Death Knell for Big Pharma?

By Michael Shulman

No, but it does make a good headline. Big Pharma is about to be washed over by the generic-drug ChangeWave that will radically alter the industry, including the industry's major players like Pfizer (PFE), GlaxoSmithKline (GSK) and Eli Lilly (LLY).

Here's why.

Major Big Pharma Change No. 1

We are just moving into a generic drug surge that's fueled by patent expirations. The generic drug ChangeWave, by 2012, will reduce Big Pharma sales by as much as $80 billion. Approximately $100 billion in proprietary drugs come off patent during that time, including Lipitor, the world's best-selling drug. Nothing in Big Pharma's current pipelines can come close to replacing this revenue and profit stream.

The expiration of patents and the subsequent onslaught of generics is formulaic. Everyone knows that when the patents expire, many generic drugs are already approved and companies are just waiting for these dates to arrive so they can go to market.

The only people who don't get this are those who are unprepared and Wall Street analysts with vested interests in the success of Big Pharma companies, along with general value investors who only look at numbers.

One pat answer to the upsurge of generic competition is Big Pharma "will figure it out," and it's not an original response. The Bank of America (BAC) analyst who followed Schering-Plough (SGP) told me the same thing years ago, just three months before Claritin went generic, and SGP lost 85% of its market share for the drug.

Other groups buoying up the Big Pharma companies being hit by patent expirations are value and deep-value investors who, when asked why these stocks should still be purchased, say, "they're cheap, so they'll come back." They calculate "cheap" based on future earnings, which these investors seem to think can't shrink. Where they get the idea that these stocks will recover is beyond me. There is no good reason to think they will -- and please take note that Warren Buffett, the ultimate value investor, isn't in this sector.

Major Big Pharma Change No. 2

Here's a fact that Big Pharma can't take to the bank: Uncle Sam is running out of money and is going to cut back on Medicare Part D and other Medicare reimbursement rates -- regardless of who's elected president -- and Medicaid and private payers will follow suit.

At the moment, the only thing stopping these cuts from happening is furious lobbying, and the threat of a filibuster by the members of Congress who receive the most funds from the Big Pharma lobbyists.

Medicare is barred from directly negotiating prices for the drug plan, which means that it pays more than the Department of Defense, the Department of Veterans Affairs (formerly known as the VA) and many private operators.

Both Obama and McCain have pledged to fix this serious problem, and they could do it with simple legislation that says Medicare will be guaranteed the best price offered by a company -- it's already standard practice in many states for Medicaid prices.

More importantly, both presidential candidates back major initiatives to expand reimbursement for "evidence-based medicine." This means that the government would only pay for what is proven to work.

That sounds pretty logical and simple, but if this standard were currently in place, then 50% to 75% of COX-II inhibitor prescriptions for arthritis pain would never be written.

This single change in purchase standards will absolutely slam large, blockbuster drugs that are routinely prescribed, despite a lack of hard data that they work for the specific malady or for a specific patient. This initiative would chop another $10 billion to $20 billion off Big Pharma revenue by 2012.

The most radical form of this standard is already in place in Great Britain. Their National Health Service will pay Johnson & Johnson (JNJ) for Velcade, a cancer treatment, only when it's proven to work. That sure sounds reasonable to me, and I am a hardcore capitalist.