Orphan Drugs: Small Patient Base, Big Opportunity

Orphan drugs don't have the potential patient numbers that cholesterol or diabetes drugs have, but that doesn't mean you should ignore them either. What they lack in volume they make up for in price.

Technically speaking, a drug can get orphan drug status if it treats a disease that affects less than 200,000 people in the U.S. A lot of cancers fall into that range -- for instance,  GlaxoSmithKline's (NYSE: GSK) Tykerb has orphan drug status for gastric cancer. But the true orphan drugs treat diseases you've probably never have heard of.

Sources: Forbes, Pediatrics, and Viropharma.

A little protection goes a long way
There are some financial incentives to gaining orphan drug status. The government kicks back up to 50% of the cost of clinical trials in the form of tax credits. And the Food and Drug Administration comps the fee established by the Prescription Drug User Fee Act (PDUFA) that drugmakers pay when submitting their marketing application.

But the biggest advantage comes from the exclusive sales for seven years in the U.S. and six to 10 years in the EU that governments give orphan drugs. It doesn't matter whether patents expire during that time, the regulatory agencies will hold off approving generic competition until the orphan drug exclusivity has expired.

Being the first to treat a disease also offers an indirect lockup of patients from other branded drugs. If the drug works well enough, patients are less likely to enter a clinical trial for a competitor's experimental drug, making it harder for the competitor to get on the market. Being first doesn't provide an absolute monopoly -- in addition to Genzyme's (Nasdaq: GENZ) Cerezyme, Shire's Vpriv is approved for Gaucher disease and Protalix and Pfizer (NYSE: PFE) are also working on a Gaucher disease treatment -- but a little protection can go a long way.

On the road to bigger things
Sometimes the orphan drug status is just a stopping point. Because the proteins that drugs interact with are often involved with other diseases, treating an orphan disease can be a good starting point before launching into another disease.

Take Novartis' (NYSE: NVS) Ilaris and Regeneron Pharmaceuticals' Arcalyst that are approved to treat a disease called cryopyrin-associated periodic syndrome (CAPS), which only affects 300 people in the U.S. Even with the addition of international approvals, it's difficult to register meaningful sales with that number of patients. Regeneron registered just $5 million in sales of Arcalyst last quarter; Novartis brought in just $4 million from Ilaris.

But neither Novartis nor Regeneron have their sights set that low. Novartis and Regeneron are both testing their drugs as a treatment for gout -- a larger market -- and Novartis is also testing Ilaris as a treatment for diabetes -- a much, much larger market.

Volatility magnified
For orphan drugs, the approval process is often quicker and more certain than the typical drug -- as much as FDA approvals can be certain. But once the drug is approved, the uncertain sales can lead to substantial volatility. When you're treating so few patients, everyone counts. Reimbursement snafus, government bulk purchases, patients missing treatments because of vacations, and a myriad of other issues can cause wild swings in sales and the company's stock price in the process.

BioMarin, for instance, has beaten the S&P 500 by 30 percentage points since analysts recommended it for the Rule Breakers newsletter in June of 2007, but it's been a roller coaster of a ride.

If you're going to invest in orphan drug manufactures -- and I think they're worth further investigation -- make sure you've got the stomach for it.