Pharma and Biotech Industry Outlook - July 2010 - Industry Outlook

The pharmaceutical industry has witnessed major changes over the past few quarters, with performance being affected by factors like sluggish prescription trends, intensifying generic competition and limited late-stage catalysts. The next five years are expected to reflect a significant imbalance between new product introductions and patent losses.

According to IMS Health, this is the main reason global pharmaceutical market growth will be restricted to the mid-single digits (5-8%) through 2014. Over the next five years, products that currently generate more than $142 billion in sales are expected to face generic competition, including Lipitor, Plavix and Zyprexa.

At the same time, new products are not expected to generate the same level of sales as products losing patent protection. With revenue growth stalling or slowing down, companies have been resorting to cost-cutting and share buybacks to drive bottom-line growth.

M&A Activity

With most of the big pharma companies already facing or likely to face patent challenges for their blockbuster products, the companies have been looking towards mergers and acquisitions (M&A) and in-licensing deals to make up for the loss of revenues that will arise with key products losing patent exclusivity.

We saw huge M&A activity over the last few quarters. Major deals include Abbott Laboratories’ (ABT) acquisition of Advanced Medical Optics and the pharmaceuticals business of Solvay Group, Johnson & Johnson’s (JNJ) acquisition of Mentor Corp., Pfizer’s (PFE) acquisition of Wyeth, the merger between Merck (MRK) and Schering-Plough, and Merck KGaA’s acquisition of Millipore Corporation.

Sanofi-Aventis’ (SNY) impending acquisition of TargaGen, a privately-held US biopharmaceutical company, is aimed at boosting its oncology portfolio. Another big player, Celgene Corp (CELG), is also on an acquisition spree to boost its oncology portfolio. The company will acquire Abraxis BioScience Inc (ABII) by year-end, having already acquired the privately-held Gloucester Pharmaceuticals earlier in the year. Mylan (MYL) intends to purchase Irish injectable drug maker Bioniche Pharma Holdings Ltd. shortly.

Elsewhere, companies have been looking towards biotech firms to build their product portfolios. Prime examples include Johnson & Johnson’s acquisition of Cougar Biotechnology, Roche’s (RHHBY) acquisition of Genentech, Bristol-Myers Squibbs’ (BMY) acquisition of Medarex, Sanofi-Aventis’ acquisition of Fovea Pharmaceuticals SA, Astellas Pharma’s acquisition of OSI Pharmaceuticals and Abbott’s acquisition of Facet.

We expect this M&A trend to continue. We also expect a significant pickup in in-licensing activities and collaborations for the development of pipeline candidates. Instead of developing a product from scratch, which involves a lot of funds, pharma companies are going shopping for mid-to-late stage pipeline candidates that look promising.

Small biotech companies are also game for in-licensing activities and collaborations. Most of these companies find it challenging to raise cash, thereby making it difficult for them to survive and continue with the development of promising pipeline candidates. Therefore, it makes sense for them to seek deals with pharma companies that are sitting on huge piles of cash.

We would recommend investors to put their money in biotech stocks that have attractive pipeline candidates or technology that can be used for the development of novel therapeutics. Therapeutic areas which could see a lot of in-licensing activity include oncology, central nervous system disorders, diabetes and immunology/inflammation.

Emerging Markets

Another recent trend seen in the pharmaceutical sector is a focus on emerging markets. Companies like Mylan Inc., Pfizer, Eli Lilly (LLY), GlaxoSmithKline (GSK) and Sanofi-Aventis are all looking to expand their presence in India, China, Brazil and other emerging markets. Until recently, most of the commercialization efforts were focused on the U.S. market -- the largest pharmaceutical market -- along with Europe and Japan.

However, emerging markets are slowly and steadily gaining more importance and several companies are now shifting their focus to these areas. IMS Health estimates that these markets will grow 14-17% through 2014, while major developed markets will grow only 3-6%. Although the U.S. will retain its position as the single largest market (estimated growth: 3-6% annually in the next five years), China will soon become the third largest market in the world.

According to IMS Health, China’s pharmaceutical market is expected to continue to grow more than 20% annually, and contribute 21% of overall global growth through 2013. Growth in emerging markets could help stabilize the base business during the industry’s 2010-15 patent cliff.

OPPORTUNITIES

We are positive on AmerisourceBergen (ABC) on which we have an Outperform rating. We believe the company, which posted strong second quarter fiscal 2010 results, is well-positioned for growth given the strong performance of its generics and specialty business. Furthermore, AmerisourceBergen boasts of a robust plasma and vaccine business with strong revenues expected to flow from it in the coming quarters as well.

In the pharma space, we have a positive outlook on Alcon (ACL). We believe Alcon will continue witnessing revenue growth based on continued international penetration, new product launches and market share expansion. Pipeline expansion through in-licensing deals and acquisitions should also add to growth.

Although we have Neutral ratings on names like Johnson & Johnson and Abbott, we maintain a positive outlook on these stocks given their diversified revenue base, strong business segments, contributions from recent acquisitions and impressive late-stage pipeline. We also have a positive outlook on Bristol-Myers, which has a strong presence in attractive areas like biologics, cancer and cardiovascular drugs.

In the biotech space, we are positive on names like Gilead Sciences (GILD) and Biogen Idec (BIIB) even though we have Neutral recommendations on these stocks. Gilead’s HIV franchise has been helping the company post better-than-expected earnings over the past few quarters, and we expect this trend to continue. Gilead is looking at increasing its presence in the Asian market for hepatitis B virus (HBV), where the infection is quite prevalent. We are encouraged by progress made by the company with its pipeline.

Biotech companies that could be acquisition targets provide opportunities for significant returns. Here, we would like to mention two companies that could be potential take-out targets -- Biogen Idec and Acorda Therapeutics (ACOR). In addition to holding a leading position in the multiple sclerosis market, we believe Biogen has the best pipeline in all of biotech and could be an attractive takeover candidate for pharma companies interested in biologics.

WEAKNESSES

We recommend avoiding names that offer little growth or opportunity for a take-out. These include companies which are developing drugs that are likely to face regulatory hurdles. The US Food and Drug Administration (FDA) has been exercising more caution before granting approval to new products and several candidates have been facing delays in receiving final approval.

For example, the FDA delayed the approval of Bydureon the lead pipeline candidate at Alkermes (ALKS), on which we have an Underperform rating. In its complete response letter (CRL), the agency asked co-developers Alkermes, Eli Lilly & Co and Amylin Pharmaceuticals, Inc. (AMLN) to finalize the label and provide a Risk Evaluation and Mitigation Strategy and clarification on existing manufacturing processes. Following the response to the CRL by the companies, the U.S. agency has set October 22, 2010 as the target date for deciding on the type II diabetes candidate.

We believe the final label will contain warnings regarding the risk of pancreatitis and thyroid cancer, on approval. Furthermore, the candidate will face intense competition once it enters the market.

We are also negative on Onyx Pharmaceuticals (ONXX), which slipped to a loss during the first quarter of 2010 driven by an increase in operating expenses. Furthermore, the failure of Nexavar to prolong overall survival in patients suffering from advanced non-squamous non-small cell lung cancer (NSCLC) in a late stage study is a setback for the company.

We would avoid companies like Eli Lilly & Co. (LLY) and Forest Labs (FRX), which are facing patent expirations on key products and do not have a solid pipeline to make up for the loss of revenues that will take place once generics enter the market. Another name that comes to mind is The Medicines Company (MDCO) -- our biggest concern with the stock is that lead product, Angiomax, will most likely lose patent exclusivity in the U.S. later this year, and the entry of generics would be devastating for the company.

Meanwhile, we continue to believe Pfizer’s acquisition of Wyeth will create an even bigger struggling company. Both companies have significant patent expirations in the years to come, and both have been severely lacking in their R&D productivity over the past few years. We recommend avoiding these names.

In the biotech sector, we would avoid Genzyme Corporation (GENZ), which has been under a lot of pressure over the past few quarters following the temporary shutdown of its Allston manufacturing facility due to contamination problems. Although the company has resumed production at the plant, we note that the company is still struggling with its supply schedule. Genzyme took a $175 million charge in the first quarter related to the consent decree that will be implemented by the FDA for the company’s manufacturing plant.Zacks Investment Research