All pharmaceutical companies ultimately face the same issue: patent cliffs, or the expiration of exclusivity periods for their drugs. Approved patents often provide exclusivity protection for 20 years. While some drugmakers might have a tough time negotiating patent cliffs, a report published by Moody's Investors Service suggests Johnson & Johnson (NYSE:JNJ) might be able to negotiate its patent cliff better than most other drug manufacturers due to its large and diverse revenue base.
Why does the maker of Band-Aids need to worry about the patent cliff anyway?
The general public often thinks of Johnson & Johnson first as a consumer products manufacturer thanks to iconic brands such as Band-Aid, Listerine, Tylenol, Neutrogena, Nicorette, and Motrin. However, J&J is much more than just its consumer brands. The consumer products division is actually the smallest of the company's three main business units, providing roughly 20% of its annual revenue. The company's other two business units, and revenue drivers, are the pharmaceuticals segment and the medical devices segment.
In recent years, revenue from J&J's pharmaceutical division has become increasingly important to the overall business. Drugs sales in 2014 increased 15% year-over-year and accounted for 43% of J&J's revenue. Thus, both opportunities and threats to J&J's pharmaceutical portfolio should be front and center on investors' minds.
Below is a chart which highlights the revenue (in billions) for J&J's ten largest grossing pharmaceutical products, sorted by 2014 sales:
At first glance, this division appears to be posting overall solid numbers. Front and center is Remicade, which is used in the treatment of various autoimmune conditions, including Crohn's disease, ulcerative colitis, rheumatoid arthritis, psoriatic arthritis, and plaque psoriasis. This drug has been a stellar performer, providing over $25 billion in sales over the past four years.
Not all good news
Meanwhile, domestic sales for hepatitis C drug Olysio, the company's second highest-grossing drug in 2014, fell by a jaw-dropping 66% in Q1 of 2015 due to the FDA's approval of Harvoni from Gilead Sciences. Harvoni, and its precursor Sovaldi, vastly improved both cure rates and patient experience while undergoing treatment for hepatitis C, rendering Olysio all but irrelevant.
Aside from innovative competing products, another huge threat to pharmaceutical lineups comes from the expiration of a drug's patent-protected exclusivity period. Once this date passes, other manufacturers are free to produce a non-branded form of the drug. These generic versions sell at a steep discount, and the erosion in sales of the original drug will usually cause a meaningful hit to revenue for the drug's original manufacturer. Each year, patents expire on well over $20 billion worth of drugs. In 2012 alone, $38 billion of worldwide prescription drug sales were lost as a result of expired patents.
Fortunately, J&J investors have some consolation. According to the aforementioned Moody's report, Johnson & Johnson is one of just three drug manufacturers that have a very low exposure to significant patent expiration. A diversified income stream from 3 distinct business segments provides the company with somewhat of a safety net and allows J&J to navigate its patent cliffs more easily than many other drugmakers. Furthermore, several of its products are specialty drugs, which tend to offer superior pricing power and a strong revenue stream while they are under patent protection.
Moody's analysis is also based on the fact that J&J is facing relatively few near-term patent losses. Consider the following list of the patent expiration dates for the top ten J&J drugs, based on their 2014 sales rank:
One issue to note is that Remicade, the company's top-selling drug, has already lost its patent in some European markets, and copycat biosimilars are beginning to erode the drug's market share there. Domestically, Remicade still holds a massive 75% market share in the IV immunology marketplace, as its patent still affords it exclusivity in the U.S. The Remicade patent was set to expire in 2018, however J&J's stranglehold on this marketplace may be in jeopardy sooner than that -- time will tell if ongoing litigation surrounding this patent is resolved in the company's favor.
Regardless of how these lawsuits settle, J&J believes significant impact to domestic sales won't be immediate. "Whatever evolves with biosimilars, it will be gradual," said Dominic Caruso, the company's Chief Financial Officer. "The dynamics in the U.S. will be different from what's happened outside the U.S."
Meanwhile, cancer drug Zytiga, HIV drug Prezista, and autoimmune drug Velcade may experience some sales erosion, as their patents are all due to expire by the end of 2017. However, the patent expiry on these drugs will likely have a smaller revenue impact than the loss of patent protection for Remicade -- which is, recall, the company's largest-selling drug.
And more drugs coming
J&J's research and development group has a number of potential blockbuster drugs in the pipeline, 10 of which the company believes have the possibility of becoming $1 billion drugs. These new drugs will be used in the treatment of various types of cancers, rheumatoid arthritis, and influenza, just to name a few applications. Two of the drugs, daratumumab for the treatment of multiple myeloma and esketamine for patients with treatment-resistant myelofibrosis, are being fast tracked by the FDA. This designation means that these drugs will hopefully be even quicker to get approved and start mitigating potential sales declines from J&J's impending patent cliff. Further, the company's strong, diverse revenue base helps ease patent concerns. However, even while J&J downplays the potential impact of the patent expiration for Remicade, the uncertainty of this situation should be something investors keep in mind.
David Weinberg owns shares of Johnson & Johnson. The Motley Fool recommends Gilead Sciences and Johnson & Johnson. The Motley Fool owns shares of Gilead Sciences. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.