It's not often that investors get an opportunity to invest in a whole new class of drugs, but they've got an opportunity to invest on the ground floor with biosimilars. Last year, the Food and Drug Administration approved the first biosimilar drug, Novartis' (NYSE:NVS) Zarxio, its version of Amgen's (NASDAQ:AMGN) Neupogen, under its new authorization granted as part of Obamacare. And there are plenty more biosimilars in the pipeline.
In short, biosimilars are copycat versions of biologic drugs, and with plenty of branded biologics -- many with sales north of $1 billion annually -- set to come off patent shortly, the industry has a lot of growth ahead of it.
Before you invest in the space, here are nine things you need to know.
Don't call them generics
Branded drugs fall into two basic categories: small molecule drugs that are usually made through chemical synthesis -- breaking and reforming chemical bonds -- and biologics that are proteins made in living cells grown in incubators and purified from the cells, making them substantially more complex.
Small molecule drugs are what you typically think of as generic drugs. Because they're made through chemical synthesis, the active ingredient is essentially identical.
Since biologics are made in living cells, it's nearly impossible to make an exact replica unless a company follows the exact same manufacturing procedure as the company that makes the brand-name drug. And since that's proprietary information, the copycat manufacturers don't have that option.
Thus was born the term "biosimilar" because changes in cell lines, growing conditions, expression times, purification process, and other variables can have minor changes on the drug. Biosimilars are similar -- but not identical -- to the brand-name drug, thus the name.
They aren't interchangeable
Because they're only similar, pharmacists won't treat brand-name drugs and biosimilars as equivalent.
With small-molecule generic drugs, if the doctor prescribes the brand name drug, pharmacists will automatically substitute a generic -- whatever generic version the pharmacy stocks -- unless the patient or doctor specifically asks for the brand-name version. With biosimilars, doctors will have to specifically prescribe the biosimilar version. In fact, the FDA has a plan to require all biosimilars to append the generic name with a four letter code to designate them as biosimilars. Novartis' Zarxio, for example, goes by filgrastim-sndz with the sndz short for Sandoz, Novartis' generic drug division.
The requirement of a specific prescription means biosimilar manufacturers will likely need to do at least some marketing to get doctors to prescribe their version -- something makers of small-molecule generics don't have to do.
Biologics get a special exclusivity period (but it's basically useless for many drugs)
As part of the negotiations that set up the law to allow biosimilars, biotech companies negotiated a 12-year exclusivity period after a biologic drug was approved before biosimilars could come onto the market. That's longer than the five years that small molecules get.
But the exclusivity period runs concurrent to the patents that the companies have on the drug. Since patents run 20 years, only drugs with long development times are going to get approved with less than 12 years of patent time remaining, especially since companies tend to pile on additional patents during clinical development.
Approval requirements may differ from biosimilar to biosimilar
While approval requirements are generally the same for small-molecule generics -- typically they just have to show they're bioequivalent to the brand name drug in a small clinical trial -- that's not likely to be the case for biosimilars.
The size of the clinical trial and what's measured -- clinical outcomes versus biomarkers -- are up for debate for each individual drug and will depend on the disease the drug treats and the side effect profile of the brand-name drug, among other issues.
Discounts might not be that great
The spending on larger clinical trials and marketing, combined with higher manufacturing costs, means that biosimilars can't be sold for the dirt cheap prices that small-molecule generics can, which often go for 10% or less of the branded-drug price. Biosimilars will likely be priced closer to the price of the brand-name drug, depending on the amount of competition. Novartis' Zarxio, for instance, launched at only a 15% discount to Amgen's Neupogen.
The EU has been approving them for years
While the FDA has been slow to react -- it took five years from when Obamacare was signed into law until the first biosimilar was approved -- European regulators have been approving them for years. Zarxio, for instance, was approved in Europe in 2009 under the brand name Zarzio.
Given the aforementioned difference in approval requirements, drugs that have been approved in Europe for many years may have a distinct advantage because there's real-life patient experience with the drugs.
The FDA actually approved one a decade ago
In 2006, Novartis sued the FDA to get approval for Omnitrope, a human growth hormone, based on what was already known about the branded versions made by Genentech and Pfizer. The judge agreed, and the FDA approved Omnitrope later that year.
The FDA dubbed the drug a "follow-on biologic," insinuating that this was a special case, which kept the flood gates from opening and approving other biosimilars until the agency was forced to as part of the Biologics Price Competition and Innovation Act that was passed along with the rest of Obamacare.
Companies are sharing the riskWhile there are some companies developing biosimilars on their own, many are partnering up. Mylan (NASDAQ:MYL) has gotten a hand in the biosimilar market through a partnership with India-based Biocon and more recently with Momenta Pharmaceuticals (NASDAQ:MNTA). Teva Pharmaceutical (NYSE:TEVA) paired up with Swiss-based Lonza.
Part of it has to do with expertise. Momenta Pharmaceuticals is better at developing copycats of hard-to-make drugs, while Mylan has a better distribution system for drugs once they're approved. The latter is true for generic-giant Teva Pharmaceutical as well.
But given the unknowns about the potential market, sharing the costs makes a lot of sense. Some biosimilars are going to be more successful than others, based on competition, doctors' willingness to prescribe the drugs, and patients' desire for a lower drug cost. Without a history of previous sales, companies are making educated guesses about which drugs might be worth the investment. It's a smart move to share the risk until the market dynamics are worked out.
Even brand-name biotechs are getting in on the action
Amgen, arguably the mother of the biotech industry, would seem like an odd entrant into the biosimilar market, but the big biotech has nine biosimilars in development, six of which have been disclosed. Likewise, Biogen (NASDAQ:BIIB), another big biotech company, has a partnership with Samsung to develop biosimilars.
While it might seem weird that Amgen and Biogen would get into the copycat business given the difference in market dynamics, there's some precedence in the small-molecule generic-drug business. Novartis has the aforementioned Sandoz. Pfizer has a generic-drug segment, and German Merck KGaA had a large generic drug division before selling it to Mylan.
Since copying biologics is substantially more complex than making small-molecule generics, it makes sense that Amgen and Biogen would have an upper hand in how to copy the brand-name drugs of their competitors. And while biosimilars might come with lower gross margins, if they're being produced with unused manufacturing capacity, the extra revenue could be a substantial addition to their earnings.
The Foolish way to invest in this trend
Biosimilars offer a new, potentially lucrative market for both branded and generic drugmakers, but picking a winner will likely take some time as we wait to see how the dynamics of the new industry play out. Fortunately, most companies entering the biosimilar space have other products. Investors' best move is likely to value the companies based on the other drugs and use the biosimilar opportunity as potential upside.
Brian Orelli has no position in any stocks mentioned. The Motley Fool recommends Biogen, Momenta Pharmaceuticals, Mylan, and Teva Pharmaceutical Industries. 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.