The following post is sponsored by GE Capital Healthcare Financial Services.
The biopharmaceutical industry is a mix of opportunities: from wins earned through negotiations over the Accountable Care Act to coming battles over reimbursement. In this article, Savant Ahmed, a senior vice president at GE Capital Healthcare Financial Services, discusses the current status of the industry and provides an outlook on the opportunities and challenges for biopharmaceutical investors.
Q. What is the state of the biopharmaceutical industry?
A. Broadly speaking, the fundamentals of the biopharmaceutical industry continue to improve due to three main factors.
First, the generic cliff is receding for the industry as a whole, essentially removing the earnings drag that the industry has experienced for the last several years.
Second, the R&D pipelines continue to improve, as FDA approvals in 2011 and 2012 set multiyear records, and confidence in the commercial potential of late-stage pipelines remains high.
Third, the industry continues to make better capital allocation decisions related to internal R&D, share buybacks, and dividends and acquisitions/divestitures. These dynamics are also positively impacting ancillary sectors such as contract research organizations (CROs) and contract manufacturing organizations (CMOs) among others.
A Deep-dive Into Specialty Pharma
A specialty drug is a class of prescription medications used to treat complex, chronic or rare medical conditions. Although this classification was originally intended to define the treatment of rare, also termed “orphan” diseases, affecting fewer than 200,000 people in the US, more recently, specialty drugs have emerged as the cornerstone of treatment for chronic and complex diseases such as cancer, autoimmune conditions, diabetes, hepatitis C, and HIV/AIDS.
These positives are clearly reflected in the public markets where pharmaceutical, Biotech, CRO and CMO indices are trading at multiyear highs in terms of forward price-to-earnings (PE) ratios. Additionally, the last year has been among the most productive for Biotech initial public offerings (IPOs). Conversely, the receding generic cliff is leading to muted valuations for generics players.
This is not to detract from challenges that remain. With healthcare systems around the world under pressure, reimbursement issues, especially for modestly differentiated drugs, remain front and center. Further, emerging markets remain promising but challenging. Consequently, the key for the industry going forward will be to continue to improve R&D productivity and commercialize drugs that represent a true advance to current treatment.
Q. What is the latest with regard to industry regulation and oversight by the FDA?
A. On the pre-market side, there is clearly positive momentum with the FDA approving 35 new molecular entities (NMEs) in 2011 and 39 in 2012 – both multiyear highs.
Some of the approvals suggest that the FDA continues to get better at evaluating the risk-benefit profile of drugs and pragmatically working with companies to develop post marketing clinical and marketing requirements (for example Risk Evaluation and Mitigation Strategies or REMS) that get the drugs on the market quickly but restrict use to target populations. The FDA continues to be supportive of new methodologies like Adaptive trials, risk-based monitoring and model-based drug development that have the potential to expedite drug development and at the same time cut costs of development.
Finally, anecdotal evidence suggests that the FDA is getting better at communicating clinical study and approval requirements to companies during the drug development process.
On the post-market side, the FDA continues to demonstrate heightened enforcement activity around cGMP (current Good Manufacturing Practices) and product labeling/marketing issues. Our view is that, in the mid to long term these efforts will make the industry more ‘investable’ by improving industry practices and providing a competitive advantage to players with high quality operations.
Q. What about healthcare reform? Any visible trends investors should know about?
A. The biopharmaceutical industry was very supportive of the Affordable Care Act (ACA), willing to trade additional fees and rebates for increased access, longer exclusivity periods for biological drugs, and, most importantly, continued free pricing of drugs. In terms of continuing healthcare reform, the main risks to the industry are curtailing the exclusivity period for biologics and, more importantly, reimbursing dual eligibles (eligible for both Medicare and Medicaid) at the (lower) Medicaid rates.
Beyond these issues, an increasingly challenging provider reimbursement landscape and the emergence of new payment models represent incremental challenges that companies must navigate.
Q: What’s the outlook for investors?
A. On balance, we feel that the opportunities for the biopharmaceutical industry significantly outweigh the risks. We see continued improvements in R&D productivity as the main driver of valuation for the biopharmaceutical industry and the delivery of innovative medicines as the key bulwark against reimbursement pressures. Biopharmaceutical expenditures represent only 10 percent of healthcare expenditures in the U.S. and there is ample evidence that appropriate use of many drugs can lower overall costs to the healthcare system.
In this regard, we remain optimistic as many business intelligence services forecast that the commercial potential of late-stage pipelines is at multiyear highs and generalist investor interest in the industry remains high.
Finally, we believe that both acquisitions and divestitures will play a central role in the evolution of the industry going forward – but the focus will remain on high quality assets and the paucity of these assets will stretch valuations.
