For investors, 2016 has been as rough of a start to the new year as anyone could have imagined. But one sector has really felt the brunt of the pain -- healthcare, specifically drug developers such as Big Pharma and biotech.
Since the beginning of the year, the SPDR S&P Biotech ETF has plunged 35%. No, that's not a misprint! The SPDR S&P Pharmaceuticals ETF, which is predominantly comprised of profitable companies with deep pipelines, is down "just" 23%.
Drug developers are often viewed as stocks with rapid growth potential because of their innovative technology and pricing power. But what if one part of this equation was in jeopardy?
Pricing power comes under fire
Beginning in September, the pricing power of a few drug developers came under heavy fire with the announcement from privately held Turing Pharmaceuticals that it was planning to boost the price of Daraprim, a drug designed to fight toxoplasmosis, by nearly 5,500% overnight. Mind you, Turing, which at the time was being led by "pharma bad boy" Martin Shkreli, didn't alter its formulation or institute new manufacturing procedures. It merely acquired the drug in August and planned to reap big profits off the relatively limited patient pool that uses Daraprim annually.
To be fair, the pricing practices of drugmakers have long been a sticking point for the consumer, even before Turing. More than a year before the Turing outrage, Gilead Sciences' (NASDAQ:GILD) Harvoni, a once-daily hepatitis C pill, was drawing the ire of the American public and Congress with a $1,125 per pill price tag. This works out to $94,500 for a standard 12-week treatment course, at wholesale prices, for Gilead's flagship HCV cure.
The recent pressure from regulators has been primarily focused on a few select companies, including Turing and Gilead, as described above, along with Valeant Pharmaceuticals (NYSE:VRX).
The entire premise of Valeant's business model is built on mergers and acquisitions. It often acquires perceived-to-be undervalued drugs, then turns around and effects a price hike. But two cardiovascular therapies acquired in February 2015, Isuprel and Nitropress, have seen price hikes of 525% and 212%, respectively, according to The Wall Street Journal, without any change in manufacturing or formulation. Now Valeant is finding itself under the microscope.
A solace no more? Seven terrifying words
However, the one solace for the majority of drugmakers has been that regulators have focused on the pricing practices of a very narrow band of companies. This should, in theory, preserve the pricing power of the vast majority of Big Pharma and biotech names.
GlaxoSmithKline's (NYSE:GSK) U.S. pharmaceuticals president, though, would lead you to believe otherwise.
In a recent interview with Bloomberg, GlaxoSmithKline's Jack Bailey, while discussing the state of the U.S. pharmaceutical industry, uttered seven of the most terrifying words drugmakers could ever hear:
"The days of unfettered pricing are long gone."
Bailey's interview with Bloomberg focused on how GlaxoSmithKline's U.S. pharmaceutical operations would work to maximize innovative efficacy, while also reducing manufacturing costs along the way. But the underlying tone of Bailey's commentary was simply that the days of setting drug prices as high as an innovator would like are over. Whereas that could be great news for insurers and consumers, who bear the brunt of drug developers' pricing habits, it's a potentially worrisome development for the bottom line of Big Pharma and biotech.
Not to in any way justify the current drug pricing process, but keep in mind that when drug developers price a product, they do so with the intention of recouping the costs for developing that drug, as well as the hundreds or thousands of drugs they've invested in at the discovery, preclinical, or clinical stages that cost time and money but never make it to pharmacy shelves. Drug developers are also attempting to cover costs for future research and development, potential patent litigation, marketing, and manufacturing associated with their new products. Many people forget that all of these costs need to be accounted for somehow, and the answer is often a lofty price tag.
Yet, for regulators these prices are simply too high for the American public to afford, and presidential candidates like Hillary Clinton have taken exception to drug pricing practices. In September, Clinton offered a proposal that would potentially limit consumer out-of-pocket spending on a monthly basis, and allow for the federal government to use its size to negotiate with drugmakers.
Systemic differences sustain high drug prices
Yet, in spite of Bailey's warning and Congress's attention on the aforementioned three drug developers, I suspect certain systemic differences between the U.S. drug industry and that of other developed countries are likely to keep high drug prices firmly in place.
To begin with, the U.S. has no universal health plan in place. Of the nearly three-dozen countries in the Organisation for Economic Co-operation and Development, or OECD, the U.S. is one of just two without a universal health plan. The Affordable Care Act has improved insured rates as a whole, but the lack of a Medicaid expansion mandate makes the ACA an imperfect law. Without universal healthcare, capping drug prices just isn't feasible.
Speaking of which, the next systemic difference is the ease with which new drugs are brought to market. Within the U.S., drug developers file new drug applications and either undergo an accelerated six-month review process or a standard 10-month review. Once approved, drugs can hit pharmacy shelves immediately. In Europe, for example, drug approval is just one step in the process of getting a drug in front of customers. The next step for a pharmaceutical or biotech company is to gain reimbursement approval for each individual country in which it wishes to sell its drug within the EU -- and most don't cave to high-priced drugs.
Demand for pharmaceuticals in the U.S. is also higher than anywhere else in the world. I know we often forget about the dynamics of supply and demand that we're taught at a much younger age, but products that are in higher demand will usually sport higher price points.
Standard of living is yet another factor. The U.S. has, arguably, one of the highest standards of living in the world. This means drug developers use the U.S. market to help subsidize treatments in underdeveloped regions where they have little to no chance of being profitable.
The last difference, which was partially touched on above, is that insurers tend to accept innovator pricing without too much of a fight. Insurers and pharmacy-benefit managers often can't afford to run the risk of alienating core members by excluding high priced drugs from their formularies.
Thus, even though the perception of prescription drug reform is in the air, and Glaxo's U.S. pharmaceuticals president believes change is imminent, the systemic differences between the U.S. and other countries makes getting prescription price inflation under control a nearly impossible task.
Sean Williams has no material interest in any companies mentioned in this article. You can follow him on CAPS under the screen name TMFUltraLong, track every pick he makes under the screen name TrackUltraLong, and check him out on Twitter, where he goes by the handle @TMFUltraLong.
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