“We think Gilead’s (GILD, Financial) HCV franchise has the capability of being a $30 billion-plus revenue generator though 2024 before the numbers start to decrease. The runway is long and wide for Gilead. Load up now.” – RBC Capital Makets, December 2015
“I’m not sure Wall Street understands the difference between what a pharmaceutical asks in price versus what an insurer is willing to (a) pay and (b) cover for treatment. An example is Harvoni/Solvadi (Gilead’s HCV franchise). Wall Street expects $8.5 billion in first quarter 2016 sales and $36 billion total sales of the HCV franchise in 2016. We estimate roughly $31 billion in 2016. We expect a further 28% decrease in revenue in 2017.That’s a big difference. And some investor is going to be hurt by this disconnect between our reality and their fantasy land.” – Gilead SVP, Commercialization
There is a growing disconnect between Wall Street’s expectations in pharmaceutical drug sales and the increased demand by insurers to drive down reimbursed drug costs. This gap is to going to grow far greater as an increasing percentage of new drug launches are in the specialty drug category. The ability to navigate the difference between expectations and market realities can provide an enormous advantage to value investors looking for underpriced opportunities in the biopharma space.
Regulatory risk versus launch risk
As biopharmas look to develop new drugs meeting patient clinical needs, they face two broad risks in their business models.
The first is risk related to the clinical and regulatory approval of their research and development efforts or “regulatory risks.” Targets can fail in the drug discovery and development process for a host of reasons – the drug cannot be safely administered, the drug doesn’t meet its trial endpoint goals (meaning it isn’t as effective as planned), the drug doesn’t receive approval from regulatory officials and many others.
The second is known as “launch risks.” These can include competition achieving better market share, lack of reimbursement or formulary coverage by insurers, negative physician impressions and/or low prescribing numbers as well as others. These two major risk categories can be key reasons why a drug becomes a blockbuster (more than $1 billion in sales) product or not. Increasingly these risks are becoming more relevant to health care investors. The ability to discern the difference between Wall Street expectations and the market realities on the ground can provide real opportunities for finding mispriced biopharma stocks.
Before getting into why this is happening, a brief primer on the major components and players related to launch risk might be useful.
The product’s indicated label
Any new drug launch consists of several major goals for the biopharma company. First, the company looks to have as broad a label as possible for its product. A label refers to the parameters of the FDA approval. For instance, a drug may be on “label” for rheumatoid arthritis (RA). This simply means the FDA has approved the drug for treatment of rheumatoid arthritis because the clinical trial process has demonstrated the efficacy of the drug in this disease. The label does not indicate or approve the drug for use in any other form of arthritis such as osteoarthritis. The broader the label means the greater the potential use of the product.
Drug prices
Once the drug has been approved by the FDA, the biopharma company comes up with a listed price. This price is the one an investor is most likely to see on the evening news. A recent article on Bloomberg discussed Gilead’s Harvoni – its hepatitis C genotype 1 drug – citing a price of $95,000 for a 12-week treatment course. While frequently cited, pharmacy benefit managers or insurers rarely pay this price.
The Average Wholesale Price (AWP) is a benchmark used for pricing and reimbursement of prescription drugs for both government and private payers. The AWP was intended to represent the average price that wholesalers used to sell medications to providers such as physicians, pharmacies and other customers. However, the AWP is not a true representation of actual market prices for either generic or brand drug products. AWP is not a government-regulated figure nor does it include buyer volume discounts or rebates often involved in drug sales. Because the number is subject to what might be mildly referred to as manipulation, it is often rejected as a true measure of a drug’s cost. When you read about AWP, take it with a grain of salt.
Harvoni: A working example
In late 2013 Gilead Sciences announced a breakthrough treatment for hepatitis C (HCV) that, unlike any previous treatment, fully cured the patient of the disease. With this announcement the race was on to develop such a cure for all genotypes of the disease. The downside? A price of roughly $86,000 for a 12-week course of treatment which is dramatically more than the traditional interferon treatment regimen. With a worldwide population of 100 million HCV carriers the numbers appeared to be mind-boggling. Gilead’s revenue and stock price reflected these numbers – revenue rising from $9.7 billion in 2012 to $32.6 billion in 2015. The stock price rose from $20.75 per share in January 2012 to peak at $122 pershare in June 2015. Not a bad return.
But while all this froth and excitement drove the price higher, many investors and money managers took their eyes off the ball that makes all value growth possible – competition (or lack thereof), access and pricing. On Feb. 3, 2015 (four months before the stock price peaked) Gilead announced it was cutting its HCV product price by 47%. Some government programs would pay less than 50% of the listed AWP. Why was Gilead doing this? The simple answer: competition. In December 2014, Abbvie (ABBV, Financial) released its HCV product Viekira Pak.
Less than four months before the stock price peaked, with a small amount of leg work and a limited understanding of health care pharmaceutical pricing, an investor would have realized the reason Gilead’s low price/earnings ratio was actually quite predictive of long-term growth. This knowledge could have avoided losses achieved by many investors as the stock price dropped from its peak of $122 per share to $87 per share today.
Conclusions
Investing in biopharma requires several core knowledge bases – the science behind drug discovery and development (pre-human, human safety/dosing, data and informatics, etc.), the pricing structure and influencers Center for Medicare and Medicaid Services (CMS), Pharmacy Benefit Managers (PBMs), Managed Care Organizations (MCOs), National Institute for Health and Care Excellence (NICE-UK) and the organizational requirements for usage and prescribing (formularies, order sets, etc.) Without rolling up your sleeves you are dependent on Wall Street research analysts and their recommendations. Frankly that’s a prescription for underperformance.
As always, I look forward to your thoughts and comments.
