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Msg  42177 of 42706  at  7/8/2022 2:05:11 PM  by

Asymmetric


The Days of Big Pharma Are Over. What the Era of Big Biotech Means for Investors.

The Days of Big Pharma Are Over. What the Era of Big Biotech Means for Investors.
By Josh Nathan-Kazis / Barrons / June 17, 2022

When GlaxoSmithKline spins off its enormous division selling drugstore staples like Advil and Tums next month, it will represent more than just the latest shuffling of assets among corporate giants.

It will mark what is effectively the end of GlaxoSmithKline, diversified pharma conglomerate, and the birth of GSK (ticker: GSK), a rebranded pure-play biopharma.

The transformation of the United Kingdombased GSK is the culmination of a decadeslong process thats turned virtually all of the worlds largest pharmaceutical companies into bigger versions of biotechnology companies like Amgen (AMGN) and Gilead Sciences (GILD), which sell high-priced, complex medicines, often for rare conditions.

Its a shift investors have demandedand the science has, too, drug executives say. But by taking away stable revenue streams that cushioned the ups and downs of the drug-discovery business, it could turn Big Pharma stocks from buy-and-stuff-under-the-mattress blue chips into riskier bets. At the same time, it may reinforce the long-term shift that has pulled Big Pharmas focus toward expensive, specialized treatments and away from drugs for the most common causes of death in the U.S., such as heart disease and diabetes.

Investors [have been] pushing companies to move in that direction, because theyre looking at the market now, says Kenneth Kaitin, a professor at Tufts University School of Medicine and former director of the Tufts Center for the Study of Drug Development. And theyre seeing that some of these drugs to treat rare diseases and rare cancers have very high price tags.

Big Pharma firms have been dumping sideline businesses for years. Pfizer (PFE) sold a chewing-gum division in 2002; Bristol Myers Squibb (BMY) spun off its infant-formula unit in 2009; Eli Lilly (LLY) spun off its animal health division in 2018. Next year, Johnson & Johnson (JNJ) plans to spin off its giant consumer health division, which sells Tylenol and Band-Aids.

Not every Big Pharma company will be a pure-play biopharma: Merck (MRK) will still have an animal health division, Roche Holding (RHHBY) will retain a diagnostics division, and even Johnson & Johnson will still have a medical-devices unit. But the majority of their peers, including Pfizer, Lilly, AbbVie (ABBV), Novo Nordisk (NVO), AstraZeneca (AZN), and Bristol Myers, will make new drugs and sell new drugsand thats it.


Though theyre getting what they wanted, investors have shown they still need to be convinced by the new model. The market values Pfizer, which effectively completed its transformation to a pure-play biopharma in late 2020 when it spun off a division that sold off-patent drugs, at eight times earnings expected over the next 12 months. That is the lowest multiple in the group.

Despite projections that Pfizer will surpass $100 billion in revenue this year, investors worry about a drop-off in sales of its Covid-19 vaccine, plus patent cliffs arriving at decades end for a number of major products.

The stock is trading well below its five-year average of 12 times earnings, and below the average forward-looking earnings multiple of the S&P 500 Pharmaceuticals industry group, which is 13. Thats a sign investors arent sure Pfizers model will work over the long term.

In fact, the pure-play biopharma approach hasnt always worked so well for large-cap biotechs themselves. Despite developing important medicines, the big biotechs have a mixed record when it comes to their ability to survive after the exclusivity periods on their top products expire. For every Amgen, which has built a broad, sustainable portfolio, there are companies like Celgene and Alexion Pharmaceuticals that sold out to Big Pharma when faced with major patent cliffs.

The Roots of Change
The story of Big Pharmas transformation into Big Biotech goes back to the winter of 1992, when Henri Termeer, the CEO of a biotech called Genzyme, sat in a Senate hearing room in Washington and defended one of the highest prices ever charged for a medicine. The treatment for Gaucher disease, a rare genetic condition, was difficult to make: A years worth of doses for a single person required tens of thousands of human placentas. Still, the price on the drug blew minds across the U.S.: roughly $380,000 a year, depending on the patient.

At the hearing, Termeer beat back a demand that he justify the drugs price, but said he would aim to make it cheaper over time. Two years later, Genzyme began selling a new version of the treatment that could be made for less money. The price hardly budged.

Termeers tenacity in setting his Gaucher drugs price and sticking to it reshaped the pharmaceutical industry. It suddenly started to awaken within the industry the idea that, wait a minute, maybe weve got this backwards, Tufts Kaitin says.

Instead of selling less-expensive drugs to treat common conditions, drugmakers realized that perhaps they should be selling expensive biotech-style drugs to treat less common conditions.

Big Pharma companies, at the time, were competing over slices of very large markets, each putting out their own cholesterol-reducing statin or SSRI to treat depression, for example, and sending their commercial teams out to battle against each other. They specialized in small molecules, the broad category of chemicals that pharmaceutical companies have been making for more than a century, which can be synthesized in chemical reactions, made relatively inexpensively, and administered orally.

Biotechs like Termeers Genzyme took a different approach. For one, they focused on a newer category of drugs called biologics, complex drugs made using genetically engineered cells. For another, they had a new approach to drug pricing. There were rules in the pharmaceutical industry around pricing, says Mick Kolassa, once a sought-after consultant on drug pricing who left the industry to work as a traveling blues musician. Biotech came out and didnt know those rules. So they didnt follow them, and they set prices that were substantially higher.

Kolassas role, beginning in the 1990s, was to make the case that drug prices should be based on the value of their impact on the health of the patient, rather than the cost of development or manufacturing. The idea, known as value-based pricing, is dogma now, and prices of branded pharmaceuticals have soared. (Kolassa talks about what happened like Dr. Frankenstein talking about his monster. We discovered the market is so fundamentally broken that the price doesnt have to be related to value at all, he says.)

The change is most stark in the kinds of prices that drugmakers are assigning to their new drugs. According to an analysis published by Harvard Medical School professor Dr. Aaron Kesselheim and colleagues in the Journal of the American Medical Association this month, the median list price of a drug first marketed in 2021 was $180,007 per year, up from $2,115 in 2008. Between 2008 and 2013, only 9% of newly launched drugs cost $150,000 a year or more; in 2020 and 2021, 47% of new drugs cost that much.

Scientific Breakthroughs
Meanwhile, as biotech was teaching pharma to charge more for drugs, an era of enormous advances in the science underlying the drug industry was arriving. Those advancesin the understanding of the human genome, in the treatment of cancer, and in new therapeutic modalities like monoclonal antibodies and gene therapieschanged the landscape for drugmakers.

The science offered opportunities in oncology and genetic diseases, among other areas. The result has been a flood of new medicines: Between 2016 and 2020, the Food and Drug Administrations Center for Drug Evaluation and Research approved 46 new therapeutics a year, on average; thats up from an average of just 22 new approvals each year between 2006 and 2010.

We have a wealth of new information now about the genetic determinants and the pathophysiology of a lot of cancers and genetic diseases that were untreatable before the beginning of this century, says Kaitin. Companies look at this, they say, The science is there. The market opportunity is there. This is where we need to be, this is where our investors expect us to be. And this is where the margins are the greatest. So, why not? Why not put our attention there?

Many of these new medicines are more complex than their small-molecule predecessors. Biologics cant be copied when their exclusivities end; rather, competitors must make so-called biosimilars, which so far have not proven to be as devastating to the revenue of the branded drugs as traditional generics. That extends their runway and extends their [loss of exclusivity] to a point where I think it becomesa more sustainable business model long term, says Sameh Ahsan, a senior investment analyst at Exome Asset Management.

To compete in the development of these more complex medicines, management teams have argued that they need more focus. Whats happened in the last seven, eight years is youve had this explosion of technology in which all the companies are trying to build positions, whether thats cell and gene therapy or mRNA or siRNA, Novartis CEO Vas Narasimhan told Barronslate last year. In order to be at the leading edge of the science, if you want to win in biopharmaceuticals, you have to focus your capital and your energy and your managements attention on that high-tech space.

Strategic Shift
That has meant dumping the diversification strategy, which dates back to at least the 1960s and early 1970s, when Pfizer and Lilly both bought cosmetics companies, and Bristol Myers bought not only one of the two major baby-formula makers in the U.S. but also opened its own Hollywood movie studio. (The studio produced The Taking of Pelham One Two Three, the 1974 classic starring Walter Matthau as a New York cop facing off against subway hijackers.) The idea, broadly, was to hedge against the inherent risk of developing new drugs and to offer cushions for when patents and exclusivity periods on those drugs expired.

The logic lasted for decades. GSKs chief strategy officer, David Redfern, says that the consumer health joint venture with Pfizer that the company is spinning off in July has provided stable cash flow to GSK, and thats been important, particularly as we went through things like the Seretide/Advair patent cliff, referring to a GSK asthma drug that began to face competition in the U.S. in early 2019.

GSK, which changed its name from GlaxoSmithKline in May, previewed its plans to separate out its consumer-health joint venture with Pfizer as early as 2018. Years of planning will come to fruition on July 18, when Haleon, as the new business will be named, is expected to begin trading on the London Stock Exchange . GSK, the stay-behind company, is projecting compound annual sales growth of 5% through 2026. Sales were 34.1 billion pounds sterling (about $41 billion) in 2021, including 9.6 billion in consumer health; the company expects to surpass 33 billion in annual sales again by 2031.

The fundamental dynamics of the biopharma industry are pretty attractive, Redfern says. GSK sees global demand for healthcare ramping up, while scientific advances allow unmet needs to be met. Thats what were going to invest behind, he says.

GSK, itself formed through a series of consolidations culminating in 2000, is following the same logic that has compelled so many of its peers. By the mid-2000s, investors and executives had soured on the diversification strategy. For one thing, investors didnt always seem comforted by steady revenue from side businesses when faced with a patent cliff. Pfizers valuation tanked in the years before Lipitor, its mega-blockbuster cholesterol treatment, was set to face competition from generics in the U.S., despite Pfizer at the time having an animal health division, a consumer healthcare division, and an infant-formula business. I dont think most shareholders and most analysts really cared a whole lot about that, says John LaMattina, Pfizers president of research and development in the lead-up to the Lipitor patent cliff.

Dissatisfied with the limits of the diversified conglomerate, investors have pushed the pharmaceutical firms toward more-focused models. The general thesis, from the investor side, is if I want to invest in an animal health company, I can invest in an animal health company, says Vamil Divan, an analyst at Mizuho . Let investors diversify their own portfolios, the thinking goes, and let the drugmakers focus on making drugs.

Heart Disease is still the No. 1 killer, and yet a lot of pharma companies are moving out of that field.
Kenneth Kaitin, former director of the Tufts Center for the Study of Drug Development

One important proof point was the 2013 deal in which Abbott Laboratories (ABT), a diversified company with infant-formula, diagnostics, and medical-devices divisions, spun off its branded pharmaceutical arm as AbbVie, a pure-play biopharma that sells the arthritis drug Humira, one of the bestselling pharmaceuticals in history. AbbVie pays a hefty dividend; its shares, including dividends, have returned about 500% since the spinoff, over a period in which the S&P 500 has returned about 220%.

Diversifications Denouement
Taken together, the pricing innovations and scientific advances have resulted in a steady shift among the Big Pharma firms toward a model close to that of Big Biotech. You can see it in the therapeutic areas on which much of Big Pharma is now focusedareas where biotech previously specialized. Almost every one of the companies lists oncology as a focus area. Many, like Lilly, AbbVie, and Pfizer, list immunology, an area where biologics have found enormous markets. Some, like Pfizer and AstraZeneca, list rare diseases.

At the same time, many of the Big Pharma firms, with a few notable exceptions, have stepped away from neuroscience. Diabetes and heart disease get attention from only a few of the companies. Heart disease is still the No. 1 killer, and yet a lot of pharma companies are moving out of that field just because its competitive, and its hard to bring products to market, Kaitin says.

There is a sound reason for some of these shifts. Pfizers old blockbuster Lipitor is a good drug; developing a better alternative to Lipitor and its cousins, all now available as cheap generics, is hard. Neuroscience, too, has proven extremely challenging. Limits in scientific understanding of Alzheimers disease, for instance, have so far hobbled attempts to introduce treatments despite the looming healthcare crisis the disease represents.

Joe Wolk, the chief financial officer at Johnson & Johnson and a key player in the companys plan to separate its consumer health division, says that advances in science determine what kind of drugs pharmaceutical firms focus on developing. He argues that, even without its consumer health division, Johnson & Johnson remains diversified. Even with the separation, J&J will remain a supremely diverse company, he says. Weve got 25 products that generate more than a billion dollars in [annual] revenue, so were not like some other companies, singularly dependent on a product or two for our overall companys performance.

How to Invest
For investors, it may simply be time to change how they think about Big Pharma. The risks associated with patent cliffs remain, but the opportunities are obvious. If youre going to be pharma-focused, youre going to have these ups and downs, Mizuhos Divan says. Investors are sort of OK with that. That is what a pharma company is.

Its an opportunity for stock picking. Investors searching for the strongest bets in the sector could look to Lilly, even though the stock trades for 33 times the next 12 months expected earnings, a valuation far above its peers. Thats due in part to a potential blockbuster obesity drug called Mounjaro. The drug, approved to treat diabetes, has shown impressive efficacy in weight loss, and the company hopes to show it can offer a range of health benefits. Unlike other blockbusters, it could address some of the leading causes of death in the U.S.

Pfizer shares, too, seem likely to climb. The stock is trading at a valuation that seems to underestimate the durability of its Covid-19 vaccine and therapeutic franchises, and to give too little credit to the abilities of Pfizers research and business development arms to surmount coming patent cliffs.

As for GSK, the stay-behind biopharma business looks strong, with opportunities in HIV treatment, a powerhouse shingles vaccine, and promising data from a new experimental drug to treat respiratory syncytial virus, among other programs. A share bought today, however, will also give you a share of Haleon, and thats a less certain bet. Pfizer and GSK both plan to sell shares in the joint venture once Haleon goes public; how Haleon shares will hold up is hard to predict. Investors interested in GSK itself, then, might want to wait until after the spinoff to place their bets.

The implications for the broader healthcare system are tougher. Kaitin says that, in the end, its the science that must catch up: It hurts the broader population, in that there isnt more investigation into areas with high degrees of morbidity and mortality.


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