Is Big Pharma Evil?

Big Pharma has been making a lot of unfortunate headlines lately, especially after Turing Pharmaceuticals' debacle surrounding pricing of Daraprim. Having once been a reasonably respected sector, recent studies have shown that in America, pharma is among the least respected industries.

In this week's Industry Focus: Healthcare, Kristine Harjes and Todd Campbell dive into the ethics around making money from life-saving drugs -- from pricing to patents to "pay for delay" deals and the controversy they spark. Also -- a look on the bright side, at what companies like Gilead Sciences (GILD -1.98%) are doing right to appeal to their customers and the world at large. 

A full transcript follows the video.

This podcast was recorded on Feb. 17, 2016. 

Kristine Harjes: Is Big Pharma the devil? We're talking ethics and biotech on this healthcare edition of Industry Focus.

It is Wednesday, February 17th, 2016, Kristine Harjes here. On the other end of the line, via Skype, we've got the cunning Todd Campbell, and we're answering a question today that we received via email. As always, you can email us at [email protected]. We love taking listener questions. We thought this one was so interesting that we wanted to do an episode to answer it.

Clay McKinney writes in. He says, "I've read Frankenstein. I've seen Splice and Jurassic Park. Science is scary. On the other hand, I'd love to make money by owning companies that are curing cancer and making the world a better place. When looking at biotech stocks, is there a way to know which ones share the same ethical perspective as me, avoid the spooky weirdos?"

Clay here has got a great point. There is this natural disconnect between wanting to help people in need, sick people who are in dire need of new treatments, and being a company that is pursuing profit. A 2015 Harris Poll on corporate reputation found that Americans ranked Big Pharma ninth out of 14 industries. That's right up there with insurance companies and airlines as far as respect goes. Clearly, Big Pharma is maybe doing something wrong, or something is not striking the right chord with the American public. Todd, can you highlight a practice that you think might be raising these red flags for people who look at companies through a moral lens?

Todd Campbell: Hi, Kristine. You know, today's topic, I'd be surprised if we didn't get a lot of listener feedback -- hopefully we will -- with their opinions on the subject. It wasn't always like this. It used to be that companies like Merck were some of the most respected companies out there. They're developing medicines that save people's lives, and that's what people focused on. You're right, that something has changed, and people now view them the way they view tobacco companies. It's not healthy for the industry, if you will, and therefore, you could argue that it's not healthy long-term for investors. I think that there are all sorts of things that are going into that reputational decline in the industry, but probably one of the more high-profile reasons why is the issue of drug pricing.

Harjes: Yeah, absolutely. Of course, this was brought into the public debate recently with the whole Turing Pharmaceuticals ordeal. As many of our listeners are probably familiar with, this guy, Martin Shkreli, the CEO of Turing, essentially bought up this old drug and jacked up the price of it overnight 5500% of an increase, and seemingly for no reason.

Campbell: Right. This drug has been used for decades, and it's used to treat parasitic infection. It's used in HIV patients to protect their central nervous system. It's not a top seller, but it was a common drug, it was used. It only, at the time, cost $13.50 a pill. Then, Turing steps in and they buy it, and that price jumps to $750 a pill virtually overnight, with no improvement. It's like taking a car that's 15 years old and then saying, "You know what, you have to buy this 15-year-old car for more than it cost brand new." It made no sense. From a healthcare perspective, it made no sense.

Harjes: Mm-hmm. With that, this question of how drugs are priced and whether it's ridiculous to be pursuing just a profit starts to become a national debate. You see all these other healthcare companies come under fire, ones that do develop their own drugs in house and then charge what some see as excessive fees for them, and particularly, drug makers that have a model of mostly buying up other companies or other drugs and then bringing these new treatments under their wing and raising the prices.

Campbell: We've got a couple different ways to think about drugs. You have drugs that are developed internally by research and development teams or externally by research and development teams that are then brought to the market and that actually make huge inroads into how patients are treated or the patient outcome or whatnot, and then you've got these other drugs that are maybe just tweaked a little bit. Maybe now instead of taking the pill twice a day, you're taking it once a day, those kind of things. The debate then becomes, "Well, should I be paying $1,000 a pill for something that maybe I only have to take once fewer a day, or should I pay $1,000 a pill for a drug that now effectively cures a disease -- for example, Gilead Sciences' Hepatitis C drugs -- or should I never pay $1,000 for a drug?"

Harjes: Yeah, and of course, there is a really complex ethical question underlying that, which is your whole premise of competition. On one hand, $1,000 a pill sounds crazy, but what if there was some sort of cap where you could only make $100 a pill? Some sort of line of, "This is the most profit you'll ever have." Would we still have this drug at all? Would it then have been worth it for Gilead Sciences to develop it? The other side of the coin is, you kind of want high prices in the pharmaceutical industry so that there's incentive to innovate and improve standard of care.

Campbell: Yeah, and to that point, if you look at it ... I'm a free market capitalist at heart, so I'm looking at it and I'm saying, "Why is it that the United States oftentimes gets access to new medicine before other markets? It's because we tend to reward innovation more than those other markets. If you set price controls and you negotiate down the profitability of a particular drug for a drug company, they're more likely to go to a market that they find more economically viable. You can make the argument, absolutely, that because we reward innovation, we get innovation first.

Harjes: Yeah, and the other element of that story is that the US has relatively strong patent protection, which raises another question that I think might be even more questionable than drug pricing, which is this policy of "pay for delay."

Campbell: Yeah. Pay for delay is something that is ... I think you're going to see a lot more stories being written about this, because I don't think it's as well-known as drug pricing to the individual investor. Pay for delay, basically what happens is, I've got a patent, my patent's expiring on a drug. I've got a bunch of generic manufacturers who are just lining up at the door to start marketing the alternative to it. My sales are going to plummet, as a result. Typically, generic drugs end up capturing 80% of the market of a branded drug once they launch, so why don't I then go ahead and approach that generic drug manufacturer and cut a deal with them where I hand them a pile of money that's less than what I can earn on the drug, and ask them to delay launching it?

Harjes: Yeah, and from a business perspective, that's a win-win. You look at who loses in this situation. Check out this stat. The FTC estimates that this practice adds $3.5 billion to drug costs every year. You have this practice that both sides of the businesses are about, and all of a sudden, it's adding so much money to these drug costs. The Supreme Court actually ruled in June 2013 that the FTC could legally pursue these agreements as potentially illegal, potentially a violation of antitrust law. We are seeing a little bit more of a conflict there between the FTC and pharmaceutical companies that are pursuing this pay for delay practice.

Campbell: Yeah. Regulators are going to pick up the pace here, and part of the reason that they're doing that is because, as you alluded to earlier, if you're delaying the entry of a generic drug, you're theoretically harming the American citizen, right? Because you're making them pay more for a drug that theoretically could save their life than necessarily was intended when the law was written. You can't just maintain a monopoly and pay to maintain a monopoly. That's not legal, right? The FTC now is going out and looking at some of these deals, and some of the money that's already being forked over by companies who are being targeted by the FTC is pretty staggering. Very recently, Teva Pharmaceutical (NYSE: TEVA) had to pay $1.2 billion to settle a pay for delay deal that occurred at its Cephalon unit back in the 2000s.

The issue is being looked into globally. GlaxoSmithKline (NYSE: GSK) was recently in the news overseas because in the UK, they just settled with the UK for $54 million for delaying the entry of a generic version of an antidepressant drug that they had. Yeah, you're going to see more of these cases. Regulators are definitely going to try and prevent this kind of monopoly like behavior from occurring, and it is a problem.

Harjes: Yeah. An even more common instance in which regulators are getting their hands involved in this regards marketing practices. You've seen a ton of instances where pharmaceutical companies have to pay for either not disclosing safety risks or marketing a drug off-label, meaning not for its actual approved indication. I saw one estimate that from January 2009 through February 2014, 11 pharmaceutical companies agreed to pay over $13 billion in fines, and this was for all sorts of allegations. All the previously mentioned ones about your misleading marketing practices, failure to report data, all that kind of liabilities.

Campbell: It's a staggering number. Staggering! I mean, you're talking about billions of dollars that the industry is willing to pay in fines, and the fact that they're continually having to pay these fines suggests to me that they're approaching it as business as usual. "Okay, well, we'll go out, we market the drug, we spend a lot of money marketing these drugs," $27 billion in 2012 was spent promoting drugs either in person to doctors or on the airwaves, if you will. This is just one more piece of that puzzle. It's a cost of doing business. We'll pay the fine because we're out there marketing these drugs and that's how we're going to grow our sales and our profit.

Harjes: Yeah. It's kind of alarming, when you consider that this is just the cost of doing business. There has been a little bit of conversation about maybe tightening restrictions on the way that you can market. There's a conversation going on about potentially eliminating TV ads that are direct to consumer. I can kind of see that argument too, that you don't want to be marketing a disease, you want to be marketing the drug. Even then, you kind of don't want people asking for a brand name specifically when A., there might be a generic equivalent out there, or B., that might not be the best drug for them. If you go with your doctor, and you're like, "Oh, I saw this TV ad, I want Drug X, it looks great," but that's not really the best drug for you, the doctor has a dilemma there, because he doesn't want to upset the patient, and if something goes wrong, possibly find himself in trouble, but he also wants to prescribe the best drug for you.

Campbell: Yeah. You've got that aspect of it. You also have the whole concept of, OK, if a drug is on the market ... investors should know this. If a drug's on the market, a doctor can prescribe it for something that's not on the drug's label. That part of it is OK. Say that you've got a pain drug that's approved for cancer, and you find that it also helps ... Peer-reviewed journals or whatever show that it also helps relieve back pain. As a doctor, you can prescribe it for back pain if you choose. However, a company that manufactures that pain drug can't start marketing it to all of these doctors to start using as a pain drug for lower back pain. You can't do that.

A lot of this off-label marketing is what's, I guess, causing these settlements, the billion-dollar settlements. You've got a lot of different issues on this front that I think you could argue aren't as efficient as they should be for creating long term shareholder value, and it's all more geared toward creating short term value for Wall Street investors.

Harjes: Speaking of investors and shareholder value, where do you stand on whether or not pharmaceutical companies should be returning money directly to their shareholders? I have heard the argument that if you have extra money, you should put that toward either more research and development or simply subsidizing the drugs that you put out there. Is there something ethically wrong with taking this excess cash that you have from your high prices and delivering it via dividends?

Campbell: I don't think so. I fall down on this side of the equation on this ... When it comes to biopharma, developing drugs is expensive. You spend hundreds of millions of dollars a year on research and development at an individual company. It costs that much to develop a drug. Your rates of success are very low, it's a 5,000:1 odds that you're actually going to take a drug from pre-clinical to commercialization. Once you start generating a profit, investors who've been with you all along should be rewarded. Oftentimes, they've been penalized because of dilution, because of shares that have been offered into the public or released into the public to raise money to fuel that research and development activity, so you could argue that the money that's being spent on buybacks is just bringing that share count back down to where maybe it "should be." Like you said, how much of that money should go back into R&D is a decision that has to be made at the top level, because in theory, if you're going to be able to get a bigger return on your investment by putting more money into drug research, then that's where you would be sending that money. These decisions are being made every day.

I think I fall down on the fact that I suppose it's up to each individual corporation to determine whether or not they can make more money down the road or generate greater value for the shareholders down the road by plowing all of their profit into research and development or returning some of it via dividends or buybacks to investors.

Harjes: I'd love to look more at Clay's question and maybe give some ideas for how you can find the companies that are doing it right and making those higher level decisions in an ethical way. First, let me just throw it out there that we have a totally new redesigned podcast hub for all of The Motley Fool's podcasts, so if you check out Podcasts.Fool.com, you can get more information about both this show, Industry Focus ... You can also hear about Motley Fool Money, Motley Fool Answers, Rule Breaker Investing, and Market Foolery, all of which are fantastic shows. Highly encourage you guys to check it out.

Now, let's talk about some of the good stuff. We talked about a lot of negativity surrounding this industry and explained why people are so skeptical of it, but there's also a lot of good out there.

Campbell: You know, when you're trying to find great investments, and it doesn't matter if you're talking about biopharma companies or you're talking about a footwear company, you want to find companies where leaders are willing to invest in people. Not only their employees, if you will, to have happy employees to create new innovation, but you also want to find those companies that are willing to invest in their consumers. In biopharma, I think one of the ways that maybe their reputation can get repaired for some of these companies is to more actively advocate for patients. There are some companies that are doing a good job of this, and they're letting people know that they're doing it, which I think is valuable toward repairing relationships with consumers and everyone.

Two of those companies that jump out are Gilead Sciences and Johnson & Johnson (JNJ -1.28%). Both of those companies have suffered their own fair share of setbacks as far as fines for acts that are arguably unethical, but at the same time, they're all also putting their money where their mouth is and showing that they're willing to make a commitment to returning money either through setting up charitable organizations, or doing a very good job of raising awareness and providing free screening for patients like Gilead Sciences does, or putting the patient at the center of their entire process ... Like Johnson & Johnson CEO Alex Gorsky said in its recent 4th quarter earnings conference call, that any discussion regarding where healthcare should go from here has to put the patient front and center.

Harjes: It's not just words, either. These companies also back what they're saying with quite a bit of money and quite a bit of initiative to fund ... Allowing access to their drugs in more developing markets. Gilead, for example, allows several Indian generic companies to make and market Sovaldi, their Hepatitis C treatment in over 90 countries in the developing world, just to provide more affordable access.

Campbell: Yeah. They didn't have to do that yet. They could have held off on that. It's good to see that they took that initiative. They also provide free screening for both HIV and HCV in certain cases. Johnson & Johnson has made a commitment globally toward helping through Save the Children and also through helping to support research into things such as Ebola. These companies are doing good as well, and they're good corporate citizens, and those are the kind of things that investors should be looking for, because over time, the people who are in it just for the current quarter, they're not the investments you want to have in a portfolio that's got a 20-year time horizon.

Harjes: One more question I want to pose to you before we sign off, and this is actually a question that comes from a co-worker of mine who came up to my desk a couple of months ago, and she was very concerned about all of this bad news that she was hearing about biotech and Big Pharma and whether or not they're ethical companies. She asked me: "Is it ever in the best interest of a company to make a cure when you could just continue to make treatments?"

Campbell: Yes, and I think Gilead Sciences showed that. I mean, they're effectively curing Hepatitis C with Harvoni and Sovaldi. Theoretically, they could have created a drug that was less efficacious, and would have basically required a pill a day for the rest of your life, but they chose not to do that, and as a result, that innovation's being rewarded in the marketplace with billions of dollars in additional sales. Yeah, I think it's within their best interests, do you?

Harjes: Absolutely. Yeah, that was a similar answer that I gave to her, which is, if you can make a cure for it, if it's possible, then somebody's going to do it. Ethics aside, it's in your best market interest to be the first one to do it. If you're the maker of treatments, and a competitor comes out with a cure, you get totally wiped out. You might as well make that cure first.

One company that I want to point out that I think sums this up pretty well is actually Biogen (BIIB -1.19%) in multiple sclerosis. They've got this Phase 2, Anti-LINGO, that the hope is it can slow, halt, or even reverse the adverse effects of lesions tied to multiple sclerosis. You're reversing the damage there. MS drug revenue for Biogen is huge for them. It's 80% of their total revenue, but right now it's coming from treatments like Tecfidera, which is just that, a treatment. When we get this results from LINGO in mid-2016, it's quite possible that Biogen could be eating their own market by bringing this to the public.

To me, that demonstrates the kind of hope that we're talking about there. It is in your best interest to cure these diseases, both from an ethical perspective and from a finance perspective. I think really, at the end of the day, that is our biggest hope, is that the two can be married.

Campbell: I absolutely agree with that. I think that they're not mutually exclusive, and I think that it starts at the top. You need to have leaders who are committed to the long haul, and to patient outcome. If you have that, then everything else will follow.

Harjes: Absolutely. I am going to end the episode with a quote from George W. Merck, who was the president of Merck & Co. quite a long time ago. He says -- and I think this sums up the best hope that we have for the industry -- he says, "We try to remember that medicine is for the patient. We try never to forget that medicine is for the people. It is not for the profits. The profits follow, and if we have remembered that, then they have never failed to appear. The better we have remembered it, the larger they have been."

As always, people on the program may have interests in the stocks that they talk about, and The Motley Fools may have formal recommendations for or against, so don't buy or sell stocks based solely on what you hear. Folks, thanks for listening!