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Which Biotechs Are Vulnerable to Generics?

Copycat versions of blockbuster biologics are coming--but big biotechs still look strong.

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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.

However, the time for the approval of a pathway for biosimilars in the U.S. may have arrived. According to the Centers for Medicare and Medicaid Services (CMS), prescription drug costs amount to roughly 10% of total health expenditures, and biologics are a key growth driver. For example, last year IMS Health reported that global biologic sales reached $75 billion in 2007, reflecting a 12.5% growth rate--virtually double that of the global pharmaceutical market. 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.

Biosimilars Struggle to Compete So Far
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.

The first biosimilar product, human growth hormone Omnitrope, launched in 2006 in the U.S., thanks to a legal loophole and years of persistence with the Food and Drug Administration. By the end of 2008, Omnitrope still held less than a 1% share of its market, according to IMS Health, as it has failed to make headway against branded versions of the growth hormone. Europe's experience with biosimilars also seems to reflect high barriers to such competition. Despite the introduction of biosimilar versions of Epogen as early as 2007, we have seen very limited impact so far on products like  Amgen's (AMGN) Aranesp. While it is still early in the launch of biosimilar versions of Amgen's Neupogen, we think Neulasta (Amgen's longer-lasting version of Neupogen) should hold up just as Aranesp did, with a relatively small (20%) price concession but stable market share. We see this as an example of how biotech innovation will make it difficult for biosimilars to pinpoint a moving target.

Protection from Biosimilars: What Is Excessive?
One of the key points of legislative debate over biosimilars in the U.S. is the period of data exclusivity, or the length of time that marketers of novel biologics can prevent biosimilar competition by withholding access to data that could help support the biosimilar's approval. An analysis recently published in Nature Reviews, Drug Discovery determined that on average, drugmakers don't break even on their investment in a biologic until at least 12 years following the drug's launch. The Biotechnology Industry Organization (BIO) has used studies such as this to argue that any exclusivity period shorter than 12 years would discourage innovation.

As Morningstar's generic pharmaceutical analyst Brian Laegeler discussed in a recent article, the Senate Health, Education, Labor and Pensions committee voted earlier this month to support 12-year exclusivity for biologics, and this version of a pathway for biosimilars in the U.S. could be attached to broader health-care reform legislation. Positive momentum from this Senate vote carried over to the House, where Rep. Anna Eshoo's (D.-Calif.) legislation supporting 12 years of biosimilar exclusivity was passed by the House Energy and Commerce Committee on July 31 by a 47-11 vote as an amendment to a broader health-care reform bill. Eshoo's proposal had gained a significant amount of traction in the House against Rep. Henry Waxman's (D.-Calif.) more conservative bill, which offers just five years of exclusivity.

At the other end of the spectrum from recent congressional votes is the June 2009 Federal Trade Commission report, which deemed exclusivity periods as unnecessary based on the strength of biologic patents. BIO claims that biologics need exclusivity because of the uncertainty surrounding the strength of biologic patents; a patent "gap" is created by the fact that biosimilars don't have to be identical to the branded product, and biologic patents tend to be narrower and more specific, so they could be easier to bypass.

However, we think exclusivity periods really only matter when patents are unusually weak or short-lived, as most biologics are covered by several patents that expire long after the product's launch. Patents on biologic drugs have also already been tested--by branded competitors. For example,  Shire's (SHPGY) Dynepo and  Roche's (RHHBY) Mircera were not allowed to launch in the U.S. due to infringement on Amgen's patents. While both products were allowed to enter the European market, prospects for commercial success were quite low; Shire has already withdrawn Dynepo from the market due to weak sales, and we are not any more optimistic about Mircera's prospects.

 

How Biotechs Stack Up
Regardless of the exclusivity period that is assigned to branded biologics in any biosimilar legislation that makes its way through Congress, near- and midterm competition for the big biotechs will still be driven by the timing of patent expirations. We currently factor both biosimilar and branded competition into our biotech models after patents expire. Overall, based on what we've seen in Europe to date, we think biosimilar competition will not be as intense as small molecule generic competition; prices will be closer to branded drug prices, and biosimilars aren't likely to wipe out all of the branded drug's profits. Patent expiration isn't the only thing determining a biotech's competitive position--manufacturing differences, market dynamics, and the size and strength of drug pipelines make some firms more exposed than others. We summarize the biosimilar vulnerability of our wide-moat biotechs below.

 Amgen (AMGN)
Uncertainty Rating: Medium | Price/Fair Value Estimate: 0.97 | 3 Stars
Four out of five of Amgen's biologics are recombinant proteins, older biologics that are widely believed to be easier to copy, and two of these products already have biosimilars on the market in Europe. We think Amgen has the most exposure to biosimilars, both by year of expiration and by ease of replication. However, Amgen has so far been able to maintain market share in the face of biosimilar competition in Europe, and CEO Kevin Sharer recently claimed that retaining 30% to 50% of cash flows from biologics exposed to biosimilar competition should be achievable. Amgen's pipeline has also seen a revival, and approved drugs like Vectibix, Nplate, and Sensipar--as well as pipeline gem denosumab--should be enough to keep Amgen afloat.

 Biogen Idec (BIIB)
Uncertainty Rating: Medium | Price/Fair Value Estimate: 0.73 | 4 Stars
Biogen Idec also has near-term exposure to patent expirations. In fact, multiple sclerosis drug Avonex is already off patent in Europe. However, the first application for an Avonex biosimilar was rejected based on insufficient efficacy, indicating that biosimilar manufacturers could have a difficult time creating a product similar enough to Avonex without boosting spending on clinical trials or manufacturing controls. Biogen also has follow-on versions of Avonex, cancer drug Rituxan, and multiple sclerosis antibody Tysabri in the works, as well as a wealth of novel drug candidates in immunology, oncology, and cardiovascular indications.

 Genzyme (GENZ)
Uncertainty Rating: Medium | Price/Fair Value Estimate: 0.63 | 5 Stars
Genzyme's unique position in biotech--its sole blockbuster biologic, Cerezyme, serves only a few thousand patients globally--makes it difficult to categorize. The niche market for Gaucher disease could make it more difficult for both biosimilar and branded competitors to infiltrate. Genzyme's recent manufacturing woes also highlight the difficulty of consistent and safe biologics manufacturing. We think biosimilar makers less familiar with such products could have an even harder time making a consistent product in an affordable way. Branded competition for Cerezyme is already in development by firms such as Shire; however, even if these firms are able to bypass Genzyme's patents, we believe Genzyme's global presence and solid control of the market will be difficult to shake. Genzyme's experimental oral treatment for Gaucher is also advancing into late-stage trials this summer, lending further support to the idea that a Cerezyme biosimilar could be obsolete sooner rather than later.

 NovoNordisk (NVO)
Uncertainty Rating: Medium | Price/Fair Value Estimate: 0.86 | 3 Stars
Novo, with its broad portfolio of insulin products, is no stranger to competition. Insulin has been sold for decades and is one of the easiest biologic drugs to manufacture. In several markets, such as India and China, Novo already faces competition from biosimilars, yet the company maintains a 60% market share by volume in these countries. Unlike many biologic drugs, insulin is consumed in such large quantities that production scale is important in driving competitive manufacturing costs. Additionally, Novo continues to separate itself from competitors with its strong brand, innovative insulin formulations and delivery systems, and focused salesforce. Although competition from generic human insulin is on the horizon, Novo has been steadily converting patients to premium-priced modern (short-acting and long-acting) insulin analogs, which will benefit from patent protection well into the next decade. By the time marketing exclusivity for these drugs runs out, Novo should be ready with yet another generation of insulins, which are currently in midstage clinical trials. Combined, we think these factors insulate Novo well from the threat of biosimilars.

 Roche Holding AG (RHHBY)
Uncertainty Rating: Medium | Price/Fair Value Estimate: 0.81 | 4 Stars
We see Roche as holding the most enviable position in biotech, with a diverse collection of blockbusters that still have several years of patent protection. Cancer and rheumatoid arthritis drug Rituxan would be the first to expire in 2016. Like Rituxan, most of Roche's other biologics are monoclonal antibodies, which are a bit more complex than older biologics from a manufacturing standpoint. We predict small double-digit declines in Rituxan sales in beginning in 2016-17, but we see this pressure softening beyond these years due to possible sales from next-generation antibody ocrelizumab. Also, in spite of the fact that Rituxan biosimilar launches could be significantly "smarter" than the first biosimilar launches in Europe that we are witnessing today, we think Roche stands to retain significant levels of sales from its massive oncology portfolio, as the life-saving nature and serious potential side effects of these drugs make consistent product a necessity.

Cost-Savings Would Require Action beyond Biosimilars
In the end, 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. However, in our opinion, government action beyond the passage of biosimilar legislation would be needed in order to begin to trim significant costs from biologic drug spending. A recent assessment by the Congressional Budget Office indicated that federal government spending would be reduced by only $5.9 billion over the next 10 years if biosimilar legislation were successfully passed--a drop in the bucket compared with our $2.4 trillion health-care system. Cost savings would increase if CMS and private insurers were to actively encourage the use of biosimilars through reference pricing, payment for results, or bundling of payments for drugs and services--but such changes are likely to take much longer to implement.

Prices as of July 30, 2009, market close.

Karen Andersen does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.