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Newsletter biotech 10.04The Pictet Funds (LUX)-Biotech Newsletter HEALTHCARE MARKET REVIEW AND OUTLOOK.
Flight to safety but not to healthcare
The recent correction in global equity markets took its toll
on healthcare stocks as well. Based on fear over the build-
up of a speculative bubble on the Chinese exchanges and an
economic slowdown in the USA (as has occurred several
times in the past few years), investors fled the equity markets
in unordered fashion with one thought in mind ; avoid risk,
any risk. Of course, markets recovered most of their losses
in the second half of March, but fear is back.
Again, the fact that healthcare stocks did not fare better than the overall market in a global flight to safety scenario comesa little bit as a surprise. First, the MSCI World Healthcare Index, which gained 1.0% during the quarter vs an increase of 2.1% for the MSCI World Index, has zero exposure toemerging markets. Second, healthcare tends to be more THE BRANDED GENERICS MODEL : HERE TO STAY recession resistant than other segments of the economy. The heavy weight of small and mid caps in industries such as biotechnology (98% of the biotechnology investment universe) does, however, provide some rational explanation for their poor performance in times of heightened risk-aversion.
Mixed news-flow keeps investors at bay
Clearly, being recession resilient and cheap by historical
standards is not enough to attract investor interest. Some
setbacks in the biotechnology industry during the first
quarter held back investors despite its solid long-term
fundamentals. Some of the larger medical technology
companies have yet to prove that they have turned the
corner. The trend reversal of large pharmaceuticals is
happening, although at a slow pace. Overall, news-flow in
the healthcare sector during the last few months has been rather mixed, providing no impetus for investors to commit herein are those of the authors and do notnecessarily reflect those of Sectoral Asset Major pharmaceuticals’ Q4 earnings, while generally of good stature, were less impressive than previous quarters.
solely for purposes of evaluating S.A.M.'s On the regulatory front, Sanofi faced delays and dis- advisory services. It is not an offer of any appointments with Acomplia in both Europe and the US, fund's securities. Past performance is no Novartis failed to gain US licensure for its DPP IV inhibitor guarantee of future results. Investing in Galvus but did get approval for its novel anti-hypertensive drug Tekturna, a renin inhibitor, while in the last week of the quarter two drugs were pulled from the market over safetyconcerns, Eli Lilly’s (and Valeant’s) Permax and Novartis’ companies' stocks may be very volatile.
Zelnorm. Permax, a drug for the treatment of Parkinson’s disease, had been linked to heart valve damage in 2002, and has since gonegeneric. Its withdrawal is inconsequential. On the other hand, Zelnorm’s market suspension is a major commercial setback for Novartis, although the risk oflitigation is minimal. After a long winding way through the regulatory processand a slow sales ramp, the drug had finally become a significant sales contributorfor Novartis (2006 sales : USD561m). The irritable bowel disease drug wassuspended from the market over evidence linking Zelnorm to increased risk of Pictet Funds (LUX)-
Noticeably, companies in the industry are forging ahead with strategicreorientation and portfolio reshuffling. Abbott sold its core laboratorydiagnostics business to GE for USD8.13bn in cash, while Schering Ploughacquired Akzo Nobel’s pharmaceutical business in a deal valued at USD14.4bn.
These deals, while significant, have failed to move the markets. They are, however,important signs of fundamental strategic reorientation at major pharmaceuticals,which should lead to a pick-up in growth and profitability as of 2008, a theme wehave highlighted before.
Major medical technology firms continued to struggle with problems from therecent past. The drug eluting stent market took a nosedive over persistent safetyconcerns about these devices, while the much anticipated ICD market recoveryhas so far failed to materialize. Here, we are somewhat less optimistic about theimminence of a recovery, particularly for drug eluting stents. We note, however,that the traditional orthopedic manufacturers continue to do well.
Specialty pharmaceuticals and generics stand out with the strongest news-flowsince the beginning of the year. Major generic players such as Teva, Stada andZentiva all reported solid 2006 results and expressed optimistic views about 2007.
M&A continued with Shire’s acquisition of New River for USD2.6bn and Zentiva’spurchase of a 75% stake in Turkey’s Eczacibasi for EUR460m, highlighting theinteresting potential existing in eastern European markets (discussed in previouseditions of our Newsletter). On the legislative front, we note the introduction ofa bill to prohibit authorized generics, the "Access to Life Saving Medicine Act"which could pave the way for a regulatory pathway for biosimilars, and potentialrestrictions on the ability of innovator companies to settle with generics.
Although none of these are assured of being passed, they could have a positiveimpact on the generics sector (especially the authorized generics in the short term).
News-flow in the biotechnology space was largely dominated by reimbursementlimitations for Amgen’s Aranesp in the US, and growing concerns about thepricing of some high profile biotechnology drugs. This didn’t prevent Alexionfrom pricing its recently approved Soliris at USD389,000 p.a. for the treatment ofParoxysmal Nocturnal Hemoglobinuria, a rare blood disorder. Clinical news wererather negative with Achillion and Gilead’s decision to halt development of theirHep C compound, Amgen’s failure with Vectibix, albeit giving a welcome boostto Erbitux (Imclone), Novoseven’s failure in stroke (Novo-Nordisk), Dynavax’ inconclusive data with its allergy vaccine and the failure of Intermune’sActimmune to improve the status of patients with idiopathic pulmonary fibrosis(IPF). There were a few positive surprises though with the success of Onyx’ Nexavar in hepatocellular carcinoma and Shionogi’s positive phase III data forPirfenidone in IPF (a plus for Intermune, which holds the US rights to the drug).
Ranexa’s (CV Therapeutics) results in the MERLIN study are best characterizedas mixed. While the drug did not improve clinical outcomes in patients with acutecoronary syndrome, it did clearly establish its safety and usefulness in treating Pictet Funds (LUX)-
chronic angina, which should allow the drug to be used more broadly.
The regulatory environment is far better than what the two recent productwithdrawals suggest. So far this year, the FDA has approved two biotech drugs– both representing significant innovations over standard of care and addressinghigh unmet medical needs – Speedel’s Tekturna and Alexion’s Soliris. Also, late inthe quarter a scientific advisory panel gave its first endorsement of cancerimmunotherapy to Dendreon’s product Provenge, despite rather mixed clinicalresults. Finally, on the follow-on biologic front it clearly appears as though clinicaltrials will be required – a not insignificant financial disincentive for genericmanufacturers – in order to get follow-on biologics approved.
To wrap up on what was an uninspiring quarter, we note that the Democrats haveso far failed to produce a clear plan to establish a centralized governmentpurchasing organization, as they had pledged during the election campaign.
Patience has got to be the mother of all virtues
Despite the recent mixed news-flow and disappointing market performance, we
are not particularly concerned about the prospects for healthcare stocks. We
admit though that the wait has been long and that it might take a bit longer before
we see a clear revival of investor interest in healthcare names. While biotechs,
generics and specialty pharmaceuticals should continue to deliver on sales and
earnings growth, as well as on pipeline progress, the turnaround of major
pharmaceutical firms, while underway, will take some time to be clearly apparent.
As this materializes, which we expect to be in the 2007 / early 2008 timeframe, we
expect to see a clear revival of investor interest for healthcare, building the basis
for a broad-based and sustainable increase in healthcare equity prices.
Based on S.A.M. estimates / Median Numbers Our preference remains biotechs for their undiminished growth potential andattractive valuation, selected medical technology players with breakthroughtechnologies, generics, particularly in Eastern Europe, and pharmaceuticals fortheir turnaround potential and equally low valuations.
THE BRANDED GENERICS MODEL :HERE TO STAY OR DISAPPEARING QUICKLY ? While the business model of generic companies worldwide can be summarizedmost simply as supplying less expensive copies of off-patent drugs, significantdifferences exist in the way these pharmaceuticals are sold in different markets.
In the US, generics are essentially a commodity business. The purchase decision Pictet Funds (LUX)-
is made at the level of payors (government, managed care providers, wholesaledistributors and pharmacy chains) and price is the most important differentiatordriving the use of one company’s drug over another. In this free-market model,increased competition led to significant price erosion in recent years, which has putpressure on margins. This in turn has driven consolidation as a means to in-creasing sales volume and lowering costs, as well as getting access to less compe-titive products such as injectables, oncology or extended release formulations.
In Europe, the situation is much more complex. A few countries have evolvedcommodity-like markets, but the majority of European generic players utilize abranded model – employing a sales force to market generic drugs underproprietary brand names. Since the decision maker in Europe is usually thedoctor, companies have a clear incentive to market products directly toprescribing physicians, with the extra cost absorbed by higher pricing.
Additionally, in the developing pharmaceutical markets of Central and EasternEurope (CEE) where access to expensive originator drugs is limited, brandedgenerics play an especially important role since they are often the first accessibleversion. Hence, generic sales forces in these markets tend to play the same rolein educating doctors and building brand awareness and loyalty as originator salesforces do for branded products in Western markets.
Are these two generic models likely to converge ? We believe it’s possible, butunlikely to happen any time soon.
The US model – A real commodity business
The US boasts the largest generics market in the world, with over USD27bn in
annual sales and representing ~60% of all prescription drugs by volume. Generics
are a highly competitive, commodity business in the US. Because pharmacists can
freely substitute generics for branded drugs, there is a strong incentive to stock and
issue the cheapest version available. With an average of 7 competitors per product
for the top 100 generic drugs, the average price discount relative to the original brand
is estimated at 70%-75% within a year of patent expiry (the discount is smaller
for drugs with fewer competitors and can exceed 80% for drugs for which 10 or
more generics are available). Although doctors can take steps to ensure the use of
a branded drug in certain cases, they do not have any input into which generic will
be dispensed. Therefore, companies have no incentive to market their products to
physicians, and instead deal directly with payors and compete based largely on price.
The following policies have helped shape the US generics market into acommodity business : Substitution : Generic substitution is used to promote cost-effective prescriptions.
State substitution laws allow (or require) pharmacists to dispense generics even
when prescriptions are written for branded products. Thus, if a physician
prescribes AstraZeneca’s ulcer drug Losec, the pharmacist can issue omeprazole
from any generic supplier. In most states doctors must take extra steps if they
want to ensure patients receive originator drugs. For example, in New York it is
necessary to write "DAW" (dispense as written) on the prescription, while in
South Dakota a DAW is not honored unless the words "medically necessary" are
added. These regulations drive expanded use of generics and essentially moved
the decision of which drug is used into the pharmacist’s hands.
Payors decide : In the US, healthcare costs are largely borne by commercial
organizations (such as HMOs) or government programs (such as Medicare)
which pay a lot of attention to managing costs. Pharmacy benefit managers
administer formularies (lists of covered drugs) and create incentives such astiered co-payments and mandatory substitution to reduce prescription drugcosts. Through the use of formularies and direct contracting with genericcompanies, these organizations not only control which drugs are reimbursed (andtherefore used), but also which generic version should be used.
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Large pharmacy chains dictate price : The US retail pharmacy market is
dominated by a few large chains, including CVS Corp, Walgreens, and Rite Aid,
which control over 50% of the market for prescription drugs. With the recent
acquisition of the leading pharmacy benefits manager Caremark, CVS alone is
set to dispense almost one billion prescriptions per year, more than a quarter of
the US total. Such large customers enjoy a lot of leverage in sourcing
pharmaceuticals, especially generics which have few differentiating features
other than price.
Patient co-pays : Of course, if a doctor or patient insists on an originator product,
the patient is able to receive it, albeit at substantially higher co-pays. These act as
a deterrent, making tiered formularies very effective in modifying consumer
behavior and driving higher generic utilization. Additionally, US pharmacies buy
drugs in bulk and dispense using neutral, unmarked containers, therefore
patients often do not know who manufactured their drugs, and hence do not
establish any brand loyalty.
Given these industry dynamics, a broad product portfolio and the ability to offer
high discounts has been a key success factor for generic players in the US, and
the industry has seen increasing consolidation. Recent transactions include Teva’s
acquisition of Ivax, which expanded Teva’s geographic reach and provided a pipe-
line of proprietary respiratory products. Barr’s acquisition of Pliva provided
access to new geographies, and gives Barr an entry point into biosimilars.
Mylan’s acquisition of Matrix, on the other hand, provided a low-cost source of
active pharmaceutical ingredients (APIs) manufacturing in India.
The number one generics company in the US is Teva, which has an 11.1% shareof the pharmaceutical market in terms of volume, placing it ahead of Pfizer, thetop branded player with an 8.4% share. Interestingly, Teva has achieved thisleadership position with only ~15 account managers who conduct business overthe phone. Teva’s strength in the US is first and foremost a result of scale – theability to bundle products and offer significant discounts, although its reputationfor quality and a good logistics network is also an important success factor.
Europe – Branded generic model prevails
Generic Penetration in Various Markets
Whereas the US generics market is relatively homogeneous, Europe presents a series of differentiated markets, with several, including Czech Republic and Hungary in CEE, as well as Germany, the UK and theNetherlands in Western Europe, boasting generics utilization rates approaching that of the US. In contrast, generic drugs make up only a small part of the pharma market in Italy, Spain, and France. The significant variation reflects differences in historical and economic backgrounds, as well as healthcare policies. There is an ongoing trend to promote generic prescribing as part of overall healthcare reforms. For example, France has recently enacted regulations whereby physicians whosign an agreement with social insurance are required to Source : European Generic Medecines Association (EGA)2006, SAM prescribe cheaper medicines, including generics.
With the exception of the UK and the Netherlands which have a commoditygenerics market similar to the US, most European markets follow a branded generics model. In Europe, the decision as to which generic is used is usuallymade by the doctor (and to some extent by the patient), therefore companies buildbrands and market their products directly to physicians. For example, Stada hasa sales force of around 2300 reps. Generic drugs in Europe tend to have muchlower discount than in the US (as little as 20% below the originator), allowing Pictet Funds (LUX)-
generic companies to absorb the cost of sales groups while maintaining profitability. In turn, brand recognition and loyalty can insulate some genericscompanies from competitive pressure.
Although significant differences between local markets exist, a number ofcommonalities have helped shape the generic landscape in Europe.
Controlled pricing : Unlike the US, where generic drug
Mechanisms for Seting Generic Price levels in Europe pricing is determined by supply and demand, most EUcountries (82%) employ reference pricing to set reimbursement levels. Medicines are categorized into groups with identical or similar active ingredients and health authorities determine a maximum reimbursementor reference price for each group. Pricing criteria differbetween markets, but are generally based on : (a) anaverage of selected EU countries, (b) a percentage below the originator price, (c) a maximum price (price index), or (d) a negotiable price (price/volume). Manufacturers tendto price products just in-line with government-mandated levels, and don’t aggressively undercut prices to gain market share. Therefore, although generic makers are vulnerable to mandatedpricing decreases, price is not the sole differentiating factor.
Few big pharmacy chains : In the UK and Netherlands, the two EU countries
with generic markets most similar to the US, governments have actively
encouraged chain and foreign ownership of pharmacies. Other EU countries
have tight controls on the pharmacy sector, with chain ownership forbidden in
Spain, France and Turkey, while in Germany a pharmacist can only own up to
4 pharmacies. Generally, countries with restrictive pharmacy legislations also ban
foreign ownership, so that few cross-border pharmacy chains exist in Europe. As
a result, pharmacies in most of Europe are dispersed and have much less leverage
in terms of pricing.
Doctors or pharmacists decide : Another key difference between the US and
the EU is the lack of centralized decision-making on which generic product is
used. For example in Germany, Europe’s largest generic market (annual sales of
EUR4.5bn, or 22% of the total pharmaceutical market in Germany), doctors can
write a prescription for an originator brand-name drug, a specific brand of
generic, or using the International Non-proprietary Name (INN). By simply
ticking a box on the prescription, the doctor can exclude substitution, legally
prohibiting the pharmacist from dispensing any other brand (although in practice
substitution sometimes occurs if the specified generic is not in stock). As doctors
tend to put a premium on keeping full control over their patients’ treatment, a
vast majority ticks the no-substitution box on prescriptions.
Through their stocking decisions, pharmacies also play a role in deciding whichgenerics are sold, and the preference tends to be for major brands that offer afull range of products. The top 3 players in Germany (>50% combined marketshare) are Stada, Hexal/Sandoz and Ratiopharm, with over 900, 1,000 and 1,200products on the market, respectively. These players offer year-end discounts topharmacists based on total annual sales and provide marketing support, such aspromotional displays or staff training that smaller companies cannot offer.
Educator role for generic sales force in CEE : While in Western Europe, the
role of the generic sales rep is essentially to make physicians aware of new
generics, drop off samples and perhaps invite the doctor to a nice dinner, in the
rapidly growing CEE markets there is an opportunity to add much more value.
Due to limited access to expensive originator drugs, the generic version is oftenthe physician’s first experience with a particular drug, especially in primary care.
It therefore falls to the generic sales rep to educate the GP about the drug’sefficacy, dosing or side-effects – a role carried out by the originator company in Pictet Funds (LUX)-
Western markets. Since the generic drugs are sold under a brand name, thisapproach leads to a high degree of brand recognition and loyalty (and caseswhere physicians believe that the generic is an original product).
One company generating very positive results applying this strategy in CEE isZentiva. Zentiva’s 1700-rep primary care sales force focuses on promoting novelgenerics to physicians in both its home markets of Czech Republic and Slovakia,and in recently entered markets including Romania, Poland and Russia. Zentiva’ssales in Poland grew by a robust 37% in 2006, driven in large part by severalbranded generic urology and GI products, as well as generic Zocor (simvastatin,Zentiva’s brand name Simvacard), which the company introduced to Polish GPsin 2005 and which is now one of the top-selling lipid-lowering drugs in Poland.
Patients have more say : In many European countries patients are provided with
incentives to use generics, since higher-priced originator drugs automatically
trigger patient co-pays. However, patient preferences and brand loyalty can
influence generic brand use. In Europe, medication is dispensed in its original
packaging which includes the drug’s brand name and manufacturer’s logo. Thus,
patients are aware of which generic drug they receive, making it more difficult
for pharmacists to switch suppliers without being questioned by their customers.
Additionally, many generic players also sell their own OTC brands, which they
can freely promote directly to consumers, building brand recognition and loyalty
to all of the company’s products.
Japan – early days
The generics market in Japan is still in its infancy, accounting for only ~16% of
the overall pharmaceutical market by volume, and 6% by value. Adoption has
been hindered by a lack of incentives for patients and doctors, as well as past
issues regarding manufacturers’ ability to ensure a stable supply of high quality
product. Additionally, unlike the US and Europe, in Japan the same medical
institution may both prescribe and sell pharmaceuticals, generating profit from
the difference between the purchase and reimbursement price tending to favor
the use of branded drugs. Nonetheless, the Japanese government has advocated
"reasonable and proper evaluation of innovative drugs" and "promotion of
generic drugs". New measures recently introduced to promote the use of generics
include forms that allow doctors to authorize generic drug dispensing, and a small
cash incentive for doctors and pharmacists to prescribe/dispense generics.
Further, national hospitals are now required to use generic drugs, and at least in
the short term, we expect the hospital segment to drive increased penetration.
Will branded generic markets evolve into a US commodity model ? Not so fast…
Will the European model give way to the arguably more efficient and less
expensive free-market model seen in the US? Perhaps eventually, but we don’t believe
this is likely to happen any time soon. With few exceptions, generic utilization
rates are still quite low in Western Europe, so governments can realize significant
healthcare savings just by promoting higher use of generics. In more mature
generics markets, such as Germany, introducing regulations to force conversion
to a commodity-type market (by cutting reference pricing to US-level discounts)
would likely be highly unpopular with physicians, who would argue that they
could no longer provide best treatment. This in turn would likely rally patients
(a potentially more influential voter demographic) against the proposals. On the
other hand, reduction of controls on pharmacy chain ownership could lead to agradual shift in the way generics are marketed in Germany, as price would likely begin to play a more important role in purchasing decisions. In CEE, wherebranded generics bring real innovation to healthcare, conversion from this modelseems even less likely as it could spell a tangible deterioration in the quality ofcare.
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Source: Perry, G, Journal of Generic Medicines (2006) 4, 4 – 14. ABOUT SECTORAL ASSET MANAGEMENT & PICTET FUNDS.
Sectoral Asset Management (S.A.M.) is an SEC-registered investment advisor based in Montreal whose focus is managing global equity portfolios by industry.
S.A.M. has one of the world’s longest track records in managing biotech equitiesand is a sub-advisor of numerous healthcare and biotech funds offered by partnersin Europe, USA, Japan, Israel and Taiwan. S.A.M. has also launched an alternative Pictet Funds (LUX)-
investment fund that offers an attractive exposure to the growing healthcare/biotech sector through both long and short positions. The firm’s assetsare USD2.7 billion as of March 31, 2007. For more information please contactwww.sectoral.com Under the supervision of Dr. Vincent Ossipow, S.A.M. has established a pro- prietary network of motivated and talented researchers and clinicians incomplementary disciplines worldwide. The Scientific Advisory Network (SAN) isdesigned to support S.A.M. with scientific due-diligence in its investmentprocess. SAN’s members include: Chang Gung Memorial Hospital, Taipei, Taiwan R. O. C.
Harvard Medical School, Children’s Hospital, Boston, USA University of Geneva, Geneva, Switzerland Morse, Barnes-Brown & Pendleton, Waltham, MA, USA PICTET FUNDS (LUX)-BIOTECH ADVISORY BOARD Director of the Swiss Institute for Experimental Cancer Research (ISREC) Director of the Massachussetts General Hospital Cardiovascular Research Center and Charles Addison and Elizabeth Ann Sanders Chair Professor, Harvard Medical School, Cambridge, Massachussets Senior Executive Vice President, Head of R&D, Serono Group, Geneva, Switzerland Chairman of the Dept of Medicine, CHUV, Lausanne, Switzerland Pictet Group’s business unit in charge of the administration, supervision anddistribution of Pictet’s investment funds. Pictet has a long-standing experience ininternational asset management and administration, which dates back to 1910 withthe establishment of its first investment company which continues to invest inAmerican equities.With over 90 funds under its supervision Pictet Funds, establishedin 1997, has already gathered assets of 37 bn Euro as of March 31, 2007.
Pictet & Cie (Europe) S.A. Succursale italiana Route des Acacias 60, 1211 Geneva 73, SWITZERLAND Via Filippo Turati 25, 20121 Milan, ITALY Guiollettstrasse 34, 60325 Frankfurt, GERMANY Pictet & Cie (Europe) S.A. Sucursal en España Pictet & Cie (Europe) S.A. Succursale de Paris 34, avenue de Messine, 75008 Paris, FRANCE Moor House, Level 11, 120 London Wall, GB-London EC2Y 5ET 80 Raffles Place, #17-01 UOB Plaza I, SINGAPORE 048624 Pictet (Asia) Limited2902-4 Exchange Square Two, 8, Connaught Place, Central, HONG KONG Tel. 00800 1805 8888 - Fax. +41(0) 58 323 1919 - Email: [email protected] Copyright 2007 Pictet Funds - All rights reserved - Issued in April 2007
In My Garden, March “It is through celebration that we become part of what we perceive: the great arc of birdsong – that runs around the world in the receding darkness and through which we are swept into the light of day – is as much part of the dawn as the sun’s first flash”. NORMAN MOMMENS March swings both ways. Think of March and we think of catkins, baa-lambs, pussy willow