical industry's success is closely tied to the regulatory environment. On the one hand, the most profitable drugs are dependent on government patent protection that let companies charge premium prices. On the other hand, the industry faces constant threats of government price controls or measures that diminish patent rights.

Rarely have drug stocks been cheaper than they are now. They trade at multiples to earnings that resemble those you typically get for an Alcoa or a Dow Chemical or other former growth businesses that are now totally hostage to the shifting U.S. economy. A key parameter for the way that the pharmaceutical industry decides on priorities is the Net Present Value (NPV) of projects. This is a means of determining the value of a given project after projecting for expenses and revenues in the future and discounting for the potential investment value of investment in the project. The NPV is usually risk-adjusted, most risk being associated with the earlier stages of the project.

According to a 2001 estimate from the Tufts University Center for the Study of Drug Development, the average cost of bringing a pharmaceutical compound through screening, chemistry, pre-clinical development and clinical testing is USD 800 million.10 Although this figure has been cited by many, it has also been challenged. The Public Citizen/Congress Watch, for example, came up with thevalue of USD71 million, using another method of calculation, adjusting for tax deductibility of R&D expenses. The truth probably lies somewhere in between.

Here is the jist of a very long post: Pressure is intense with the pharmas. Decline in productivity has produced mergers. The main causes for the drop in productivity cited by Pharma include tighter regulation and difficulty coping with the explosion in information spawned by the genomics revolution. On top of that, costs are simply going up. Investment in drug development has tripled in the past 10 years to more than $30 billion (US), but the industry has fewer new drugs to show for it.

The blockbuster business model is broken and Phamas haven't accepted it. The pharmaceutical industry is a prisoner of its past successes. While the business environment for pharma companies has changed dramatically in the past five years, the pharma business model that served the industry well over the past decades has not kept pace.

Top three innovation policy priorities according to pharmaceutical executives:
Length of patent exclusivity
Narrowing the time lag between marketing and reimbursement approval processes
Harmonizing regional and global regulations

Interesting and may proove to be damning as the industry heavyweights face an even more perilous situation. Market value is shifting already to some smaller players that have adopted new models, as companies like Novo Nordisk AS, Genentech Inc. and Forest Laboratories Inc. have demonstrated.

A more noble sector from the past does not exist. However, from my point of view many Pharma Folks have lost their moorings, that is the moorings couched in ethics as was in existence with the founder of Merck. Chemical toys such as Viagra or the recent flu vaccine debacle answers the question: does the industry really have an interest in developing drugs for which there is great need but from which one can derive little profit ? Well, the answer is no, profits determine corporate R&D, not human needs.

The multimillion dollar marketing hype for impotence treatments such as Viagra has moved up the ladder and would now have us believe this is a young mens' disease. And you know what? Let me share what my husband's barber says about Viagra. "The young kids are really into this drug, they say they can go all night." I thought only the beauty shops were for a quick way to find trends. An aside, did you know that Viagra was intended to be a blood-pressure medicine and failed. This other event that about a lucky opportunity.

Society does recognize the benefits of health science innovation. There is a complex relationship between the pharmaceutical industry and society. The industry, patients, physicians, regulators and politicians are all driven by their own agendas and are subject to sometimes very powerful influences. The primary aims of pharmaceutical companies are, through research, development, production and marketing, to provide new medicines to improve the health of populations, and, as any other industry, to run a profitable business. Unfortunately, large multinational companies spend more time and financial resources on the generation and dissemination of medical information than they do on researching and developing new treatments. Say it isn't so!

But what we have here are some poll numbers, the ones that show big drug companies are less liked than even pump-gouging multinational oil companies. Yep, the moral majority market is speaking up, whatever that means, however you want to interpret it.

Storytime: A college student challenged a senior citizen, saying it was impossible for their generation to understand his. "You grew up in a different world," the student said. "Today we have television, jet planes, space travel, nuclear energy, computers,..."

Taking advantage of a pause in the student's litany, the geezer said, "You're right. We didn't have those things when we were young; so we invented them! What are you doing for the next generation??"

Only so much innovation out there I would say, Intel and Cisco would sure like a 'new new thing.' Big pharmas/biotechs are fantastic innovators that have created life-saving drugs�and thousands of jobs�for years. We are talking about industrial jewels, that of the Pharmas. So how did they become the whipping boys of both parties, and Main Street and Wall Street and why, after years of fending off pricing regulation through intensive lobbying and political donations, have the drug companies at last been dealt a losing hand in Washington?

I sure hate to think of the disagreements that will ensue, but here I go. The big pharmas got their just deserts.
1. Price increase after price increase to meet double-digit growth expected by shareholders and the street.

2. Inability to create blockbuster drugs, so defer to channel stuffing (Bristol-Meyers), kickbacks to insurance companies (Schering-Plough), products coming off patent coming up with a so-called new formula. Then don't forget the lawsuits against generic manufacturers to block the introduction of copycat drugs.

3. Between the FDA and Pharmas, trials/research are becoming targets for investigation, Senator Grassley is heading up this committee, also looking at teenage suicide from antidepressants and Vioxx. The FDA has ordered drug makers to place a "black box" label on antidepressants, warning consumers that the pills may contribute to teen suicide. The FDA seems to get caught off guard with drug disasters: cholesterol-lowering drug Baycol, diabetes drug Rezulin, antihistamines Seldane and Hismanal, and the diet-pill duo Phen-Fen.

While stopping off at the FDA, we now have Internet purveyors of penis enlargers. Open your e-mail and you will find offers for diet pills, powerful pain medicine, breast enhancers and erection pills. The FDA seems powerless to stop the flood of bogus products.

4. Developing nations present drug makers with an operating environment fraught with uncertainty. The dynamic economic growth and burgeoning populations of countries such as China and India offer huge potential for revenue generation, but they lack the strong intellectual property protection pharmaceutical companies rely on to boost margins.

The wide diversity of legal and regulatory frameworks from country to country creates a number of significant problems for drug marketers. Most notable in terms of demand is the growth of the so-called "parallel trade" market. For instance, regulatory and exchange rate conditions make prescriptions in Canada considerably cheaper than in the U.S., and many American consumers take advantage of this fact to save on drug costs. A similar situation exists in Europe.

5. Medicare benefit passed, federal government will soon be buying 50 Percent of nation's drugs, up from current 16 percent.

The pharmas just become the easiest target for the Feds to beat up on, the companies have failed to explain to the public why the costs are so high especially when they are so much cheaper in other countries. Price controls are increasingly likely once the federal Medicare insurance program for the elderly begins covering prescription drugs in 2006. Drug costs rank above corporate misconduct and the federal budget, voters say, as a source of their economic woes. My, my, what data an election can give forth.

6. No flu vaccine because U.S. companies don't consider that medicine sufficiently lucrative.

Hereto wit: the public despises the drug companies, no matter how many life-saving ads they bombard us with. This generalization will irritate a few, but I can be as brave as Will Rogers.

Merck's innovation record or pipeline problem:
How many drugs for diabetes do you think this army of scientists managed to come up with in the past four years? None. How many anti-cancer drugs? Zero. How many drugs that fight infectious diseases? Zero.

Analyzing a drug company's pipeline is more than just a numbers game. What numbers alone can't foretell are the quality, value, and chances for success of drug candidates, or the strategies major drug firms are trying to fill and advance their pipelines. U.S. drug industry R&D spending alone has more than doubled over the past decade, to about $35 billion, while the number of new molecular entities (NMEs) submitted for approval has dropped by nearly 50%, to about 40. This dismal return on investment comes despite an increase in the number of drugs in R&D. In recent years, the pharmaceutical industry has generally not been very good at producing new drugs. Globally, since 1991, R&D spending has doubled, but has increased only slightly faster than revenues. The number of new molecular entities approved each year by the FDA fell from 53 in 1996 to 21 in 2003. The long cycles of science tend to hide costs and divorce accountability from action; many pharma executives have been slow to respond.

Modern Drug Discovery Journal highlights the pipelines of the world's six leading pharmas (I recommend reading this link in references):
Pfizer - Pipeline
400 projects in discovery
225 development projects: 130 NMEs and 95 product extensions

JNJ - Pipeline
157 late-stage drug discovery projects
154 development projects: 82 NMEs and 72 product extensions

Glaxo - Pipeline
53 pre-clinical candidates
148 clinical development projects: 83 NMEs, 20 vaccines, and 45 product extensions

Novartis - Pipeline
47 advanced pre-clinical candidates
78 clinical development projects: 53 NMEs and 25 product extensions

AtraZeneca - Pipeline
77 pre-clinical and clinical development projects: 52 NMEs and 25 product extensions

Roche - Pipeline
62 pre-clinical and clinical development projects: 52 NMEs and 10 product extensions

Genentech - Pipeline
33 pre-clinical and clinical development projects: 9 NMEs and 24 product extensions

Amgen - Pipeline
19 clinical development projects: 18 NMEs and 1 product extension

The number of new drugs being launched is generally considered too small to sustain the major companies and meet shareholder demand for earnings growth. Advances in genomics, computer science, molecular biology, and combinational chemistry are radically changing the drug development process. These technological advances are expected to yield thousands of new drugs over the next two decades I have been told. Pipelines do go through cycles.

On top of this, many major firms have to plug holes in their pipelines as drug patents expire and generic competition emerges. Many new drugs fall into the 'me too' category. Does consolidation breed success? Maybe yes, maybe no.

"The drying up of the products in the pipeline in the case of many big pharma companies has lead to a spate of mergers and acquisitions during the past five years and now even that avenue seems to be closed. The overheads on account of sales, general and administrative expenses amount to 33 percent of the revenues in the drug industry, which substantially affect the company's bottom line and the pockets of the consumer as well. Further, it is reported that the standard management practices such as consolidating procurement, outsourcing personnel and finance functions and automating transaction processing all compare poorly with other industries, according to Mr. Christopher White of AT Kearney. Thus there is an urgent need to address these issues that have assumed gargantuan proportions posing a threat to the survival and sustainability of the industry.

The words WTO, TRIPS and product patenting have become sacred mantras for big pharma companies. Developing countries are both a lure and a dread for pharma giants _ the size of the population lures them but the lax legal system and unresolved issues of intellectual property rights are a nightmare. However, India and other countries are bracing themselves up to meet the deadline of 1-1-2005 when product patenting comes into force.

Growing awareness among consumers, demand for detailed drug information and pricing, alternative systems of medicines and treatment, personalized attention and information being sought from doctors and such other desirable trends are keeping pharma companies on their toes. Though the force of inertia seems to prevent them from shedding their complacency, there is a discernible shift in their attitude and approach in recent times"

M&A, Exec Salaries, R&D

The evidence on the success of M&A strategy is somewhat mixed. CenterWatch for instance found that research spending and productivity declined sharply during the three years after a merger, while DiMasi points to the success of companies such as Johnson & Johnson, Lilly and Merck in maintaining relatively high rates of new product introductions without participating in major mergers or acquisitions.

I would be remiss to not mention salaries of Executives; increasingly, more and more resources that could otherwise go to corporate R&D are being funneled into pay packages for the top layers of the pharmaceutical industry. Add the lower but super salaries of a couple of thousand top executives in the industry and you can figure how R&D has gone through the roof.

Pfizer : Hank McKinnell, total annual pay package : US$28 million, plus US$30.6 million in unexercised stock options ;

Merck : Raymond Gilmartin : US$ 19.5 million, plus $48 million in unexercised stock options (OK that figure changed) ;

Bristol Myer Squibb : PR Dolan, US$8.5 million, plus US$3.4 million in unexercised stock options ;

Glaxo Smith-Kline : Jean Pierre Garnier, US$11.8 million.

The industry faces threats from competitive forces. Both buyers and suppliers are getting stronger, and the degree of intra-industry rivalry is intensifying as generic manufacturers expand and research productivity stalls.

We can get into the discussion of cost of R&D and that is the hotly debated issue today. I am beginning to find some myth along the way from the pharmas. The pharmaceutical industry is continually lecturing us second-class people inhabitants of planet earth that we're not paying our fair share of pharmaceutical R&D costs. It costs $400/600/800 million to bring a drug to market, they cry (take your pick of the latest Big Lie statistics).

But the ongoing legal action between Glaxo and tiny biotech firm Biota over the flu drug Relenza reveals how much they really spend on research, development and marketing. Glaxo paid pennies for this drug, promising handsome royalties in return.

I really hate taking this potshot, but you know I am going to anyway. Just for fun, type in the words "Pfizer" and "Corrupt" into Google (about 3760 hits), or do a Google search for Pfizer and Overcharging (about 683 hits) or Pfizer and Fraud (about 19,900 hits). That might give ya'all something to read or think about over the weekend. [Michael Lascelles at:]

New England Journal of Medicine Editor Marcia Angell sums up what is wrong with our pharma-dominated health system. Here's a taster:
In the past two years, we have started to see, for the first time, the beginnings of public resistance to rapacious pricing and other dubious practices of the pharmaceutical industry. It is mainly because of this resistance that drug companies are now blanketing us with public relations messages. And the magic words, repeated over and over like an incantation, are research, innovation, and American. Research. Innovation. American. It makes a great story.

But while the rhetoric is stirring, it has very little to do with reality. First, research and development (R&D) is a relatively small part of the budgets of the big drug companies�dwarfed by their vast expenditures on marketing and administration, and smaller even than profits. In fact, year after year, for over two decades, this industry has been far and away the most profitable in the United States. (In 2003, for the first time, the industry lost its first-place position, coming in third, behind "mining, crude oil production," and "commercial banks.") The prices drug companies charge have little relationship to the costs of making the drugs and could be cut dramatically without coming anywhere close to threatening R&D.

Second, the pharmaceutical industry is not especially innovative. As hard as it is to believe, only a handful of truly important drugs have been brought to market in recent years, and they were mostly based on taxpayer-funded research at academic institutions, small biotechnology companies, or the National Institutes of Health (NIH). The great majority of "new" drugs are not new at all but merely variations of older drugs already on the market. These are called "me-too" drugs. The idea is to grab a share of an established, lucrative market by producing something very similar to a top-selling drug. For instance, we now have six statins (Mevacor, Lipitor, Zocor, Pravachol, Lescol, and the newest, Crestor) on the market to lower cholesterol, all variants of the first. As Dr. Sharon Levine, associate executive director of the Kaiser Permanente Medical Group, put it,

If I'm a manufacturer and I can change one molecule and get another twenty years of patent rights, and convince physicians to prescribe and consumers to demand the next form of Prilosec, or weekly Prozac instead of daily Prozac, just as my patent expires, then why would I be spending money on a lot less certain endeavor, which is looking for brand-new drugs?

Third, the industry is hardly a model of American free enterprise. To be sure, it is free to decide which drugs to develop (me-too drugs instead of innovative ones, for instance), and it is free to price them as high as the traffic will bear, but it is utterly dependent on government-granted monopolies�in the form of patents and Food and Drug Administration (FDA)�approved exclusive marketing rights. If it is not particularly innovative in discovering new drugs, it is highly innovative� and aggressive�in dreaming up ways to extend its monopoly rights.

And there is nothing peculiarly American about this industry. It is the very essence of a global enterprise. Roughly half of the largest drug companies are based in Europe. (The exact count shifts because of mergers.) In 2002, the top ten were the American companies Pfizer, Merck, Johnson & Johnson, Bristol-Myers Squibb, and Wyeth (formerly American Home Products); the British companies GlaxoSmithKline and AstraZeneca; the Swiss companies Novartis and Roche; and the French company Aventis (which in 2004 merged with another French company, Sanafi Synthelabo, putting it in third place).[5] All are much alike in their operations. All price their drugs much higher here than in other markets.

Since the United States is the major profit center, it is simply good public relations for drug companies to pass themselves off as American, whether they are or not. It is true, however, that some of the European companies are now locating their R&D operations in the United States. They claim the reason for this is that we don't regulate prices, as does much of the rest of the world. But more likely it is that they want to feed on the unparalleled research output of American universities and the NIH. In other words, it's not private enterprise that draws them here but the very opposite�our publicly sponsored research enterprise.

A Few Trends in the Offing

Drug spending is still increasing at a faster pace than all other health services, but the CMS Office of the Actuary reports that the prescription drug spending increase peaked in 1999 with a 19.7% rise from 1998 levels. Since then, the trend has been slowing, and CMS projects that it will continue to slow through 2013. The percentage increase in 2013 is forecast to be only 9.2% over 2012 levels for drug spending.

Drug stocks have risen a scant 2% this year, compared with a 2% decline in the Standard & Poor's 500, according to Zacks Investment Research. And while the group has climbed 46% during the past 52 weeks, compared with the S&P's 17%, the heady out-performance was driven by Little Pharma, not Big Pharma.

The pharma industry has known for a long time that the best salesmen they can hire are doctors themselves. Only they're not known as drug reps but "opinion leaders". Now at last the AMA is cracking down.

Pfizer's partnership with Yale also illustrates the continuing trend toward large drug companies partnering with academia and smaller biotech companies bolstering their in-house research with access to drug candidates or new technology (such as Yale's scanners).

Monday's Wall Street Journal brought a disturbing story about some leaked e-mails and internal memos from Merck and its troubles with Vioxx. Eli Lilly and Co. shares hit another recent 52-week low. Pfizer, the world's largest drug maker, disappointed investors last week with revenues that missed analysts' estimates. Its profits beat estimates by a penny per share, but it also warned that next year's results could be hurt by the arrival of generic competitors against four of its drugs. GlaxoSmithKline keeps analysts busy upgrading then downgrading. Bristol-Myers Squibb continues making good progress to 'transform their portfolio' so they say.

For another day, the changing strategies of the Big Pharmas. Glaxo takes the lead in retooling for regeneration of growth. The push for productivity drives pharmaceutical reorganization. From the Stockholm Network: The decoding of the human genome has made this process even more complicated because knowledge of illness-relevant genes and gene products, so called targets, has increased remarkably as a result. Only a few years ago, no more than around 500 targets for new medicines were known. Today, gene researchers are faced with 25,000 to 50,000 new targets even when not all of them will form the basis of new drugs. Scientists concede that little is known about the number of new genetic products for genes that cause illnesses. Industry experts thus recommend a change in research efforts, with companies concentrating on their particular indication specialties, as well as a more interdisciplinary approach.

Blockbusters are not going away. History has overemphasized these lucky breaks, but how they are made will change significantly. Big Pharma has argued, if not fully believed, that "bigger is better," but t'aint necessarily so. It turns out that research and development doesn't scale�that bigger may be worse. That's why the engines of pharmaceutical innovation have for some time now been smaller biotech firms like VGX. However, big pharma argues that blockbusters are far from dead.

Johnson & Johnson has been the most successful of the Big Pharmas since 1999, in terms of stock appreciation, based in part based on the company's radically decentralized structure following Dell and General Electric. There is a reason that I follow J&J so very closely, scrutinizing every move. J&J has the chameleon culture that can adapt to new environments. Big pharma companies will need to come up with their own approaches geared to their situations and aspirations.

According to a latest report, the growth of the biotechnology company will continue to outpace that of pharmaceutical companies, with the seven largest biotechnology companies growing at rates faster than the pharmaceutical industry's 9.1 per cent average. That report is for e, as I know he likes the biotechs.

Should we ignore drug stocks? Not at all, just know what changes might enhance profitability before making a pick or purchase and for sure look at the time horizon. Overall, this is not an industry for the meek. Investors worry about three political and legal threats: (1) government action to make it harder to extend patents and thus give a boost to generic drugs, (2) a drug benefit for Medicare that could get Washington into the business of setting pharmaceutical prices, and (3) huge open-ended class-action lawsuits.


Selected references:

Pharma Watch

Modern Drug Discovery Journal, pipeline reference.

Progressions: 2004 Global Pharmaceutical Report outlines the key variables of innovation and the forces that accelerate or inhibit progress toward improving a broader set of health and economic outcomes. It also marks a first step toward defining the combination of factors that equal the Total Value of Innovation.

Drug spending:

The waning of the blockbuster drug:

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