SNY - Is Big Really Beautiful?
Note: this post was
carried today on Wallstrip
Overview
Times they are a changin’, and not just for SNY but for all of Big
Pharma. The issues being faced by the largest pharmaceutical companies
are as vast and as complex as ever: In-house R&D versus purchased
R&D? Benefits of scale versus benefits of focus? How to beat back
the constant onslaught of generics and illegal copies? How does the
increasingly stringent regulatory landscape for new drug approvals
impact the drug development cycle and, therefore, valuation? None of
these questions are easy. But the internet gives us a window into some
of these issues and their potential ramifications for SNY. In a
nutshell, they will have to walk a very fine line to be successful, not
exactly the “margin of safety” I generally am looking for when making
investments. But before drawing any conclusions…
Big Pharma – Not as Diversified as You’d Think
An extremely interesting and insightful post from the online industry journal Pharmaceutical Executive gives us some historical perspective on this issue:
For decades, blockbuster product development has driven
the pharmaceutical industry. Under that model, a handful of
products-and, in some cases, a single product-produce the lion’s share
of revenue and dictate a company’s strategic direction. As companies
get larger, they rely more and more on blockbusters to sustain their
growth. The high cost of developing major, successful drugs only
reinforces the need to focus on blockbusters. It’s a vicious cycle that
remains firmly in place for most Big Pharma.In 2000, for instance, Claritin (loratadine) accounted for 45
percent of Schering-Plough’s total revenue. Similarly, Prilosec
(omeprazole) represented 44 percent of AstraZeneca’s 2000
pharmaceutical revenues. At Aventis, two blockbuster therapies-Allegra
(fexofenadine) and Lovenox (enoxaparin)- accounted for 22 percent and
20 percent of reven-ues, respectively. (See “Big Pharma’s Product
Pie,”)Although the blockbuster approach has served well for many years, it is now under pressure on several fronts:
Uncertainty over pipeline sufficiency. There may not be enough blockbusters in the pipeline to sustain the industry’s double-digit growth .
Genomics and the promise of personalized medicine. These powerful trends raise the possibility of fragmented, smaller markets, unsuited to the blockbuster model.
Increased speed of “fast follower.” The time
between product innovation and second-generation has dropped from years
to months, limiting pharma’s ability to maintain a premium price for
innovative therapies.Reimbursement and cost pressures. Payers are trying
to reign in healthcare costs, and pharmaceuticals are a prime target.
Some states have refused to pay the high price of innovative drugs and
threatened such actions as limiting reimbursement levels.Tightening of regulatory pressures. FDA and other
regulatory agencies are raising the bar for both getting new drugs
approved and keeping existing ones on the market.As those pressure points converge on Big Pharma, it becomes clear that the existing blockbuster model will not survive unchanged in this decade.
This article offers lessons from medium-size pharma companies that have
pursued alternative approaches with comparable success and from other
industries that have had to reinvent their blockbuster strategy in the
face of changing economic and competitive imperatives.
Oh, and FYI, that post was from four years ago. Talk about
prescient. These are exactly the issues being faced by Big Pharma today
and have profound implications for the restructuring of this massive
industry. Remember what happened to Merck when Vioxx was pulled? Even
without the financial overhang of pending lawsuits, the loss of a key
revenue stream was absolutely crushing. Because of the high cost of
bringing a drug from “whiteboard to Walgreens,” Big Pharma has grown up
around the blockbuster model to generate the cash necessary for
R&D. This model has to change.
Big Pharma - a Broken Business Model
The key issues surrounding this business model/R&D problem were illustrated in a very interesting piece by in-Pharma Technologist.com:
New data gathered by the Financial Times Research Centre
shows that on average, the top 30 pharma firms spent almost 17 per cent
of sales on research last year, not so surprising considering that
bringing a new drug to market can now cost anything between $900m
(€715m) and $1.2b.As expected, the big spender is Pfizer, with over 14 per cent of its
£27bn sales invested in R&D in 2005, followed by GlaxoSmithKline
with over £3bn spent on research during the same year, and French giant
Sanofi-Aventis with £2.7bn.Meanwhile, it seems that Big Pharma is changing its approach on how to spend it.
The report suggests that relying on in-house research and
development only has become increasingly complex in terms of budget and
resources and it is now almost unviable for companies to have control
over all the aspects of drug development.As a result, companies are staying away from big mergers with other
giant companies and are instead buying smaller biotech companies,
entering joint ventures or in-licensing drugs, according to the report.“Shifting away from over-reliance on in-house R&D makes sense, but brings new risks too,” the report said.
This is due to the failure of the majority of biotech start-ups and
to the fact that academic researchers now try to commercialise their
work at a much earlier stage.According to the report, this leads to companies rushing to buy
overpriced acquisitions of academic ventures with no real product in
sight.Meanwhile, the report also shows that the biggest players are not necessarily the most profitable.
The most profitable companies last year were either young biotech
firms with successful drugs or reputable pharma companies with off
shored operations taking advantage of the lower costs and high-skill
base of developing countries.
So this raises the issue - is the skill set necessary to succeed in
21st century Big Pharma really more akin to venture capital than hard
science? Given the troubling ROI of in-house R&D, are successful
Big Pharma execs simply better asset allocators than their peers,
doling out monies across in-house researchers, licensed research from
leading academics, licensed R&D from small-and mid-size
biotechnology firms and selective fill-in acquisitions, with each
trying to find that optimal point on the efficient frontier (that
balances risk and return - akin to striving for the highest Sharpe
ratio)? Wow, I can’t believe how much the industry has changed since my
perception of the benevolent scientists in their lab coats in the
1970s. Today we’re talking expensive suits, complex asset allocation
algorithms and probability matrices of drug efficacy and success in
getting through clinical trials. It makes my head hurt.
Big Pharma - But Wait, There’s More
Looking towards the future, the risks to Big Pharma are only getting
bigger. Staring down the barrels of (1) an increasingly litigous and
costly landscape together with (2) ever-more stringent FDA rules means
more and more drugs will never actually make it market. These two
factors alone should cost Big Pharma billions and billions of dollars a
year. Further, states are pushing the use of generics: see
Massachusetts’s mandatory healthcare bill
which means a greater emphasis on generic drugs. Oh, yes, and then
there are the issues of knock-offs. China and India continue to flood
both their home and foreign markets with counterfeit versions of
blockbuster drugs, costing Big Pharma additional billions each year.
And, last but not least, let’s not forget the number of patents set to
expire. What has been a windfall for Big Pharma will turn into a
competitive nightmare, compressing margins, depressing revenues and
thinning out IP portfolios. Taken together, this is not a pretty
picture.
So, in short, it seems that Big Pharma just sucks right now. It’s
all about risk/reward, and it is not hard to see how the scale is
tipped in today’s environment.
Investing in Pharma - The Internet as a Source of Value
Taking a look at small- and mid-cap biotech companies out on the
internet is a hoot. Stocks skyrocketing and crashing based upon little
tidbits of news, be it related to a drug in Phase III trials, pending
FDA approvals, mergers and acquisitions, whatever. We have noticed
significant timing asymmetry between information that is specifically
released by companies, and that which is available from various
credible sources out on the internet. For example:
Accentia,
a company that specializes in cancer vaccines. For months it had little
trading volume, with its share price in slow but steady decline. Once word came out that
its vaccine demonstrated promising results, millions of shares traded
hands and the stock price surged over 40%. Not too shabby.
Interestingly enough, Wall Street never caught on that the trial results were posted on both the Journal of the National Cancer Institute and the University of Navarre websites, several weeks before the Company issued a press release. People were even blogging
about it. This is the kind of cool stuff that can be gleaned through
tools that help users extract and filter information from the internet.
Conclusion
SNY and Big Pharma is a rough place to be at the moment. Sorry. But
that doesn’t mean that money can’t be made investing in pharma - as
long as you have the tools. You see, there is always a silver lining!
Hat tip to Rick Calmon for the Accentia find.
The author does not have a position in the securities of Sanofi-Aventis.
