How to make money as Big Pharma falls off the patent cliff
By Kevin Mahn, CIO, Hennion & Walsh Asset Management
Finding opportunities in health care through biotech
Scientific and technological innovations continue to propel opportunities in the health care sector (XLV). Some of the catalysts that have led to increased investment spending in the health care sector include, but are not limited to, the following:
an increased understanding of the disease mechanism
genomics enabling precision medicine
improved therapeutics
In conjunction with these innovations are certain demographic trends that are feeding into the overall demand for health care solutions:
increase in life expectancy
an aging global population that is expected to reach 1.4 billion people over the age of 60 by the year 2030
the degree to which our aging population will spend money on health care, recognizing that half of all lifetime health care expenditures occur from the age of 65 and higher
increase in the rate of developing chronic illnesses globally
Accepting that there is a greater demand for health care solutions today and an increase in the types of health care solutions that are now available (or are on track to someday be available), the issue then becomes how best to find investment opportunities within the sector.
Large pharmaceutical companies facing the ‘patent cliff’
Valid systemic concerns can be presented with respect to the potential negative impact of regulatory measures, such as the Affordable Care Act. But with heightened pricing scrutiny on drugs and health care products in general, I believe that these risks are primarily borne by large pharmaceutical companies. These large pharmaceutical companies also face the risk of falling off a “patent cliff” in the coming years as several of their larger revenue producing drugs are scheduled to come off patent and face generic competition. In 2016 alone, drugs with pre-expiration values totaling a combined $56.4 billion are subject to this patent cliff, according to S-Network Global Indexes, Inc.
As a result of these patent expirations, large pharmaceutical companies will need to replace these sources of lost revenue while also finding ways to help minimize the systemic concerns cited earlier. In order to accomplish this, some might suggest that they should turn to their own research and development for a pipeline of new drugs and solutions. The problem is that the majority of larger pharmaceutical companies has not been investing adequately, or successfully, in their own R&D and thus do not have a pipeline where they can confidently turn.
Before casting any aspersions on “big pharma” in this regard, one should understand that the R&D process in the health care sector is not an elementary one and often results in expensive and non-successful results. For example, it is estimated that the development of a new drug costs around $2.6 billion on average and that less than 12% of the developed drugs that make their way to clinical trials ultimately win regulatory approval from the Food and Drug Administration (FDA).*
Biotech companies to become buyout targets
From our perspective, this quandary presents investment opportunities not only for manufacturers of generic drugs but also for biotechnology (“biotech”) companies focused on innovation, as big pharmaceutical companies will likely look to acquire these companies to help replace revenue lost to the patent cliff.
As opposed to the multi-pronged focus of large pharmaceutical companies, the primary focus of biotech companies is to develop new and innovative health care solutions. While this focus does not make the process of bringing a new drug to market any easier or less expensive, the previously mentioned patent cliff and recent momentum on the side of regulatory approvals present reasons for biotech optimism. With respect to the latter, 45 new drugs were approved by the FDA in 2015. This represented the second-highest total of drug approvals in at least 35 years, and half of the drugs that were approved were for rare diseases.*
Biotech companies with approved drugs, or drugs believed to be near the final approval stage, should look very attractive from a mergers and acquisitions standpoint to large pharmaceutical companies in this environment. In this regard, there was $219.4 billion in worldwide biopharma M&A transaction volume in 2015 and $130.7 billion thus far in 2016, according to data from Biopharm Insight provided by S-Network Global Indexes, Inc., including completed and announced deals, asset deals and acquisitions of divisions. This is a trend we, at Hennion & Walsh, see continuing in the future.
* Source: July 31, 2016 article on The Motley Fool by Keith Speights entitled, “12 Big Pharma Stats That Will Blow You Away.”
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Disclosure: Hennion & Walsh is the sponsor of SmartTrust® Unit Investment Trusts (UITs) and currently has allocations within its SmartTrust®, Healthcare Innovations Trust consistent with the information cited above. For more information on SmartTrust® UITs, please visit www.smarttrustuit.com. The overview above is for informational purposes and is not an offer to sell or a solicitation of an offer to buy any SmartTrust® UITs. Investors should consider the Trust’s investment objective, risks, charges and expenses carefully before investing. The prospectus contains this and other information relevant to an investment in the Trust and investors should read the prospectus carefully before they invest.
