Despite significant positive catalysts, record patent expirations end in 2012.
By Brian Laegeler, CPA 12-22-08 06:00 AM
No one can deny the significant positive catalysts ahead for the U.S. generic drug industry during Barack Obama's first term. The president-elect favors:
- significant increases in insurance coverage
- increased generic drug utilization in the name of cost containment
- greater Food and Drug Administration resources to speed along generic drug applications
- a new legislative pathway for generic biologics
- other pro-generic industry reforms, such as the reduction of authorized generics and state carve-outs.
In addition, a historic $19 billion of branded drug sales per year are slated to lose patent protection between 2009 and 2012.
Despite this positive outlook, it could be game over in 2013, when the average year's pipeline is halved from $20 billion to $10 billion. Halving the pipeline would cut off oxygen to an industry that, because of price erosion in the existing business, requires new product launches for growth. Under this scenario, a major price war could crush margins and growth.
Although the generic drug industry is typically hypercompetitive, price wars can occur in any year that there isn't enough growth to go around. Small players have to cut prices to an irrational level to gain share, and larger players end up having to match the price of their most desperate competitors.
The last price war that we recall at the manufacturer's level occurred in late 2004 to the first half of 2005. Despite record patent expirations, the industry had matured to the point where smaller players became desperate. In our view, pricing only became rational again because of significant catalysts, such as Medicare Part D in 2006, unprecedented industry consolidation in 2007 and 2008, and a 50% increase in annual patent expirations from 2005 to 2006.
Several factors could mitigate the possibility of a major price war in 2013.
Emerging Markets Exposure
Generic drug markets in Eastern Europe, India, and Latin America have significantly higher growth rates than their U.S. counterpart. Several Western European markets, such as Spain, also remain relatively underpenetrated by generics. Major players, including Teva and Mylan, are less exposed to a U.S. slowdown as only a third of their generics business is U.S.-based. Pure domestic players, such as Watson and Par are at the greatest risk of seeing their margins destroyed. Emerging markets have slowed because of the credit crisis, and the patent situation in Western Europe is similar to the U.S. However, we still view international exposure as a positive in this context.
Industry executives argue that generic biologics will usher in a new era of growth based upon the billions of dollars of branded biologics that have yet to face generic competition. Even if a U.S. legislative pathway is approved in 2009, the first major round of generic biologics won't launch until 2013 at the earliest because of a characterization process, limited clinical trials, and application review. Upon approval, they will not take 90% market share upon launch like small molecule generics. Large molecules need to be sold directly to physicians. Plus, we believe big pharma and biopharma could capture at least 50% of this new generics market as they already have the manufacturing, salesforce, and clinical trial expertise.
Perhaps generic drug companies hope to consolidate to the point that pricing will remain rational among a handful of top players. We don't believe the industry will ever be concentrated enough for this to happen. Barriers to entry are too low on a drug-by-drug basis. There are some benefits of being a one-stop shop, but for key drugs, the biggest players will always have to match the craziest price.
The largest generic drug companies have a branded drug component, which could counterbalance a price war in U.S. generics. The branded pipelines will have to be evaluated on a company-by-company basis closer to 2012.
Branded Sales Growth
The nominal branded sales at risk in 2013 and beyond will continue to increase during the next five years. However, growth will become harder to come by in this economic environment. The differential between 2012 and 2013 will not change much as both figures continue to increase.
We're still at least 24 months in front of the peak of this potential bubble. The size of the peak will depend on the significance of Obama's health-care policy, the effectiveness of industry consolidation, and the rate of recovery of global markets. The timing and depth of any decline will depend on how early the market recognizes the Obama catalysts, how soon the market recognizes the upcoming patent expiration problem, and the extent of which market participants are willing to admit that generic biologics are potentially a major disappointment. Even though we're unsure ourselves what exactly will happen, these are the factors and scenarios we'll consider in the years ahead.
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