GOOD RETURNS MOTIVATE PHARMA TO DEVELOP NEW DRUGS
(Part 2 out of 2)
by Stephen D. Simpson, CFA
There's a sizable difference between mean and median costs, as certain kinds of drugs (particularly cardiovascular, metabolic, and autoimmune/inflammatory) require much larger and more expensive trials. All things considered, independent biotechs tend to focus on developing drugs with more modest Phase 3 requirements, while the largest trials are often only run by the big drug companies.
Arena's (Nasdaq: ARNA) Phase 3 BLOOM study (which was just one of three Phase 3 studies for the obesity drug lorcaserin) enrolled almost 3,200 patients and likely cost upwards of $200 million. By comparison, Medivation's (Nasdaq: MDVN) Phase 3 AFFIRM study for prostate cancer drug Xtandi enrolled 1,200 patients, while a single Phase 3 study of Eliquis, an oral Factor Xa inhibitor marketed by Pfizer (NYSE: PFE) and Bristol-Myers (NYSE: BMY), enrolled more than 18,000 patients and the total Phase 3 development program enrolled more than 60,000 patients across multiple studies. Even if Pfizer and Bristol-Myers somehow managed to do those trials at about only half the cost of a normal Phase 3 study, that's still upwards of $1.5 billion in Phase 3 development costs.
Earning Back Those Costs
Not only do approved drugs have to pay for themselves, but they also have to subsidize the company's failures and still leave something for shareholders. While multi-billion dollar blockbusters like Pfizer's Lipitor, AbbVie's (Nasdaq: ABBV) Humira, and Sanofi (NYSE: SNY)/Bristol-Myers' Plavix certainly have more than paid their way, they really are the exception.
The average approved drug generates about $300 million per year in revenue over its lifetime. Excluding R&D costs, the average Big Pharma drug will generate a margin of approximately 50% and will have a productive revenue-generating life of about 15 years. Looking again at the averages (and excluding taxes or the cost of capital), those two-of-10 approved drugs will earn back their cost of development in about three years and pay for their failed siblings in another two and a half years.
That means roughly one-third of the productive life of an average drug goes to paying back the cost of drug development. It also explains why drug companies are so willing to spend on marketing and follow-on label extension studies and so fierce in protecting their patents – each extra year of branded drug sales has a significant impact on the net present value of the drug in question.
Using the prior inputs, that portfolio of 10 drug candidates could be expected to produce an IRR of about 13.25%. Just one extra year of exclusivity on the back-end for both drugs would improve the overall IRR by about a quarter-point, and the development of blockbuster drugs like Lipitor can lead to huge IRRs. By the same token, though, companies that hit dry spells in their clinical development and/or have major disappointments and late-stage trial failures can see their portfolio IRRs quickly plunge.
The Bottom Line
At the end of the day, any analysis of the cost of drug pricing comes down to a question of fairness. While some advocates and commentators choose to focus on what's fair for patients and payers, I think it's also worth considering what is fair the drug companies as well.
I will admit that the mix of medians, averages, and estimates makes the conclusions here only rough at best, but is a 13% internal rate of return excessive when the odds of success are pretty poor and large sums of money have to be invested with no expectation of any returns for five to 10 years? Looking at it differently and using an NPV approach, a 10% discount rate on those cash flows would lead to a net present value of about $270 million for that fictional 10-drug portfolio. While it's certainly true that the occasional blockbuster drug can lead to substantially higher returns for pharmaceutical companies, it's likewise true that a dry spell in the clinic and/or expensive late-stage failures can lead to periods of very poor returns.
Again, “fair” is a very subjective concept. I see nothing wrong with pharmaceutical companies earning a good return given the large amounts of capital and high risks that go with drug development. Perhaps just as much to the point, if the public continues to demand new drugs that allow them to live longer and/or better and that are proven to be relatively safe, they need to realize that they're going to have to pay for them to keep the companies motivated to take on the development risks.
Arena's (Nasdaq: ARNA) Phase 3 BLOOM study (which was just one of three Phase 3 studies for the obesity drug lorcaserin) enrolled almost 3,200 patients and likely cost upwards of $200 million. By comparison, Medivation's (Nasdaq: MDVN) Phase 3 AFFIRM study for prostate cancer drug Xtandi enrolled 1,200 patients, while a single Phase 3 study of Eliquis, an oral Factor Xa inhibitor marketed by Pfizer (NYSE: PFE) and Bristol-Myers (NYSE: BMY), enrolled more than 18,000 patients and the total Phase 3 development program enrolled more than 60,000 patients across multiple studies. Even if Pfizer and Bristol-Myers somehow managed to do those trials at about only half the cost of a normal Phase 3 study, that's still upwards of $1.5 billion in Phase 3 development costs.
Earning Back Those Costs
Not only do approved drugs have to pay for themselves, but they also have to subsidize the company's failures and still leave something for shareholders. While multi-billion dollar blockbusters like Pfizer's Lipitor, AbbVie's (Nasdaq: ABBV) Humira, and Sanofi (NYSE: SNY)/Bristol-Myers' Plavix certainly have more than paid their way, they really are the exception.
The average approved drug generates about $300 million per year in revenue over its lifetime. Excluding R&D costs, the average Big Pharma drug will generate a margin of approximately 50% and will have a productive revenue-generating life of about 15 years. Looking again at the averages (and excluding taxes or the cost of capital), those two-of-10 approved drugs will earn back their cost of development in about three years and pay for their failed siblings in another two and a half years.
That means roughly one-third of the productive life of an average drug goes to paying back the cost of drug development. It also explains why drug companies are so willing to spend on marketing and follow-on label extension studies and so fierce in protecting their patents – each extra year of branded drug sales has a significant impact on the net present value of the drug in question.
Using the prior inputs, that portfolio of 10 drug candidates could be expected to produce an IRR of about 13.25%. Just one extra year of exclusivity on the back-end for both drugs would improve the overall IRR by about a quarter-point, and the development of blockbuster drugs like Lipitor can lead to huge IRRs. By the same token, though, companies that hit dry spells in their clinical development and/or have major disappointments and late-stage trial failures can see their portfolio IRRs quickly plunge.
The Bottom Line
At the end of the day, any analysis of the cost of drug pricing comes down to a question of fairness. While some advocates and commentators choose to focus on what's fair for patients and payers, I think it's also worth considering what is fair the drug companies as well.
I will admit that the mix of medians, averages, and estimates makes the conclusions here only rough at best, but is a 13% internal rate of return excessive when the odds of success are pretty poor and large sums of money have to be invested with no expectation of any returns for five to 10 years? Looking at it differently and using an NPV approach, a 10% discount rate on those cash flows would lead to a net present value of about $270 million for that fictional 10-drug portfolio. While it's certainly true that the occasional blockbuster drug can lead to substantially higher returns for pharmaceutical companies, it's likewise true that a dry spell in the clinic and/or expensive late-stage failures can lead to periods of very poor returns.
Again, “fair” is a very subjective concept. I see nothing wrong with pharmaceutical companies earning a good return given the large amounts of capital and high risks that go with drug development. Perhaps just as much to the point, if the public continues to demand new drugs that allow them to live longer and/or better and that are proven to be relatively safe, they need to realize that they're going to have to pay for them to keep the companies motivated to take on the development risks.
Fuente: SmartBrief - INVESTOPEDIA
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