The Global Pharma universe today has low valuation multiples, definitive five-year free cash flows and a strong dividend yield which hedges the downside, while dwindling R&D productivity and an uncertain pricing environment rules out any major upside for this universe. Although fundamental growth drivers like higher prevalence of chronic illnesses and an aging population remain intact, in this challenging environment, where is Global Pharma headed?

Pricing Rationalization is Just a Matter of Time

The US, which to date has been the largest pharma market, will be forced to give into economic pressure and pricing flexibility will be increasingly difficult.

US is the highest spender on healthcare: The US spends twice the number of healthcare dollars per capita than any other major industrialized nation. This is despite the fact that in 2007, 21% of total prescription drug sales and 65% of total prescriptions dispensed were for generic drugs. Over the past 30 years, US healthcare expenditures have grown at 2.8% per annum; faster, on an average, than the rest of the economy. If this continues, in another 30 years, healthcare expenditures will consume 30% of the gross domestic product – a proportion that exceeds the current government spending for all other purposes combined! The retail prescription drug prices increased an average of 6.9% a year from 1997 to 2007 more than two and a half times the average annual inflation rate of 2.6% over the same period. The current recession will likely result in a growth of enrollment to medical insurance, as unemployment increases and employer sponsored coverage declines. This escalating healthcare burden is not sustainable.

 Increasing copayment is not viable: There is little flexibility for insurance companies to increase copayment levels from patients since they are already at 25% and among the highest when compared to other developed nations.

Payors’ bargaining power will grow with greater availability of therapeutic and generic substitutes, putting a further squeeze on prices.

Cancer drug prices are aggressive and can only go down: The oncology market has shown remarkable growth in recent years, driven by a high level of unmet need. While this will provide companies with opportunities, increasing pharmaco-economic vigilance from cash-strapped healthcare payment systems will keep prices in check.

 Combinations of two drugs (biologics or chemicals) are being increasingly used in clinical trials. Such combinations, which may provide higher efficacy and lower individual side effects, will reduce the acceptance of new expensive drugs.

President-elect Obama’s Agenda: With a view to control healthcare expenditure, the US President-elect has suggested measures like re-importation of drugs, greater generic drug use by Medicare, Medicaid, etc, and establishing a government institute for comparative research between drugs.

R&D productivity – Economy-Driven Slowdown by the FDA?

Of late, The US Food and Drug Administration (FDA) appears hesitant to approve drugs merely on acceptable efficacy and safety data from clinical trials. The drug must prove better than an existing therapeutic option or address a large unmet need. Merely being “non inferior” or having a different mechanism of action may not be enough. R&D output is thus dwindling while several patented drugs face generic exposure in the near future. Global Pharma companies reported cumulative pharma sales of ~$360b in 2007. If Global Pharma were to just maintain these revenues, they need to get 200 New Molecular Entities (at an average peak sales of $750m) approved by the FDA in next eight years – that is 25 NMEs every year! This is obviously impossible.

The FDA approved only 18 NMEs (nine from global companies) in 2007, the lowest single-year number since 1983. Until third quarter 2008, 15 NMEs/biologics had been approved of which the Global Pharma share is only five; missing the requirement by 23. Two hundred and sixty NME’s /biologics were approved from 1993 to 2000, while for the period between 2001 and 2008 only 165 have been approved. This decline in productivity comes at a time when the worldwide pharmaceutical industry is estimated to be spending more than $40 billion each year on R&D activities!

Emerging Markets – Much Ado About Nothing

Emerging markets like Brazil, Russia, India, China, South Africa and Turkey, much hyped by all as growth drivers of the future, have been unable to deliver. These are extremely price sensitive markets with very little reimbursement. The biggest brand in India clocks revenues of $20m, while most “blockbusters” reach their plateau at ~$7m, around two years after the launch. In China as well, peak sales of any expensive patented product cannot break the $25m barrier. Assuming Global Pharma companies take 35% share in the emerging markets, the yield would be $10b in annual sales, a small fraction (2.5%) of the current base. Inability of the governments to subsidize high priced medicines for large patient pools and pharmaco-economics decisions at the physician and patient family levels will not allow high growth rates from these markets in the foreseeable future. Biogen Idec launched its product Avonex for Multiple Sclerosis through Nicholas Piramal (market leader ranked 4th in India), but generated poor demand as the product was sold at its US price.

THE WAY AHEAD

The Global Pharma business model that is best suited to meet the challenges will have the following characteristics:

• A large portfolio with moderately priced products that serves the need of larger patient populations versus premium priced products with limited use.
• Innovation risk hedged by a presence in OTC/Generics/Diagnostic/Animal Health.
• A balanced spread of revenues across markets including emerging markets, with a strong base business driven by patent-expired/generic products
• Increased “externalization” of R&D through in-licensing, etc. vs. in-house R&D to improve Global Pharma’s risk-reward scenario
• A dynamic management willing to take austerity measures

Use the cash! Robust free cash flow and net cash position can be leveraged in this economic downturn to make sensible acquisitions. As valuations have taken a hit across the healthcare sector, it is an opportune time for Global companies to use the mileage of their cash positions to make small-mid size acquisitions. Pfizer, Roche, Merck and Novartis are well positioned to leverage this opportunity