Finance & Investment ClubHealthcare SectorSummer 2012

Senior Analyst: Roy Tong

Generic Pharmaceuticals

 

2

Executive Summary – Generic Pharmaceutical Manufacturing

• Growth in revenue outpaces that of GDP• Acceptance of Generics evident in growing domination of sales mix

at the expense of brand names

Generic Drugs Industry in Growth

Stage

• Lower cost to manufacture than brand names• Sales further driven by patent expiry of brand names

Generics Growth Fuelled by Low Prices

• Increased government Medicare and Medicaid spending leading to more consumer access to prescription drugs as opposed to OTC

• Most insurances (both private and public such as Medicare) do not cover brand names when generics are available

Use of Generics Aided by Government

Spending and Reform

• Large aging population increasing – elderly more vulnerable to diseases that require medication to treat

• Unhealthy American lifestyle, too much fat and calories, inadequate exercise and fiber, breed obesity and other diseases

Aging Population and Unhealthy American

Lifestyle

 

3

Industry Definition – Generic Pharmaceutical Manufacturing• Generic pharmaceutical and medicine manufacturers develop prescription drug

products that are used to prevent or treat illnesses in humans or animals

• Generic drugs are produced, marketed and distributed without patent protection, yet at the same time comparable to brand listed drug products (if existent) in dosage, strength, administration, quality, performance and intended use

• Firms are allowed to manufacture generics of brand name drugs AFTER the expiration of patents protecting the branded drugs, and are able to do so at a much lower cost due to the bypassing of discovery costs

Ligand PharmaceuticalsNASDAQ: (LGND)

Avanir PharmaceuticalsNASDAQ: (AVNR)

Catalyst PharmaceuticalsNASDAQ: (CPRX)

Sagent PharmaceuticalsNASDAQ: (SGNT) Hi Tech Pharmaceuticals

NASDAQ: (HITK)

Source: Yahoo Finance Industry Center, Various Firms’ 10K & IBISWorld Analysis

 

4

20.1%

25.3%

3.1%

23.1%

28.5%

Health Care$2,384.26B

(100%)

Drug Manufacturers and Related

$1,423B(61.23%)

Generic Drug Manufacturer

$45B(1.89%)

Health Care Sector BreakdownIndustry Breakdown by Market Cap ($BLN) Breakdown by Market Cap

LGND $317.78M

AVNR $399.33M

CPRX $48.57M

SGNT $364.84M

HITK $450.88M

Total $15.81B

Selected Companies Market Cap

Source: Yahoo Finance Industry Center & Various Firms’ 10K Analysis

 

5

Breakdown by LTM Revenue (Total: $427.28M) Biological Products

6%In-Vitro Diagnostic

Substances Products6%

Pharmaceutical Prep for Other Drugs

35%

Pharmaceutical Prep for Metabolic Drugs

14%

Pharmaceutical Prep for Cardiovascular

Drugs12%

Pharmaceutical Prep for Central Nervous

System Drugs11%

Pharmaceutical Prep for Psychotherapeutic

Drugs7%

Medicinal and Botan-ical Products

10%

Industry at a Glance

7.10%2.48%

36.03%54.38%

Source: Yahoo Finance Industry Center, Various Firms’ 10K and IBISworld Analysis

Revenue $52.8B

Profit $7.8B (14.7%)

Exports $19.6B

Annual Growth (07-12) 5.4%

Expected Growth (12-17) 6.3%

Businesses 1,103

Product Segmentation

 

6Source: Various Firms’ 10K and Firms’ Website Analysis

Pre Clinical Trials

Generic Drug Manufacturers Revenue Generation

Stage I Stage II Stage III

Manufacturers Research and Development Partners

New Drug Application

(NDA)

PassPassPass

PassFDA

ReviewMarketed and Sold

Through Partner

Sales Team or Retailers

Direct through Sales Team

Institutions

Retailers

3rd Party

End User

Royalties or Licenses

Pipeline

FDAApproval

 

7

Geographical Distribution of Generic Pharma Manufacturers

Source: IBISworld Analysis

• Mid-Atlantic and West regions with most manufacturers but sales branches typically located close to end market

• Advantage of locating near other manufacturers include local specialize workforce, experienced business services & availability of facilities that are specialized and expensive to build

• Sales of generics follow population trends – Southeast, home to significant portion of elderly, accounts for largest region in terms of revenue

 

8

100%

Hi-Tech Generics86%

Health Care Products (OTC)

7%

ECR Pharmaceuticals (Branded)

6%

58%

42% 40%

31%

20%

9%

100%

2011 Revenue Generation Breakdown by Segments

Source: Various Firms’ 10K Analysis

 

9

19.67%

71.75%

8.57%

55.64%44.36%

2011 Operating Expenses Breakdown by Segments

Source: Various Firms’ 10K and Firms’ Website Analysis

21.58%

53.96%

24.46%

21.58%

78.42%

30.14%

58.25%

11.61%

* No selling

 

10

5

2

28

8

Product Development Stages

(22%)

(78%)

63

33

(66%)

(34%)

(71%)

(29%)

33

51(61%)

(39%)

8

(100%)

Source: Various Firms’ 10K and Firms’ Website Analysis

 

11

Time Series Analysis

2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013(est) 2014(est) 2015(est) 2016(est) 2017(est)0

10

20

30

40

50

60

70

80

0

100

200

300

400

500

600

700

800

Generic Drugs Revenue Medicare Spending Medicaid Spending

$ in

Bill

ions

$ in

Bill

ions

• Revenue – Medicare Spending Correlation: 0.98 • Revenue – Medicaid Spending Correlation: 0.86 • Based off anticipated US government spending on Medicare and Medicaid (which can be found from

records and projections from the US Government Office of Budget and Administration), we can reason that a comparable growth rate will be found in projected revenue of the generic drugs industry

• Projected Revenue (Billion $) = 6.601 + 0.112*Medicare – 0.68*Medicaid Spending (Billion $)• Accurate within +/- 3 Billion $

Source: Office of Management and Budget, IBISworld & BUFC Analysis

 

12

• Generic pharmaceutical manufacturing shows key features of an industry in its Growth stage

• The value that industry (revenue) adds to the US economy is growing at a much faster pace than US GDP

• Rapid introduction of products and brands coincides with growing customer acceptance of products

• This is seen in how market share has grown substantially at CAGR of 5.4% for past 15 years compared to brand name drugs’ decline

Trend 1 – Growth of Generics Revenue > GDP Growth

2007 2008 2009 2010 201190%

95%

100%

105%

110%

115%

120%

125%

% o

f 200

7

Generics Revenue

US GDP

1995 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 20100

10

20

30

40

50

60

70

80% Distribution of Brand vs Generic Sales Mix

CAGR: 5.4%

Source: US Census Bureau, Mintel & IBISworld Analysis

 

13

• Patent expirations have huge impact on sales, as brand name drugs quickly lose market share once generic versions are on the market

• Drugs representing more than $140 billion in sales will lose patent protection between 2012 and 2017

• The patent expiry of “blockbuster” drugs would continue to stimulate sales in the generic industry

Trend 1 (Con’t) – Growth of Generics Revenue > GDP Growth

Source: Mintel, IBISworld & Frost and Sullivan Analysis

Brand Name Generic Name US Sales (billions) Company % of

Revenue

Plavix Clopidogrel 6.1 Bristol-Myers (BMY) 48%

Actos Pioglitazone 3.5 AstraZeneca (AZN) 53%

Advair Flucticansone 4.03 GlaxoSmithKline (GSK) 34%

Top Selling Drugs to Lose Patent by End of 2012

 

14

Trend 2 – Competitive Edge in Low Costs

Source: US Census Bureau, Mintel & IBISworld Analysis

• Lure of generics are obvious, with a 74% difference in average retail prices as of 2010

• Virtually all major pharmacy chains offer generics at extremely inexpensive prices, leading to price wars

• Result of this has been an increase in sales of generics, often at the expense of brand names

• In 2010, 93% of physicians prescribed generics when they were available – compared to 83% in 2003

• Some 75% of prescriptions dispensed in 2011 were generic drugs – compared to 40% in 2000

1995 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 20100.00

20.00

40.00

60.00

80.00

100.00

120.00

140.00

160.00

180.00Average Retail Prices of Brands vs Generic ($)

Pharmacy Chain Offer Price

Walmart 30 Day $4

CVS 90 Day $9.99

Kroger 30/90 Day $4/$10

United Healthcare

Provides for co-payments for Medicare

Part D$2

 

15

Wil Not Pay for Brand Name if Generic is

Available59%

Will Pay for Certain Brand Names, Does Not Cover Generics

13%

Doctor Willing to Pre-scribe Drug, But Not

Covered (i.e. Viagra for Sexual Dysfunction)

16%

Prescription Drugs Covered but Doctor Will

Not Prescibe It (i.e. Xanax for Anxiety)

12%

Covers Prescription Drugs90%

Does Not Cover Prescription Drugs

7%

I Don’t Know3%

Trend 3 – Government and Private Insurance Coverage

• Of the pool of respondents in a Mintel study, 90% of the total indicated that their insurance covers prescription drugs

• Furthermore, close to 60% of respondents indicated that their insurance would not pay for Brand Name drugs should a Generic be available

Source: Mintel & IBISworld Analysis

 

16

2006 2007 2008 2009 2010 2011 2012 (est)

2013 (est)

2014 (est)

2015 (est)

0

100

200

300

400

500

600

700

800

Medicare

Medicaid

Spen

ding

in M

illio

ns

Federal Medicare & Medicaid Spending• When Medicare and Medicaid receive

more funding from the government, more consumers gain prescription drug coverage

• As a result, industry demand increases with the population’s ability to afford the industry’s products

• Coverage by these government aids usually will not cover the cost of brand name drugs if generics are available

• Health Care reform in 2010 expected to benefit generic pharmaceutical manufacturers - PPACA

Source: Office of Management and Budget, Mintel & IBISworld Analysis

CAGR: 6.7%

CAGR: 8.7%

Patient Protection and Affordable Care Act (PPACA)

Section 10609

Prevents brand-name manufacturers from

making label changes to the brand-name or listed drugs, thereby

delaying generic products

Trend 3 (Con’t) – Federal Health Care Spending & Reform

 

17

Trend 4 – Aging Population & Unhealthy Lifestyles

2006 2011 2016(Est)0

10,000

20,000

30,000

40,000

50,000

60,000

70,000

80,000

90,000

100,000

20%

21%

22%

23%

24%

25%

26%

27%

28%

>55 >55 % of Total Population

Popu

latio

n O

ver 5

5 Ye

ars

Old

%

• American population is an aging one, with Americans aged 65-74 estimated to see the greatest hike from 2011-2016, followed by 55-64s

• This means that the 2 fastest growing demographics are at or approaching the age when the aging process will place them at greater risk for a variety of age-related ailments

• The elderly are more vulnerable to certain diseases, including Alzheimer’s, heart disease, diabetes, cancer etc, which require preventive or treatment measures provided by pharmaceuticals

Source: Mintel & IBISworld Analysis

 

18

Trend 4 (Con’t) – Aging Population & Unhealthy Lifestyles

Source: Mintel & IBISworld Analysis

• Lack of exercise and poor diet primarily responsible for increase in number of diseases

• 67% of population is overweight/obese, with cancer and stroke strongly associated with obesity

• Some 81 million Americans (34%) have heart disease, and 92.7% have at least 1 risk factor for the disease (obesity, high blood pressure, high cholesterol, diabetes, smoking)

• According to NIH, diets high in fat result in higher mortality rates and incidences of colon, breast and prostate cancer

Unhealthy American Lifestyle

Insufficient Exercise

70% of Population is inactive, 12% of

respondents in CDC survey meet weekly recommended

amount of 150 mins of moderate-intense exercise

Too Many CaloriesDaily caloric consumption

up from 2172 a day to 2775 over past 30 years

Too Much Fat

Average American diet is 34% fat, 12% being

saturated, above AHA recommendations of no

more than 7% saturated fat

Not Enough FiberAdult Americans consume

only 50% of optimum amount of fiber

 

19

Trend 4 (Con’t) – Aging Population & Unhealthy Lifestyles

Source: Mintel & IBISworld Analysis

Heart disease

Cancer

Stroke

Respiratory Diseases

Accidents

Alzheimer's Disease

Diabetes

0 100,000 200,000 300,000 400,000 500,000 600,000 700,000

616,067

562,875

135,952

127,924

123,706

74,632

71,382

Leading Causes of Death

• A result of high disease counts has been an increase in the number of prescriptions dispensed, up 3.2% from 2007 to 2009, almost double the increase in US population in the same time period

• Those affected by chronic disease and require chronic medication, a large portion of which are older adults, resort to skipping/reducing doses when faced with increased medication costs which can lead to expensive hospitalizations and adverse health outcomes

• However, patients who initiate therapy with lower cost generic medications have higher rates of adherence, making generics appealing to health care providers who want to ensure treatment compliance and avoid unnecessary spending

 

20

Comps Financials

Company Market Cap (In Millions)

Closing Price

(Aug 28)% of 52 wk High

P/E Ratio

EV/EBITDA EPS Debt/

EquityLTM ROE

Quick Ratio

Ligand (LGND) 326.17 16.36 82% 32.08 85.3x 0.51 3.31 60% 0.71

Avanir (AVNR) 403.1 2.96 73% (5.8) (4.8x) (0.51) 0 (85%) 5.93

Catalyst (CPRX) 46.73 1.52 77% (7.24) 7.6x (0.21) 0 (170%) 7.47

Sagent (SGNT) 233.69 14.68 55% (15.29) (17.9x) (0.96) 0.03 (19%) 1.89

Hi Tech (HITK) 460.14 35.26 79% 9.82 4.5x 3.59 0.01 20% 4.74

Industry 45,000 - - 50.1 - - - 7.6% -

High 460.14 35.26 82% 32.08 85.3x 3.59 3.31 60% 7.47

Low 46.73 1.52 55% (15.29) (17.9x) (0.96) 0 (170%) 0.71

Median 326.17 14.68 77% (5.8) 4.5x (0.21) 0.01 (19%) 4.74

Mean 293.97 14.17 73% 2.71 14.9x 0.48 0.67 (39%) 4.15

Source: Yahoo Finance Industry Center, Google Finance, MacroAxis & Various Firms’ 10K Analysis

*does not include industry values

 

21

RisksRisk 1 – OTC, Complementary & Alternative Medicine• Greater motivation to self-treat in order to save time and money with a trip to the doctor• Greater Availability of OTC remedies that were once available only with a prescription to treat

minor illnesses such as colds, allergies, headaches or coughs• Desire for natural healing (CAM) to avoid potential side effects from prescription drugs

Risk 2 – External Competition from Brand Names• Many brand competitors try to prevent or delay approval of generic equivalents by attempting to

extend patent protection• Brand competitors sometimes launch authorized generics concurrent with 1st generic launch• Brand competitors also seek to lower prices of brand name drugs after patent expiry to compete

with generic equivalents

Risk 3 – Other Health Care Reforms or Changes to Current Policies• “Evergreen” loophole in health care regulation that allows innovator drug companies can extend

market exclusivity for branded drugs through strategies like authorized generics• Branded-Generic patent settlements paid to firms to compensate generic producers for keeping

generics off the market• Changes to current policies with elections coming up and potentially new directions could

adversely affect the generic drug industry

Source: IBISworld, Mintel & Various Firms’ 10K Analysis

 

22

Conclusion and Recommendation

•Growth stage industry fuelled by continual acceptance of products, low prices of goods and federal health care spending•State and behavior of American population set to have positive effects on prescription drugs and therefore generic industry in the next 5 years

Industry: Positive

•Competition from brand name manufacturers that attempt to keep generics off the market for a longer period of time•Must stay responsive to potentially new government regulations and health care reforms, especially during election years

Industry Risks to Overcome

•HITK is profitable, with 4.7 Quick Ratio showing good financial health and liquidity in addition to having minimal debt (0.01 Debt-Equity Ratio)•LGND with diverse revenue generation, yet could mean complicated business model •Both with ROE well above industry average and poised to take advantage of trends

Why Recommended Firm(s)

 

23

Q & A

• Executive Summary• Industry Definition• Health Care Sector Breakdown• Industry at a Glance• Revenue Generation• Geographical Distribution• Revenue Generation Segments• Operating Expenses Segments• Product Development Segments• Time – Series Analysis• Trend 1 – Growth of Generics • Trend 1 – Patent Expiry

• Trend 2 – Generics’ Prices• Trend 3 – Insurance Coverage• Trend 3 – Government Spending• Trend 4 – Aging Population• Trend 4 – Unhealthy Lifestyles• Trend 4 – Leading Causes of Death• Comps• Risks• Conclusion and Recommendation• How to Calculate Patent Expiry• What are CAMs?

 

24

How to Calculate Patent Expiry in USAFor Patents filed before 08/06/1995 (INID Code 22)• Add 17 years to patent issue date shown on front page of patent (INID code 45) to

obtain 1st date• Add 20 years to the application date of the earliest related application shown on the

front page of patent (INID codes 62 or 63) to obtain 2nd date• Later of the two dates is the expiry date• Add any applicable extensions of adjustments to the patent term, and then account for

any terminal disclaimers to obtain the full-term expiry

For Patents filed on or after 08/06/1995 (INID Code 22)• Add 20 years to the date of the earliest related application show on front page of

patent (INID codes 62 or 63) to obtain the expiry date• Account for any terminal disclaimers to obtain full-term expiry

Source: http://www.genericsweb.com/

 

25

What are CAMs?Complementary & Alternative Medicines• A group of diverse medical and health care systems, practices, and products that are

not generally considered part of conventional medicine• Complementary medicine refers to the use of CAM together with conventional

medicine, such as using acupuncture in addition to usual care to help lessen pain• Alternative medicine refers to the use of CAM in place of conventional medicine

Categories of CAM• Natural Products – “natural products”, many sold OTC as dietary supplements, include

probiotics• Mind & Body Medicine – focus on interaction among brain, mind, body. Techniques

include meditation, postures, yoga, acupuncture, breathing exercises, tai chi etc• Manipulative & Body Based – focus on the structure and systems of the body including

bones and joints, soft tissues etc, such as spinal manipulation or massage therapy• Other CAM – these include movement therapies such as pilates etc to promote

physical, mental, emotional and spiritual well-being. These also include manipulation of energy i.e. magnet therapy

Source: http://nccam.nih.gov/health/whatiscam