As was discussed in Part 1 and in Part 2, the Supreme Court of the United States announced earlier this month that it will hear the case of Federal Trade Commission v. Watson Pharmaceuticals that involves the legality of "reverse-payment" or "pay-for-delay" agreements. This is the name given to the settlement agreements between brand-name and generic-drug makers in which the patent holding company pays the generic to stay out of the market for a set period. The instant case involves an agreement that was reached between Watson (NYSE:AGN) and Abbott (NYSE:ABT) relating to Abbott's Androgel. The case comes from the 11th Circuit, but its outcome will directly impact a case from the Third Circuit that was decided against these agreements .
Breaking it down
In order to give this topic the thorough coverage it needs, this discussion has been broken into three distinct parts. In Part 1, I discussed the history of the case and how it got to the Supreme Court. In Part 2, I focused on the critical questions of law that are at issue and what considerations are most critical. Finally, in this final installment, I will analyze the ramifications of various potential outcomes.
In an effort to make this more than an academic exercise, in each part, I will include some investment analysis; ultimately the three parts combined will be of the greatest value to you as an investor.
The case basics
In the complaint that SCOTUS will hear, the FTC asserts that the price of Androgel would have decreased by at least 75% when the generic version was released in 2007. The loss of exclusivity could have cost Abbott as much as $125 million in annual revenue. In response to the application by several generics to manufacture cheaper options, Abbott filed suit alleging that the generic infringed on its patents. The patent litigation between the parties was settled by delaying the release of the generics until 2015 in exchange for combined payments that amounted to roughly $42 million annually.
The FTC, which has made these types of settlements a target, filed suit, alleging that the agreement was anticompetitive. As described in Part 1, the case made its way through the lower courts until the FTC appealed by filing a Writ of Certiorari that was granted by the high court. The case is expected to be decided by June.
Possible outcomes and corresponding impacts
There are three possible outcomes to the case, within some fairly broad parameters:
- Uphold the ruling of the lower court, thus leaving as settled law that reverse payment arrangements are legal.
- Overturn the ruling, determining that pay-for-delay agreements are presumptively anticompetitive and making them illegal
- Limit the scope of these agreements, making them permissible under specifically enumerated circumstances.
Technically, the court could remand the case, sending it back for further consideration, but a more concrete answer seems more likely at this point. Let's take a look at how each of these scenarios could play out.
If the court upholds the ruling of the lower court, the most significant impact will be felt by Merck (NYSE:MRK). Last July, the Third Circuit broke from the opinions of the Second, 11th, and federal circuits , determining that pay-for-delay agreements violate antitrust laws and are therefore presumptively illegal. The appellate court ruled that purchasers of Merck's drug could pursue claims against the company for illegally paying Upsher-Smith Labs $60 million to delay the release of a generic alternative. If the Supreme Court disagrees, any ongoing litigation based on the Merck case will be ended and Merck's liability removed.
Under this outcome, the industry is likely to continue doing business as usual. Since 2005, several major drug companies, including Teva (NYSE:TEVA) and Bristol-Myers (NYSE:BMY), have entered into these agreements. If the court finds these agreements permissible, it should be seen as a positive for the whole industry and will be a short-term positive catalyst.
If, however, SCOTUS sides with the Third Circuit, the potential shakeup to the entire industry could easily reach into the billions. The brand-name players will be forced to seriously reconsider the strength of the patent protection that is available to them. Settlements of this nature will no longer be an option, so the cost of patent litigation will be higher. Additionally, since many drugs will lose exclusivity faster, the big pharmas may have to revisit their pricing models. This should be seen as collectively bearish for the brand-name players like Abbott, Merck, and Bristol-Myers.
On the other hand, the case breaking this way is net bullish for the generics like Watson and Teva. These companies will be able to get their drugs to market faster, which should be a positive. The caveat to this benefit is that they will forgo the income that these settlements generated with less certainty of success. If the big drug companies are not permitted to settle, the protracted litigation may delay the generics nearly as much as the settlement, without the benefit of the payment. Still, the overall impact should be positive.
The wild-card scenario is if the court limits the scope of these agreements. For example, earlier this month, U.S. Senior District Judge William Walls interpreted the Third Circuit's ruling as defining reverse-payment arrangements as presumptively illegal only when actual payments are made. He explained:
K-Dur's pressing concern is about uneven bargaining power -- companies with money buy off too easily generic challengers with lump payments. In settlement situations where monetary payments are off the table, companies with abundant cash have less leverage to delay entry of generic drugs.
If SCOTUS goes this route, or some variation thereof, the impact to the industry may be difficult to define without further analysis. Overall, brand-name shareholders and generic drug company shareholders should each be aware of how the case is progressing. The negative impact to the big pharma names is likely to be more severe than the positive for the generics. A ruling against pay-for-delay will likely be bad for the industry.