The Right Remedies

Research’s Health Care Guide:

• Beckman Coulter Inc. (BEC)
• Roche Holding AG (RHHBY)
• Watson Pharmaceuticals Inc. (WPI)

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Karen Andersen, CFA
Morningstar
312-384-4826
[email protected]

Senior pharmaceutical analyst Damien Conover wrote about the challenges of patent expirations in an article earlier this year, citing the 2011 patent cliff as a hurdle that large pharma firms are being forced to combat with heftier drug pipelines and sizeable acquisitions. However, these patent expirations are tied to small molecule (or conventional) drugs — produced in a lab via chemical synthesis.

In contrast, most biotech drugs, or biologics, are manufactured using living cells. With a few exceptions relating to the oldest biologics, there is no pathway for the approval of generic versions of biologics (or “biosimilars”) in the United States, and the complexity of biologics manufacturing has so far prevented a new law allowing such products from making its way through Congress.

While drug spending growth has moderated since 2007, as several blockbuster drugs begin to experience generic competition, the lack of a regulatory pathway for biosimilars has left branded biologics largely immune to such pressure in the U.S. The passage of large-scale health-care reform hinges on finding ways to pay for universal coverage, and biosimilars could find a place within such legislation this summer.

Biosimilar drugmakers face many new challenges not seen with small molecule generics, such as steeper costs related to manufacturing, development, and marketing. Patients and physicians could be hesitant to switch to biosimilars due to fears over quality and efficacy. Insurers could even have a hard time encouraging their use; biologics are usually reimbursed as medical benefits, not pharmacy benefits, and therefore don’t have the tiered formularies and co-pays that pharmacy drugs do.

We think all of these challenges would conspire to allow branded biotech to retain significant market share beyond patent expirations. In addition, small market share and high development costs would force biosimilar drugmakers to price their products at levels approaching those of branded alternatives, reducing the cost-savings potential of an emerging biosimilar industry.

We expect pending legislation to give biotechs the exclusivity they need to remain innovative and profitable. The debate over the long-term effect of biosimilars on biotech firms really comes down to innovation, and most of the bigger biotechs are well-positioned to create either improved versions of their current drugs or completely novel drugs by the time biosimilars enter their markets.

Roche’s first-half results were slightly stronger than our estimates, as the Genentech acquisition appears to be producing larger and more rapid synergies than we had anticipated, and sales growth in Roche’s pharmaceutical and diagnostic divisions are surpassing comparable market growth by a wide margin.

We’re maintaining our fair value estimate, and we continue to believe that low generic and biosimilar exposure – as well as a broad, innovative portfolio of products and drug candidates – give Roche the strongest competitive advantage in biotech.

As a market leader in both biotech and diagnostics, Roche is in a unique position to guide global health care into a safer, more personalized and more cost-effective endeavor. Key acquisitions, such as Ventana Medical and Genentech, complement this firm’s innovative offerings, and we’re confident in the sustainability of Roche’s competitive advantages.

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Michael Tong, CFA
Wells Fargo Securities
212-214-8020
[email protected]