By Amy Tsao
Start with the fact that a record number of popular prescription drugs will lose patent protection over the next several years. Add in the certainty that as the baby-boom generation ages and retires, both insurers and federal programs such as Medicare will seek every way possible to hold down health-care costs. What you end up with is a prediction that the next five years should be the most prosperous ever for generic-drug makers -- and an enticing opportunity for investors.
Indeed, David Moskowitz, an analyst with investment bank and brokerage firm Friedman, Billings, Ramsey, expects annual sales for the generics industry to rise from $9.8 billion in 2000 to close to $20 billion by 2005. "Everyone has become more cost-conscious," he says. "That's driving demand for generics."
Of course, no bet is a sure thing. Generics makers routinely face time-consuming and expensive legal battles with major drug companies, who fight tooth-and-nail as their products go off patent. It's also imperative for generics companies to file first with the Food & Drug Administration to produce an off-patent drug, since that wins them an exclusive right to sell the generic version for six months -- during which they'll reap most of the profits that drug will ever produce.
Failing on either front can be devastating. Ask Watson Pharmaceuticals (WPI ) in Corona, Calif. The No. 3 generics maker in the country by revenues, Watson shocked investors in November when it lowered its earnings projections by more than 40% for the fourth quarter and by 50% for 2002, after which its stock plummeted by nearly 40%. It said going forward it would emphasize its name-brand products to lessen exposure to cut-throat competition on the generics side.
Yet while the generics business can be "disquieting," it can "also be an opportunity," says Jerry Treppel, an analyst at Banc of America Securities. He adds: "The chance to earn extraordinary rates of return is probably better in this industry than in others."
Given the short exclusivity window for new generics, the most successful producers are the brawniest bulldogs in a dog-eat-dog world. That's a hint that investors should look for generics companies with a tough management team and the resources to battle big pharmaceutical companies in court.
Most important is to have a robust pipeline of drugs -– as many as possible with exclusive status. Increasingly, analysts say, it's also critical for a generics company to have a strategy for diversifying into other businesses -- such as proprietary patented drugs.
A PILE OF FILINGS.
When it comes to strong pipelines, the world's largest generics maker, Israel-based Teva Pharmaceutical (TEVA ), arguably is king. Matt Jenkin, senior managing analyst at Dreyfus Corp., notes that Teva currently has 56 filings for generic drugs at the FDA. On 17 of those, it should have first-to-file status. Jenkin expects the company's earnings to rise 20% to 25% in 2002. In the first nine months of 2001, Teva posted earnings per share of $1.45 on revenues of $1.5 billion.
"They've been beating revenue estimates for the last year, and we expect that to continue," Jenkins says. The stock has been hurt because of Teva's location in the Middle East, Jenkin says. But at $58, which is well off its 52-week high of $76, and with a price-earnings ratio of 31 times 2001 earnings vs. an average p-e of about 34 for the group as a whole, he sees it as a good buying opportunity.
Besides its success in generics, Teva has also been one of the few generic drugmakers to effectively diversify into Big Pharma's territory of proprietary drugs. In fact, most major generic companies, including Watson, Mylan Laboratories (MYL ), and Barr Laboratories (BRL ), plan to expand into that side of drugmaking, which is riskier but more profitable. With partner Aventis, Teva already sells a nongeneric called Copaxone, which was approved in 1997 for the treatment of multiple sclerosis. For the first nine months of 2001, the companies sold $260 million worth of Copaxone, up from $175 million for in the same period in 2000.
Another company with a robust pipeline is Barr Labs, which trades at around $78 per share with a p-e of 25 based on its anticipated earnings for 2001. Barr, headquartered in Pomona, N.Y., has some 25 generic filings at the FDA, seven of which are expected to have first-to-file status. It recently won two patent challenges for the right to sell generic versions of Eli Lilly's popular antidepressant, Prozac.
To insulate itself from competition, the company concentrates on drugs with a high barrier to entry. For instance, it's planning to launch generic version of Britian-based Shire Pharmaceutical's (SHPGY ) Adderall, a popular treatment for attention-deficit disorder, early in 2002. Other generics makers may be less inclined to compete for that market, since the main ingredient is an amphetamine, which is hard to come by and regulated by the federal Drug Enforcement Agency.
Barr's long-term strategy includes targeting the oral-contraceptives market with both generics and name-brand drugs. As a number of patents in this category expire, Barr plans to launch 6 to 10 generic versions in 2002. The company also expects to apply for approval of its proprietary oral contraceptive, Seasonale, in the second quarter of the year. With Seasonale, women would take pills for up to 84 consecutive days and then would have a seven-day pill-free period. The regimen is designed to reduce the number or menstruation periods from 13 to 4 per year. Analysts expect Barr to make $4.60 per share in fiscal 2002 ending in June, compared with $1.70 in 2001.
The top pick of analyst Friedman, Billings' Moskowitz is Andrx Group (ADRX ). That company, whose shares trade around $70, or a p-e of 68 based on anticipated 2001 earnings, has just 12 filings with the FDA, but half of those are expected to get first-to-file status. Besides generics, Andrx, which is based in Davie, Fla., develops drug-delivery systems, expertise that allows it to produce generic versions of more complicated drugs -- such as popular hypertension drug Cardizem and Glucophage for diabetics.
"That's very important," says Moskowitz. "These drugs have high barriers to entry because of their delivery technologies. They have large markets and are protected from the onslaught of competition." By the middle of next year, Moskowitz expects Andrx will begin its six-month exclusivity period for Prilosec, the generic version of Astra-Zeneca's blockbuster ulcer treatment. With help from that product, he expects Andrx sales to rise to $1.37 billion in 2002, compared with projected revenues of $741.4 million in 2001. Moskowitz expects earnings per share to rise to $3.85, up from $1.16 in 2001.
Protein-based therapy is also a fast-growing niche for generic-drug makers. These are injectable drugs, often for cancer, that don't work as tablets because the digestive system breaks them down them before they can enter the bloodstream and do their work. Sicor (SCRI ) in Irvine, Calif., competes with just a handful of companies in this market, including newly public American Pharmaceutical (APPX ) and traditional drug and medical technology companies Abbott and Baxter.
While these drugs are hard to make, they have long life cycles and are relatively free of pricing pressure. That's a big advantage for companies that can make generic versions, especially since there's pent-up demand for affordable treatments, especially in developing countries.
Sicor is "making real inroads into generic biologics," enthuses Michael Kress, an analyst with Credit Suisse's Pershing division. "They're bringing life to the unexciting world of generic drugs." Kress recommends Sicor, whose shares trade at around $16, or a p-e of 44 based on expected 2001 earnings. Analysts on average expect the company's earnings per share to rise to $0.76 in 2002, compared with $0.63 in 2001 and $0.28 in 2000.
Unlike the big pharmaceutical companies, which benefit from an image of earnings reliability, generic-drug companies have to earn their stripes every day. And they have to diversify wisely. Analysts shake their heads over Watson, which stumbled as it diverted resources from its generics business to its proprietary drug operation.
One fact remains indisputable, though. Just as baby boomers aren't getting any younger, demand is going to grow for generics drugs, which sell for substantially less than their brand-name counterparts. In 2000, the average brand-named prescription sold for 238% more than the average generic prescription, according to the Generic Pharmaceutical Assn. trade group. And that's a promising prognosis for the makers of no-name drugs.
Tsao covers the pharmaceutical industry and co-writes The Biotech Beat column for BusinessWeek Online in New York