Biologics, or drugs developed from biological sources, have taken the pharma world by storm over the past decade or so. Five of the top 10 best-selling drugs in 2014, for example, were biologics indicated for either autoimmune disorders or cancer.

Source: Wikimedia.

The rapid rise of biologics has come from a variety of factors, including their ability to effectively control a range of debilitating diseases, their premium pricing structures, and a tendency toward a long shelf life stemming from the onerous U.S. regulatory pathway for the development and approval of generic versions known as "biosimilars". 

However, a number of blockbuster biologics, worth an estimated $52 billion in global sales, are set to lose patent protection over the next five years. Biosimilar sales are thus expected to blossom from about $1.9 billion to $2.6 billion in the U.S. next year to a staggering $25 billion by 2020, representing a 7.7% compound annual growth rate, or CAGR.

That puts biologics on par with the impressive CAGR projected for the medical marijuana industry, making it one of the fastest-growing segments in healthcare in general. 

With this in mind, let's consider some of the most compelling opportunities -- and biggest risks -- facing investors hoping to cash in on biosimilars.

Source: Wikimedia

Biggest risks
Although the Food and Drug Administration approved its first biosimilar with Novartis' ZarxioTM earlier this year as a less costly replacement for Amgen's white blood cell-boosting Neupogen, the industry still faces a highly uncertain regulatory process in the U.S. that could hinder growth going forward. 

The issue at hand is that biosimilars, by the nature of their development process, cannot be exact replicas of approved biological drugs. This issue has left considerable room for pharmas to defend their star products in the patent arena, or through novel formulations or changes in delivery devices that leave biosimilar sponsors in no-man's land on the regulatory front, so to speak. 

The Biologics Price Competition and Innovation Act was signed as part of the Patient Protection and Affordable Care Act (better known as Obamacare) in March 2010, creating a formal regulatory pathway for biosimilars. However, it took another two years for the FDA to release its long-awaited guidelines for biosimilar regulatory submissions, presumably because of the fierce pushback from pharma companies looking to protect their top brands. 

What arose from this draft guidance is a complex framework in which companies can theoretically resolve patent disputes, and a stepwise approach toward demonstrating a candidate's "biosimilarity."

The problem, though, is that the originators of a biological-based medicine can alter any number of aspects of their product to frustrate copycats, such as switching from vials to autoinjectors or changing the presentation (for example, from powder to liquid), while simultaneously withdrawing older forms of the medicine from the market.  

All of these defenses can be used to greatly slow a biosimilar's market uptake or dispute its "interchangeability", which is the formal term for the generic version being essentially equivalent to the original biologic. AbbVie, for instance, hopes to stave off biosimilar competition to its flagship anti-inflammatory drug Humira in 2016 by upgrading its delivery device. 

Aside from the regulatory hurdles, biosimilars also don't come with a huge pricing advantage compared to generics for small-molecule drugs. While generics are often priced at a discount in the 90% range from branded drugs, the high cost of bringing a biosimilar to market and producing it on a commercial scale leads to a discount of only about 20% to 30% compared to the branded version. 

So, in the real world, doctors might not be as keen on prescribing knockoff versions simply for pricing reasons. The fact that biosimilars rarely take more than 30% of market share from branded drugs in Europe, where they have been commercially available since 2006, lends some credence to this notion. 

Because biosimilars have the potential to save the U.S. healthcare system a whopping $44 billion over the the next decade, payers and regulators alike will probably continue to push for a more streamlined regulatory pathway. That's why major pharmas and biotechs such as Amgen, MerckPfizer (via its acquisition of Hospira), Novartis, and Teva Pharmaceutical Industries have all been busy building out their biosimilar pipelines, with their collective sights set primarily on big-ticket drugs such as Herceptin, Humira, and Remicade. 

At the same time, a wealth of much smaller biosimilar companies have sprung up around the globe, particularly in emerging markets where the regulatory environment is far more lax than in the West. 

That being said, I think investors' best opportunities reside with the bigger names. Larger players such as Amgen, Pfizer, and Novartis are undoubtedly going to help shape the regulatory environment. And they have the resources necessary to deal with the lengthy delays in regulatory filings that are certain to arise from the current FDA guidelines. 

Source: Wikimedia.

If you twisted my arm regarding the best opportunity in biosimilars, though, I would have to go with Pfizer. The Hospira acquisition gives it one of the most knowledgeable and experienced teams in the space, along with a pipeline of 11 medicines across multiple therapeutic areas. 

What's next?
I think biosimilars will one day be a huge growth story in pharma and biotech. But I'm not so certain that day is close at hand. Too many headwinds face sponsors in the U.S. right now, and originators have an arsenal of weapons at their disposal to lower the impact of biosimilars upon approval.

That's why I believe this area of biotech is worth keeping tabs on from an investing perspective, but it doesn't come across as nearly as promising as, say, immuno-oncology at the moment. In short, the U.S. regulatory environment needs to mature further before biosimilars can really take flight.