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Guess what? The FDA approved Gilead Sciences (GILD -1.15%) newest hepatitis C drug, Epclusa, earlier this week. Not surprised? You're not alone. After delivering 98% cure rates and arguably best-in-class safety in trials, just about everyone believed the FDA would give Epclusa a green light.

Yet Gilead Sciences shares jumped 4% higher on news of Epclusa's approval, leaving many to wonder why a green light hadn't been priced into shares ahead of the decision. To understand why investors got more optimistic following Epclusa's approval, you need to understand the company's plans for the drug.

Gilead Sciences' hepatitis C strategy

Although Epclusa is the first drug to win approval for use in patients with every hepatitis C genotype, its use might be more limited than you think, at least at first.

Leading up to the FDA decision, investors were wondering how Gilead Sciences would price Epclusa and whether Epclusa would cannabilize the company's existing market share in the indication. Management addressed both of those questions after the FDA go-ahead.

As a reminder, Gilead Sciences is the market share-leading maker of hepatitis C drugs, and last year, it hauled in more than $19 billion in hepatitis C drug sales. The company markets two hepatitis C drugs: Sovaldi, a drug often used in non-genotype 1 patients, and Harvoni, a treatment for genotype 1 and genotype 4 patients.

Of the two, Harvoni is most important to the company, because genotype 1 accounts for about 70% of the 2.7 million Americans diagnosed with HCV and Harvoni's sales represent about 70% of Gilead Sciences' first-quarter hepatitis C sales.  

Obviously, Gilead Sciences had to consider carefully how it would position Epclusa so that it posed the least risk to stealing away Harvoni sales. Its decision to price Epclusa at $74,500 for a 12-week course of therapy may successfully do that.

Although Epclusa's list price is lower than Harvoni's $94,500, the price insurers pay for Harvoni has dropped significantly in the past 18 months as competitors have launched cheaper, competing therapies.

AbbVie Inc(ABBV 0.25%) set the price for Viekira Pak $10,000 lower than Harvoni when it won approval, and then AbbVie negotiated additional discounts to secure exclusivity with Express Scripts, the nation's largest pharmacy benefit manager.

Similarly, Merck & Co. (MRK -0.11%) won FDA approval of Zepatier, a genotype 1 drug, earlier this year, and when it did, management priced it at only $54,600 for a full 12-week treatment course.

Rather than undercut existing genotype 1 drugs, it would seem Epclusa will be more expensive than Harvoni, Viekira Pak, and Zepatier on a net basis. Assuming Gilead Sciences holds the line and doesn't negotiate Harvoni-like discounts, then it's likely most payers will continue to steer patients to Harvoni, Viekira Pak, and Zepatier. That would be a good thing for Gilead Sciences, because AbbVie's deal with Express Scripts makes it most likely that any genotype 1 market share Epclusa wins would come at Harvoni's expense.

Therefore, Gilead Sciences appears to be positioning Epclusa to significantly disrupt genotype 2 and genotype 3 treatment. Those genotypes are particularly tough-to-treat and currently, doctors usually prescribe multi-drug combination therapies as standard of care. For example, combining Sovaldi with either ribavirin (a prior--generation therapy that can cause side effects) or Bristol-Myers Squibb's (BMY 0.96%) Daklinza is common.

While combination approaches like these can be effective, they can also be very expensive. Insurers have to pay for each drug used in a combination therapy separately, so the cost of these approaches often eclipses $100,000. Additionally, combination therapies can cause more side effects, reducing patient adherence rates and negatively affecting cure rates. When that happens, it can result in the costly retreatment of patients.

Considering the pitfalls associated with using combination approaches, I think that Epclusa will quickly become the standard of care in these patients. Importantly, it will become that standard without Gilead Sciences' having to cut Epclusa's price to win market share.

Looking ahead

AbbVie is more insulated than Merck and Bristol-Myers Squibb from Epclusa's challenge because of its sweetheart deal with Express Scripts. Sales of Merck's Zepatier are only trickling in so far, so it appears to me that it's Bristol-Myers Squibb that could be hardest hit by Epclusa. If so, then there could be a billion-dollar swing in hepatitis C market share in the coming year. Last quarter, Bristol-Myers Squibb's U.S. hepatitis C sales totaled $259 million.