Last month’s 10% drop in the Nasdaq iShares’ Biotechnology Index — not to mention the fact that biotech stocks, after a torrid two years, are up less than 4% year-to-date — has investors worrying that the sector’s two-year boom is over.
We’re living through major changes in how medicines are developed that will improve our lives for the better. But that doesn’t meant biotech stocks won’t retreat. Quite the opposite: Biotech innovation is funded in great part by investors whose timing is wrong, and who get left holding the bag at the end of the sector’s inevitable boom cycles, only to have some of the companies, products, and technologies they bet on succeed later on. The biotech boom has been fueled in part by fundamentals: stunningly lucrative new drug launches and research breakthroughs. But some investors seem to be seeing rainbows and missing the rain. Here are three things I’ve heard from investors and executives, or seen in the invaluable polls of buy siders run by ISI Group’s Mark Schoenebaum, that I think are misplaced optimism.
1. We have not reversed the decline in R&D productivity. We probably haven’t even slowed it. Back in 2009, investors seemed to believe that no experimental medicine would ever succeed again. Now it seems we’ve forgotten that more than 90% of the drugs that start clinical trials fail.
The whole drug industry — and biotech companies are separated from larger drug companies by distinctions of business model, not fundamental science — has been caught up in what has coyly been termed “Eroom’s law”: the amount of R&D money sunk per molecule is rising exponentially. There’s no proof that this multi-decade trend has abated.
Geoffrey Porges, an analyst at Bernstein research, recently looked at the drugs in development at large biotechnology companies such as Celgene CELG -1.24% (the best-performer over the past year), Gilead, and Biogen Idec BIIB -0.34%. He points out that many of these firm’s R&D successes have actually been “derivative” products based on approaches that were already known to work. Celgene’s success has come through drugs derived from its original success, repurposing thalidomide as a treatment for multiple myeloma and from Abraxane, an improved version of the 1990s cancer drug Taxol. Biogen’s big hit, Tecfidera for multiple sclerosis, is a new formulation of a drug that had been used to treat psoriasis in Germany.
Porges points out that Celgene is now betting on a new first-in-class molecule, sotatercept. And Biogen’s big event this year will be data for its anti-LINGO program, which is a brand new way to treat multiple sclerosis. He says Alexion and Vertex are likely facing longer odds than they have in the past. Drug research: it’s really, really hard.
2. The FDA is not fundamentally friendlier to companies than it was in the past. Another trope that’s gotten passed around a lot is the idea that the Food and Drug Administration is friendlier to companies, better at communicating, and more likely to approve drugs than it used to be. This kind of thinking is dangerous, and I say that having fallen into the FDA-got-easier-trap several times myself — and been wrong.
There was a period, starting a decade ago, when the FDA, normally relatively friendly to industry, became unusually negative because there were a lot of drug safety controversies, including those over the pain medicine Vioxx and the antidepressant Paxil. Regulators who were afraid Congress would go after them were noticeably more reticent to approve drugs. And there has been movement to make the FDA bureaucracy easier to manage, particularly with the creation of the “breakthrough” designation for important drugs. And in cancer, in particular, where there are more drugs in development than in any other disease area, the FDA does seem to be working more closely with companies.
But the FDA still makes most of its decisions based on the same conservative science it always has, and to be as tough as it ever was, sometimes going back on its word with companies when it decides the facts have changed.
Look at how the FDA publicly (justifiably) took down Aveo Pharmaceuticals when patients on its drug survived less long than those in the control group. Novo Nordisk found itself years behind competitors because the FDA insists on a heart safety study of its new insulin. Amarin and Omthera, both makers of fish oil pills, both told investors the FDA said it would allow them to market their products to a broader population if they started big studies to prove the pills prevent heart attacks and strokes; then the FDA apparently changed its mind. The bull case for Sarepta Therapeutics SRPT +0.49% was that the need for its drug for muscular dystrophy was so great that the FDA would allow it to file to be approved on a study so small it would have been unprecedented. That didn’t happen. Nice friend, biotech.
I’d interpreted the FDA’s decision to let Avandia back on the market as a sign that it was becoming more friendly to industry. I now think Steven Nissen was right when he wrote that the FDA’s goal was to “avoid accountability for its role in the Avandia tragedy.”
Sure, there has been a bump in the number of new drugs approved, perhaps in part because of a slight easing at the FDA and a slight improvement in R&D productivity from its nadir earlier this decade. Or maybe it’s just that bugaboo of investors in any time period: random chance changes that don’t mean anything.
3. Pricing Power May Not Last Forever The most important question for biotechnology and drug companies isn’t how many new drugs they can invent but how much they can charge for them. Fears surrounding Congressional noise about the high price of Gilead’s Sovaldi for hepatitis C seem to have started the current drop in stock prices.
And here the news is pretty good. In the U.S. in particular companies seem to be able to command huge premiums for important drugs. Canada is playing hardball over the cystic fibrosis drug Kalydeco, saying it won’t pay the full price of $307,000 per patient per year. But even if it gets a discount, the cost is likely to be fairly close to that sum.
But what I hear from drug company executives who are trying to look ten years or further into the future is that they are expecting to face more and more pricing pressure as time goes on. Joseph Jimenez, the CEO of Novartis, points out that many governments around the world are going to see their health costs double as their population ages. He foresees a “new, brutal world” where governments become much tougher negotiators, forcing drug companies to become much more focused of providing services along with their medicines. This is not a future that sounds like easy going for small biotech companies.
None of this is a reason to abandon biotechnology stocks en masse. Plenty of companies are likely to be launching promising new drugs and racking up impressive sales on those they have already launched. Wall Street is justifiably worried that Gilead’s Sovaldi is not going to be able to maintain its sales, but a medicine that seems likely to have some of the best annual sales ever has got to be worth something. Regeneron and partner Sanofi have several potential blockbusters in their shared pipeline, including not only their PCSK9 cholesterol drug but medicines for rheumatoid arthritis and asthma. Personally, I think Vertex’s combination therapy for cystic fibrosis could show positive results later this year. There are always going to be good biotech stocks to pick, even in the worst market. A breakthrough drug remains one of the most profitable products you can ever sell, and it will for the foreseeable future — maybe as long as there are sick people.
But investors should avoid thinking that the drug business has undergone a fundamental change in the past few years. It hasn’t.