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Is innovation killing the pharmaceutical industry?

Written by DS on in the category VC Views with the tags , .


In the past few years, the speed at which new drugs have been coming to the market has accelerated significantly [1]. This means there is a lot more competition than before, greatly affecting the price of drugs. Peak sales for a drug often don’t even last until the expiration date of its patent. This influences the valuation of pharma and biotech companies. In this article, we give an insight on the mechanisms affecting the changing financial landscape in the life sciences sector. 

The competition is growing

When new drugs are developed, they often fall within an existing class. According to Leerink Partners [2], in 2017, 90% of the 46 approved new molecular entities (NMEs), were for indications for which medication is already on the market and 75% belonged to an pre-existing drug class. In 2017, there were in total 12 approved drugs that were first-in-class, and only 5 that were first-in indication.

First-in-indication approvals included entities such as Biomarin’s Brineura (Batten disease), Ultragenyx’ Mepsevii (mucopolysaccharidosis) and Spark Therapeutics’ gene therapy Luxturna (RPE65 mediated inherited retinal disease). First-in-class approvals included molecules such as Regeneron/Sanofi’s IL-4/13 antibody Dupixent, Celgene’s IDH-2 inhibitor Idhifa and Novartis’ CD-19 CAR-T product Kymriah.  The rate of approvals of first-in-class and first-in-indication drugs has stayed fairly stable over the years. The increased number of drugs coming to market disproportionately represents follow-on drugs, either by class or by indication. 

Some indications (e.g. rheumatoid arthritis, psoriasis, atopic dermatitis, etc.)  experience more competition and have a more rapid turnover in the drug market.  Leerink estimates that the pace of introduction in competitive indications increases by about 2 new drug options per year.  This has a tremendous effect on the number of therapy options that become available over the span of a decade. Although this greatly benefits the patient, drug sales reach a plateau much faster than before, sometimes within a few years. Moreover, the sales plateau lasts less long than before, both due to reduced volumes and pricing competition from similarly efficacious drugs and due to the entry of new treatment options.

This means future and current drugs will rarely keep selling well until the patent expiration date. Drugs in competitive categories won’t command premium prices anymore, which obviously impacts valuations by management, investors and even acquirers.

Cannibalizing sales

Hepatitis C is a clear case where increasing competition for a finite group of patients and accelerating product iterations led to significant downward pressure on pricing and profitability.

Gilead brought out 4 regimens to treat hepatitis C between 2013 and 2017, each time cannibalizing its own sales.  Competition came from AbbVie with Viekira Pak (2015) and Mavyret (2017) and from Merck with Zepatier (2016) [3]. These competitors drove down prices significantly. In 2014, the list price for Gilead’s hepatitis C drug Harvoni started at $94,500 (for 12 weeks of treatment) but rebates progressively got larger, up to 50% of the list price. Abbvie surprised analysts with a list price of just $26,400 (for the 8 week regimen), putting further pressure on Gilead.  Gilead’s hepatitis C drug sales peaked at $19.2 billion in 2015, and are now tracking for only $3.5 to $4 billion in 2018. 

Similar examples in other indications are easy to find, for instance the recent pricing battle between Praluent and Repatha, both PCSK9 inhibitors for cholesterol lowering [4].

Ward Capoen, V-Bio Ventures: “The way drug development is being valued is changing.  Modelling sales figures that ramp to peak in 5 years and then assuming stable sales up to the patent cliff is no longer realistic. Products will be made obsolete so quickly that, realistically, the bulk of the value is in just a few years after launch."

Competitive dynamics affect the valuation of pharma and biotech companies

Some companies, mostly large cap biotech companies, focus all their efforts on one class of drugs or on one particular indication. They have to rely on the sales revenue of drugs within one class, or within one disease indication, which makes them heavily dependent on what the competition is doing.

The median percentage of earnings attributed to the top single indication of biotech companies is 71% (e.g. Vertex gets 100% of earnings from cystic fibrosis medication, Gilead 63% from HIV medication, Biogen 67% from MS medication). In pharma, the median concentration from the top single indication is only 22% (e.g. GSK gets 22% from respiratory, Novartis only 9% from haematology oncology). The Leerink study shows that there is an inverse link between valuation and concentration of earnings from a single product.  Why is this?

Valuations for diversified pharma are higher than for large cap biotech, which seems remarkable as biotech is perceived to be a high growth sector. It turns out that price-to-earnings (P/E) ratio for large established biotech companies such as Amgen, Gilead, Celgene, Biogen is 10% lower than that of large pharma companies such as Novartis, Pfizer, Roche, Astra, GSK, etc.  This is even more obvious when looking at the P/E-to-growth (PEG) ratio: PEG ratios are better for pharma companies (median PEG 2.3) than for biotech companies (median PEG 1). Clearly, the market discounts portfolio concentration, potentially because it sees this as a threat to future profitability.

What now?

A headwind for the large integrated biotech companies, however, may be a boon for small development stage biotech companies.  The increasing competitive landscape and changing dynamics will drive the market towards consolidation and diversification.  Large integrated players need to defend their existing franchises and expand into new ones.  And so, mergers and acquisitions will remain a driving force in the life sciences industry.  Small biotech companies are the purveyors of value in this context, they are the ones developing novel drugs.  Of course innovation is not actually killing the drug industry, but it is changing the dynamics and business models in a profound way and we haven’t seen the end of it.
Ward Capoen: “The need for large companies to diversify and grow benefits the ecosystem of small biotech companies. Large pharma companies need these small, dedicated companies to find novel targets, to develop new drugs and to fill their pipeline.”

References

[1] New drug approvals hit 21 year high in 2017, Reuters 

[2] Leerink Partners 

[3] AbbVie Wages HCV Drug-Price War on Gilead, Bloomberg

[4] Regeneron takes aim at Amgen and Esperion Therapeutics, Madison

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