July 11, 2019

Focus: Biologic Blockbusters Pending Competition

Joseph Morgan


The rise of biologics over the last two decades has led to global pharmaceutical companies to shift and increase their focus towards their development and the formation of large biotech companies. Some biologics have become huge blockbusters, generating multiple billions of dollars per annum over a longer than five year period, allowing their producers to recuperate the research costs and a lot more. However, as patent expiry dates approach, some of these blockbuster biologics will start to face competition from generic/copy drugs. Therefore, leading biologic producers, which were consistently reporting mid-single to high-single digit revenue growth, 40% margins and annually increasing dividends, may not be as safe as they were previously perceived to be.

In order to make the right investment decision, we believe it is prudent for investors to pay attention to the research and development strategy of each company. This includes:

  1. Examining the drug pipeline for optionality, for example whether the pipeline is diverse enough so that the failure of a few drugs will not be detrimental to the future growth prospects of the company.
  2. Investigating for potential orphan drugs, a drug that treats a medical condition which does not have a current treatment plan, in the pipeline. This gives the company a niche product.
  3. We place importance on acquisitions. We prefer bolt-on acquisitions than large and expensive mergers.
  4. We also like companies that have a track record of establishing partnerships and co-development agreements with smaller start-ups that are in early stages of development. This indicates to us that the company has a strong awareness of new potential drugs and is actively preparing for long-term growth.

Importance of Biologics

A biologic is an active protein product which is used in the treatment of human diseases. Biologics are made using living organisms through a complex manufacturing process which requires fermentation, aseptic processing, sterile storage and constant monitoring, and are typically administered by a physician through an injection. The cost of researching and developing a biologic is greater than a traditional chemical drug. Studies estimate that the total cost of developing and undergoing the approval process for a new biologic was ~US$1.4bn in 2011. This is approximately 40% more than a chemical drug. Even after a biologic is fully approved by the regulatory authority, there are still significant maintenance and storage costs. As a comparison, a typical manufacturing process for a chemical drug might contain 40 to 50 critical quality control tests, however a biologic might contain 250 or more, over five times the amount of quality control tests.

Even though the costs are substantial and at early stages the success rate is low, biologics are critical to the future of medicine. Due to their structure, biologics can target diseases which have not been treatable by traditional chemical drugs. Biologics can recognize and then bind themselves to specific receptors associated with a disease in the human body. This makes their effect exceptionally precise and generally safer for patients. Diseases that biologics are currently being used to treat include: various forms of cancer, rheumatoid arthritis and multiple sclerosis. Improvements in technology and scientific knowledge will lead to the medical conditions that biologics can treat and success rate of their treatment becoming even greater than today.

When a pharmaceutical company has a successful biologic, it can become a cash cow for the company, generating billions of revenue per annum. The large costs of developing biologics and the types of diseases they treat results in a premium price. Moreover, because biologics treat serious medical conditions, treatment periods can span from one year to six years. This gives their producers consistent revenue and enables them to increase prices overtime, improving profit margins, without fear of declining volume sales. This has therefore led to demand from other pharmaceutical companies to create generic/copy versions of these multi-billion dollar biologics.

Biosimilars Consuming Biologic Revenue

A biosimilar is the generic/copy drug of a biologic. As the patent of a biologic expires (approximately 10 to 12 years post regulatory approval depending on the region), biosimilars can enter the market, undercut the price of the biologic and eat into the biologic’s market share. However, as hinted from the name, biosimilars are only “similar” to biologics. So, unlike traditional chemical drugs which can be automatically substituted for a cheaper generic version, a biologic cannot be substituted out. For a biosimilar to be used instead of the original biologic, this requires the physician’s and sometimes even patient’s permission. In addition, it is unlikely that a physician would recommend swapping out a biologic for a biosimilar in the middle of a treatment period, giving more safety to the biologic producer in retaining a certain level of revenue for a period of time.

The inability to automatically substitute out a biologic for a biosimilar has led to questions regarding the pace that biologic revenue will decline once faced with biosimilar competition. Translation for investors is: in how much potential danger is the revenue and earnings of a lead biologic producer who faces an upcoming patent expiry?

Current data suggests that in Europe the biosimilar uptake rate is better than in the US. For example, when there was a biosimilar entry into the European market, the revenue of the biologic declined by 25% in the first year and 30% in the second. For the exact same situation, same biologic and same biosimilar entry, in the US, the biologic revenue decline was noticeably different. In the first year of biosimilar competition, the biologic revenue decline was only 5% and this increased in the second year to 20%. This different biologic revenue erosion rate by region is important to take note of, because generally these biologics generate 60% or more of their total global revenue from the US. Therefore, given a historically slower uptake rate in the US, this could give the pharmaceutical company slightly more leeway to take measures against revenue decline for the entire company.

The different uptake rate of biosimilars can be explained by regulatory differences and familiarity of biosimilars in their respective markets. The European Medicines Agency was the first to create a biosimilar regulatory approval pathway for the European Union member states in 2005, while the US created guidelines for regulatory approval in 2010. The first biosimilar in Europe was approved in 2006, while in the US the first was approved in 2015, almost a decade later. In addition, even though by the end of 2018 sixteen biosimilars have been approved by the US Food and Drug Administration (FDA), only six are actually available for sale and being marketed. Others have not entered the market, due to litigation from the biologic producer or the biosimilar producer itself decided not to sell their biosimilar. However, we believe that as the US market and physicians become more accustomed to these biosimilars, their uptake will increase, leading to faster erosion of biologic revenue. Also, we think the current practice by biologic producers to delay biosimilar entry through litigation and other means should decline.

What We Recommend Looking Out For

In summary, we believe it is essential that investors are aware of upcoming patent expiry of pharmaceutical companies that have these blockbuster biologics, especially if they make up a lion’s share of total company revenue. If a biologic makes up 20% of the total revenue of a company and this biologic faces biosimilar competition causing the biologic revenue to drop 25% for example, this means that, if everything else remains the same, total revenue of that pharmaceutical company would drop by 5%, which is significant. In order to prevent this from occurring, we believe it is essential that a company has a reliable and strong drug pipeline. A drug can take more than five years to develop and success rates, although improving, are still low. It is therefore important that research and development be a critical analysis point. In particular, we like a pharmaceutical company that we believe has a strong pipeline and is on track for long-term growth.

Sources: BR&R Biosimilars, Company Financial Statements, European Medicines Agency, Harvard Health Policy Review, Office of Health Economics, US Food and Drug Administration and CIGP Estimates.