Biotech Stock Outlook

Brian Hicks

Updated December 20, 2007

To a whole host of consumers, generic drugs are whole lot more than just good medicines. In addition to curing what ails them, they are also big-time money savers.

That’s because on average generics cost a full 70% less than their bigger brand-named peers. The result is that cash strapped consumers now save over $10 billion every year at pharmacies across the country with the lower price knockoffs.

But as good as those generic drugs have been for consumers everywhere, to Big Pharma companies like Pfizer Inc.(NYSE: PFE) and Merck & Co. Inc.(NYSE: MRK), those same generics are a four-letter word. That’s how much they hate them.

In fact, as a group generics are expected to wipe out $67 billion in revenues from Big Pharma between 2007 and 2012 as more and more blockbuster drugs go generic.

But as massive as those losses for Big Pharma are, however, on the flip side they are turning out to be nothing but a big boon for biotech stocks.

The reason for this is simple.

Faced with shrinking pipelines and falling revenues, the old way of drug development using chemistry alone is giving way to the modern technologies of gene sequencing, protein analysis, and nanotechnology . It’s those same cutting edge areas that the biotechs dominate. And Big Pharma knows it.

And without the cutting edge research and development that the biotechs offer, revenues at the Big Pharma level will likely hit a wall.

Part of that reason lies in those same generics that Big Pharma loves to hate

Here’s why.

In the United States, a company that develops a new drug can be granted a patent for the drug itself, for the way the drug is made, for the way the drug is to be used, and even for the method of delivering and releasing the drug into the bloodstream.

Those patents grant the company exclusive rights to a drug for 20 years. The problem however, is that it usually takes about 10 years in between the time a drug is discovered (when the patent is obtained) and the time the drug is approved for human use. That leaves the company only about half of the patent time to exclusively market a new drug.

After a patent has expired, other companies may produce and sell a generic version of the drug as long as the FDA has approved it, which is practically a given these days. And without all of the costs built into the product that were necessary to bring it to the market in the first place, generic companies can easily sell the identical drugs at much lower prices.

That just crushes revenues at companies like Merck.

Take Merck’s osteoporosis drug Fosamax, for instance. In February, Merck will lose its exclusivity on the drug. As a result, sales of the drug are expected to plunge by 50% next year as generics knock offs begin to enter the marketplace. That means a cut in revenues for Merck from $3.1 billion in sales this year to likely $1.4 billion in 2008.

Big Pharma Turns to Biotech Stocks

That’s one of the big reasons that Big Pharma has been turning to both acquisitions and partnerships with upstart biotechs companies. Because unlike traditional drugs, these new biologics are not yet vulnerable to generic competition since the FDA hasn’t decided how to regulate them.

So instead of having only ten years of exclusivity to a particular therapeutic, these new classes of drugs are currently protected indefinitely.

But that is only part of the story.

The other is that faced with the economic pressures of a declining pipeline and diminishing returns for their own research and development, the truth is that these mergers and partnerships just make good business sense.

After all, the biotechs themselves have come a long way.

In fact, U.S. biotech sales grew 20% to $40.3 billion in 2006, compared to 8% growth in pharmaceutical sales, to $275 billion, according to pharma consulting outfit IMS Health.

Here’s just a sampling of exactly where the biotech industry stands today.

  • 4 out of 5 therapies currently in development are biotech-based.
  • Over 190 biotech drugs and vaccines are currently available.
  • Over 400 biotech products are currently in clinical trials.
  • Biotech had twice as many new molecular entities (NME) approved by the FDA in 2004 as big pharma.

The Biotech Gold Rush

It has been that type of industrywide advantage and performance that has led to a rush of activity to either scoop up these smaller biotech companies or to collaborate with them to bring new their new drugs to market.

In fact, just three weeks ago, Merck & Co. agreed to pay Swiss biotech Addex as much as $170 million to develop a new class of drugs for Parkinson’s disease. Under the terms of the agreement, Addex and Merck will collaborate on the drug’s preclinical development.

But Merck is hardly alone.

Numerous other drugmakers are also looking to fill their pipelines and are paying ever larger sums to biotech companies for early access to their cutting-edge developments.

And the key word there is early.

Because as is the case in most of these acquisitions, these news drugs are often several years away from the crucial Phase III trials that will actually bring them to market.

In fact, many of these acquisitions are occurring even before these new drugs even reach Phase II trials. That at least was the story in these recent buyouts as the bigger names gobbled up the smaller in the race to fill their pipelines:

  • Amgen, Inc. (NASDAQ:AMGN) agreed last year to acquire the 96% of Avidia that it did not already own for $290 million up front, plus two potential earn-outs—based on the development of certain compounds—that could total up to $90 million. Avidia, was a privately held biopharmaceutical company that discovered and developed a new class of human therapeutic known as Avimer(TM) proteins.

  • In September, Bristol-Myers Squibb Co. (NYSE:BMY) paid $505 million to acquire Adnexus Therapeutics, a private biotech that was the exclusive developer of Adnectins. Adnectins are an emerging, proprietary protein therapeutic class that can be designed to address a broad range of diseases.

  • In March, Japan‘s fourth-largest drug maker Eisai Co. Ltd. paid $325 million in cash to buy privately held US biotech Morphotek. Formed in 2000, Morphotek developed proprietary human antibody technology to produce therapeutic monoclonal antibodies to treat cancer, rheumatoid arthritis, and infectious disease.

  • In October last year Merck & Co. Inc.(NYSE: MRK) paid an eye-popping $1.1 billion to buy Sirna Therapeutics Inc., a tiny biotechnology firm developing drugs based on the new technology at the heart of a Nobel Prize for medicine. That was about 225 times Sirna’s 2005 sales. Sirna was developing drugs using so-called RNA interference technology, a technique discovered by Nobel winners, Andrew Fire of Stanford University and Craig Mello at the University of Massachusetts.


Anavex and Big Pharma

One of the stocks, of course, that could be a big beneficiary in this rush to biotech gold by big Pharma is one that Brian Hicks recommended a few weeks ago called Anavex Life Sciences Corp.(OTC: AVXL). Stock shares of the company are up over 35% since it appeared in these pages just three weeks ago.

That’s because Anavex’s pipeline utilizes a fairly new and proprietary class of drugs that is very different from anything else on the market today.

In short, the story is this: The company’s proprietary Sigmaceptor Technology Platform represents an area that has yet to be exploited by the big pharmaceutical companies.

That’s true even though numerous scientific publications have exposed the enormous and versatile therapeutic benefits that this family of receptors represents. Those studies suggest that the novelty, efficacy and optimal safety profile of this new class of drugs has the potential to make a major market impact in the years to come.

So how big exactly is this market?

Well, given what this series of drugs will treat it is huge. It includes:

  • Alzheimer’s Disease
  • Epilepsy
  • Depression
  • Colorectal Cancer
  • Prostate Cancer
  • Breast Cancer
  • Lung Cancer

In short, all of big ones.

In fact, if the company is successful with all of its current trials it projects that it will eventually earn some $5.6 billion a year.

That, of course, is the reason why this relatively unknown biotech company has attracted so much attention to its stock lately even though its drugs are all in the very early stages of development.

That’s because when it come to biotech stocks these days, Big Pharma has definitely begun to notice them in a big way.

That’s a trend that will carry on into 2008 and beyond as Big Pharma fights the decline in revenues at the hands of the generics. That makes biotech stocks one of the places to be in the new year.

Wishing you happiness health, and wealth,

Steve Christ, Editor

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