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Pharma Patent Ruling Pinches Opportunities in Emerging Markets

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The decision by an Indian court not to grant a new patent to drug firm Novartis for a modified form of its cancer drug Glivec (known as Gleevec in the U.S.) was a heavy blow to the company. It may be more than that, though, as other pharmaceutical companies had been eagerly awaiting the outcome of the case, because of the bearing it has on their own businesses in India and in other emerging-market countries.

For those companies, the news is not good. The ruling signals higher risk in emerging markets for pharmaceutical companies, according to Fitch Ratings. However, it is not necessarily bad news for international investors, who may want to turn their attention instead to the makers of generic drugs in India. Here’s why.

Novartis had been fighting in India for the right to patent the new version of Glivec since 2006. While Novartis holds patents in almost 40 other countries for Glivec, the original drug was not patented in India because it was developed before the country’s patent law was passed in 2005. In its decision, what the Indian court did was to strike a blow against “evergreening” or the practice by drug companies of developing a slightly different version of a successful drug and obtaining a patent on that new version.

Evergreening is common practice among pharmaceutical companies, who seek to sustain patents for as long as possible on the drugs they develop because of the high cost of development: it can run more than $1 billion on average, according to Fitch, for a company to develop a drug and bring it to market. This includes the costs of researching failures—drugs that do not survive trials and actually enter the market.

Holding a patent on a highly successful drug, which Glivec is, means substantially higher revenue for the drug company holding the patent. In markets in which Glivec is patented, for instance, it costs patients about $2,600 per month. The generic version costs about $175 in India—which of course makes it accessible to far more patients. HIV drugs have fallen similarly in price with the expiration of patents, from perhaps $10,000 annually to around $150, and some cancer treatments now cost only 3% of their original price, according to figures from Medicins Sans Frontières.

As a result, the Indian court’s decision has been greeted with relief by medical professionals who point to the high cost of patented drugs as an obstacle for the poor in countries all over the world. The Indian patent law contains a provision that specifically addresses evergreening, by only granting patents for drugs that are completely new and not simply variants on existing products.

Novartis isn’t the only company to feel the sting of the Indian patent law. In September, Bayer failed to prevent its drug Nexavar from going generic in India, with Natco Pharma emerging triumphant as the manufacturer of the generic version. (Natco’s stock soared on news of the Glivec decision as well, even as Novartis’s stock fell.)

According to Britta Holt, an analyst at Fitch Ratings, patent protection is an important factor in a company’s rating and has been a reason for mergers and acquisitions in the past. “Within the patent protection period, revenue generated from drug sales is fairly predictable. The pharmaceutical companies usually need this period to recoup the huge group R&D expenses connected with the development of products. Thus a product portfolio with a lengthy patent protection period is a positive credit factor,” she stated in a research report.

In addition, large companies benefit, she said, from diversification and economies of scale for research. Having several different drugs in the pipeline at various stages of development “is important given the high risk coupled with a long research cycle.” Smaller companies carry lower ratings typically for their lesser ability to reap such “economies of scale in R&D, marketing and from other cost efficiencies,” according to the report.

Still, while large pharmaceutical companies cannot look forward to an indefinite series of patents in India—or, for that matter, in China, where in June of last year intellectual property laws were modified to allow government issuance of compulsory licenses for domestic generic drugmakers to produce products that are still under patent elsewhere, for “reasons of public health”—Fitch expects emerging markets to offer the main opportunity for growth of large pharmaceutical firms in the next few years, driven by both economic and population growth.

European drug makers have suffered recently, according to Holt, from patent expiry in the U.S. and in Europe, as well as from structural problems in the European market that has seen drug companies’ prices decline by mid-single digits. This loss in profitability across Europe—with AstraZeneca logging a drop of 19% in European sales at constant exchange rates, Sanofi down 9%, GlaxoSmithKline 7%, Novartis 5%, and Roche 2%—has led pharmaceutical companies to look to emerging markets for growth, even as at least one company, GlaxoSmithKline, looks to reduce its exposure in the European market.

While the “patent cliff”—expiring patents—is less than half as severe for 2013 as it was in 2012, it remains a problem for large companies with patents on the verge. As a result, companies are looking toward opportunities elsewhere. Fitch expects M&A activity in emerging markets, despite lower profit margins, because of the potential for growth. Indeed, Brazilian drug company Ache Laboratorios Farmaceuticos, which reportedly engaged Lazard to look into a potential sale of the company, has been attracting attention from a number of companies. Fitch’s expectation is for small-to-medium acquisitions rather than major deals that could imperil a company’s credit profile.

Bayer and Sanofi are best positioned among European pharmaceutical companies to take advantage of emerging market growth, since both already have a substantial share of healthcare sales there—33% for Bayer and 32% for Sanofi, according to Fitch. And while the research firm said it expects sales from mature markets to fall from 2011’s 66% to around 57% in 2015, data analytics company IMS Health has projected that Brazil, China, India, Mexico, Turkey, South Korea, and Russia will account for 30% of the world market in 2016. As of 2011, their share was 20%.