November 17, 2008 / 12:17 PM / 10 years ago

Pharma struggles to adapt as patents expire

NEW YORK (Reuters) - New threats to drug makers’ revenues are rising even as the industry maneuvers to plug huge holes from looming patent expirations.

Top pharmaceutical companies 2009 estimated EPS growth. REUTERS/Graphics

A newly elected U.S. administration under President-elect Barack Obama brings concerns over pricing and further potential scrutiny, at a time when drug companies have already faced increased uncertainty from the regulators of their products.

And although investors traditionally see the drug industry as insulated from rocky economic times, there are signs the global turmoil is taking its toll and forcing consumers to cut back on their medicines.

These issues arise as drug companies near a brutal period when many of their blockbuster products will lose patents and see sales eroded by generic rivals. Meanwhile, the industry has spent billions on research with insufficient return.

To some, the industry’s struggles demand drastic change.

“We would not be buyers of the sector at current levels until we see signs that managements are beginning to take bold action to control their destiny,” Jami Rubin, a U.S. pharmaceuticals analyst for Goldman Sachs, said in a recent research report.

Leaders of many of the world’s top pharmaceutical companies — including Pfizer Inc (PFE.N), Merck & Co (MRK.N), AstraZeneca (AZN.L), Bayer AG BAYG.DE and Daiichi Sankyo (4568.T) — will address these challenges this week at the Reuters Health Summit in New York.

Others guests from the biotech and specialty pharmaceutical industries include Gilead Sciences Inc (GILD.O), Amgen Inc (AMGN.O), Shire Plc (SHP.L), and Elan Corp ELN.I, as well as chief executive officers of top health insurers WellPoint Inc WLP.N and Aetna Inc (AET.N), which face their own set of challenges with a new U.S. political landscape.

To be sure, the pharmaceutical industry overall has proven to be a defensive investment in weak economic times. This year, the American Stock Exchange Pharmaceutical index .DRG of large U.S. and European drug makers has fallen 23 percent, compared with a 40 percent drop for the S&P 500 index .SPX.

With investors worried about balance sheets like never before because of the credit crisis, health-care products companies overall can boast better liquidity than any other sector except for information technology, according to a recent report from Credit Suisse.

The market turbulence created another silver lining for cash-rich drug makers: the chance to pick off biotech companies or other assets with dramatically depressed valuations.

Indeed, as Eli Lilly & Co’s (LLY.N) purchase of ImClone Systems Inc IMCL.O shows, pharmaceutical companies may seek to buy themselves out of their patent expiration and pipeline woes.

A pharmacist in a file photo. REUTERS/Marcos Brindicci

But just as the current climate yields opportunities, problems may be on the horizon.

The Obama administration’s appointments in key areas that oversee the industry — such as the commissioner of the U.S. Food and Drug Administration and secretary of Health and Human Services — could lead to tighter regulation.

A Democratic-led Congress may seek to allow the U.S. Medicare health program for seniors to have direct negotiations with drug makers, which have long feared such a move would lead to price controls. The possibility of broader U.S. health-care reform is also a wildcard.

“This administration, although I suspect it won’t be as bad as rhetoric would suggest, will be more pro-regulation and they will eventually deal with pricing issues,” said Miller Tabak analyst Les Funtleyder.

Drug sales in the United States, the world’s largest pharmaceutical market, are expected to climb only 1 percent to 2 percent next year, according to market research firm IMS Health. The economic downturn is a factor, as people may cut back prescriptions as they lose health insurance or face costly co-payments.

“The reality is the economy is having an impact on people’s utilization of drugs,” Funtleyder said.

This compounds the patent problems that many of the large pharmaceutical companies face into the next decade, including Pfizer, Merck and AstraZeneca.

Goldman’s Rubin, who covers the six major U.S.-based companies, calculates that around $60 billion in pharmaceutical revenue will disappear due to generic rivals between 2007 and 2015. She projects the industry’s revenue will grow 3 percent from 2007 to 2011, but decline 3 percent from 2011 to 2015.

Revenue growth for seven large U.S. pharmaceutical companies is expected to average 5.1 percent over the next decade, according to Thomson Reuters Proprietary Research. That growth is a far cry from the double-digit sales increases during the industry’s boom times in the late 1990s.

Companies have begun adapting to the challenges through a variety of strategies.

Some, like GlaxoSmithKline (GSK.L) and Novartis NOVN.VX, are diversifying more heavily into areas such as over-the-counter products, generic drugs and emerging markets.

Pfizer and other drug makers are also narrowing their research to focus on potentially lucrative disease areas such as cancer and pushing more into pricier biotech medicines that are less vulnerable to generic competition.

And companies such as Eli Lilly are pursuing new business partnerships to share the risks of developing new treatments for areas such as Alzheimer’s disease, or outsourcing functions like research to cut costs.

“The pharma company of the future needs a new business model and/or capital and cost structure to prosper into the next decade,” Rubin said.

Editing by Richard Chang

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