Can Biologics Make You Rich?

Editor's note: In a previous version of this article, it was stated that Teva's lipegfilgrastim and balugrastim were approved by the FDA, but they are still in clinical development. The Fool regrets the error.

The patent cliff is forcing big pharma to scramble for solutions, both short and long term, to falling R&D productivity and blockbuster-less pipelines. A recent study by IMS Health estimates that loss of exclusivity will result in $79 billion in lost sales for brand-name drugs in the next three years. So it's kind of a big deal.

The urgency will be met with strategic acquisitions -- more than usual, anyway -- to inject promising new drugs into pipelines, and with a reevaluation of R&D departments. Management teams across the industry are pegging their hopes for finding the next basket of blockbuster drugs on one field in particular: biologics.

They aren't crazy for doing so. According to IMS Health, the top 10 biologics generated more than $53 billion in revenue in 2011.Spending on biologic therapies is expected to grow 45% from 2010 to 2015 -- accounting for more than 25% of all growth in pharmaceutical spending. With that much money being thrown around, can biologics make you rich?

What is a biologic?
A biologic is a compound produced by a cell line derived from a living organism such as an animal, plant, bacterium, or virus. It may freak you out, but Chinese hamster ovary lines are the easiest to scale at the moment and are used in seven of the top 10 biologics. This production method differs from traditional small molecules that must be chemically synthesized. Generic biologics are called biosimilars (please don't use the term "follow-on biologics").

Chasing compounds or ailments?
To develop a new biologic, the traditional way of developing small molecule pharmaceuticals must be turned on its head. Small molecules are synthesized and then applied to a range of applications. This process can be costly, as companies don't know which indications will respond best to treatment. A small molecule that fails in phase 2 or phase 3 trials could cost a company billions of dollars and up to 10 years of effort.

Biologics are created by finding an ailment first, and then looking for cell-regulating proteins or antibodies involved in intracellular processes. This revolution in development bodes well for establishing a new guard at R&D facilities across big pharma.

The players
To get a feel for the top companies, let's take a quick look at the top five selling biologics from 2011.

Source: Nature Biotechnology 2011.

This doesn't include Teva's (TEVA +1.15%) $400 million acquisition of CoGenesys in 2008, as it looks to corner the empty U.S. market for biosimilars. Last year, the FDA approved the company's drug Tbo-filgrastim for the treatment of neutropenia in some cancer patients. The biologic, which is not a biosimilar, will be launched in the U.S. in late 2013 to compete with Amgen's Neuopogen, which brought in $1.26 billion ($959 million U.S.) in sales in 2011. The drug is already cutting into international sales.

AbbVie took the biologics and ran after a recent spinoff from Abbott Laboratories. The company's top biologic, Humira, is locked in a fierce battle with Amgen's Enbrel for the U.S. arthritis market. Although as fellow Fool Keith Speights pointed out, Enbrel generates 25% of Amgen's total sales while Humira accounts for more than half of AbbVie's total revenue.

Biogen is one of the purest biologic plays on the market, with four approved treatments for multiple conditions and a pipeline stocked full of potential. At just $35 billion, the biologics company is smaller than peers AbbVie ($59 billion) and Amgen ($64 billion). In terms of efficiency and profitability, however, Biogen (38.4% operating margin) compares favorably with the two (35.4% for AbbVie and 33.9% for Amgen).

And of course, a talk about biologics doesn't amount to much if it doesn't mention the ginormous $20.4 billion deal for Sanofi's (SNY +0.11%) acquisition of Genzyme, announced in 2011. The sticker shock among shareholders was quickly abated when Sanofi released 2011 financial results: revenue growth of 5.3% with Genzyme, revenue contraction of 1.2% without. Looking ahead, Genzyme currently has six biologics in the pipeline (half are in phase 2 or higher) and markets an additional six approved therapies.

In Syracuse, N.Y., Bristol-Myers Squibb (BMY +0.83%) is wrecking the old-world view of pharmaceuticals in favor of biologics. Literally. The company plans to regenerate its aging East Syracuse facility, which supplied the Allied Forces with antibiotics in World War II, and transform the site into a biotechnology research campus. Those plans may have to wait (who knew tearing down giant steel drums from 60 years ago could release toxic amounts of antibiotics into the environment?), but Bristol has forged ahead with its biggest biologic, ipilimumab.

The drug treats melanoma skin cancer and brought in $514 million in its first 12 months on the market. A slow start, but the company hopes it can generate peak sales of up to $1.5 billion for the indication and is currently testing the antibody in lung and prostate cancers.

Limited generic competition
The patent cliff has heightened the IP awareness of pharmaceutical investors, so it's fair to question the viability of biologics that have lost, or are about to lose, market exclusivity to biosimilars. For instance, Humira begins losing protection in 2016, while Amgen is already being confronted by competition to Neuopogen.

While the loss of patent protection does have an effect on sales of biologics, it won't be as steep of a cliff traversed by small molecules. Sales for Bristol and Sanofi's blockbuster blood-clot drug Plavix fell 96% in the first full quarter with generic competition. Amgen's Neuopogen, which competes with 10 other companies globally, saw international sales drop only 15% from 2009 to 2010.

Why can't biosimilars pack the same punch as small-molecule generics? Consider that large-scale manufacturing of biologics is a notoriously difficult thing to master. Displaying biomanufacturing competence to the FDA will be a big challenge for smaller firms that have gained traditional generic market share. Even Genzyme's world-class facilities became infected with a virus in 2009, which caused drug stocks to plummet in the following months.

Perhaps the biggest reason for softer competition from biosimilars is price. Genzyme's newest facility in Framingham, Germany, cost $175 million to build, or about $22,000 per liter of bioreactor. Without big technology breakthroughs, the cost of manufacturing is unlikely to drop significantly, which will keep biosimilar prices close to their originator biologic predecessors. This will allow successful biologics to remain relevant after protection expires.

Foolish bottom line
Big pharma is turning to biologics as yesterday's blockbuster small molecules lose protection and market share. The current complexities involved in biomanufacturing provide a sizable moat for early adopters, while also giving incentives for smaller companies to innovate their way into the market. Until that happens, investors should be able to look forward to market-beating growth and steady returns.