NEW YORK, Aug. 18, 2014 – Baird, an employee-owned international capital markets, private equity, wealth and asset management firm, will host its annual Health Care Conference in New York City Sept. 3-4.
The conference will bring together institutional and private equity investor attendees to hear presentations from executives representing more than 80 public and privately held companies across a range of sectors.
As a preview to the conference, Baird Senior Research Analyst Brian P. Skorney, who covers Biotechnology, shares his thoughts on biotech valuations and the impact of high-price therapies.
How much does biotech industry valuation depend on firms’ pricing powers?
Pricing power is extraordinarily important for any company involved in the development and commercialization of therapeutics. This is clearly evidenced by the disparity in the valuations of companies involved in the commercialization of therapeutics where there is pricing power (i.e., oncology, orphan drugs) such as Pharmacyclics, Inc. (PCYC) and those where there is diminished pricing power (i.e., antibiotics) such as Cubist Pharmaceuticals Inc. (CBST). Where the larger pharmaceutical companies are choosing to focus their resources is also very telling – most large pharma companies have abandoned antibiotics due to the inability to commercialize them.
The costs of drug development have accelerated significantly as regulatory requirements have become increasingly burdensome. Without the power to price drugs to cover both the cost of successes and the cost of failures, the Net Present Value (NPV) on investing in the space would be negative.
As certain specialty drugs gain attention for their high price points, how much pressure are companies feeling to alter prices? What could catalyze real changes to pricing structures, and what would the impact be on biotech and pharma profits?
The debate around drugs with high price points has been part of the sector for 20 years, but the noise has certainly been elevated recently. Companies like Gilead Sciences, Inc. (GILD) and Vertex Pharmaceuticals Inc. (VRTX) are feeling varying degrees of pressure from different stakeholders such as patient advocacy groups in HIV, pharmacy benefit managers in respiratory disease, or government representatives in various indications.
It remains to be seen what could catalyze real changes to pricing structures especially when we are still debating whether pricing structure changes should be done at all. We do know that buying power does have the ability to help drive these changes, whether it is through a single-payer government system, or collaboration among Pharmacy Benefit Managers and insurers. This dynamic is already evidenced in the European Union where many countries have levered their single payer systems to limit drug prices. This has had a very detrimental effect on biotech and pharma profits in these regions – to the point where some companies have chosen to not sell a drug at all where they have unfavorable reimbursement. The U.S. – the world’s largest pharmaceutical market – has not followed suit, but if it did, the effect on profits would be catastrophic.
How dependent are firms on one or two blockbuster drugs for their profits? Has this caused additional volatility in the sector as patents run out and generic competition enters the market?
I would argue more than 90% of companies in the sector are entirely dependent on one or two drugs, and it’s those drugs that allow companies to become diversified global pharma companies. Two of the biggest companies in the biotech sector, Gilead and Celgene Corporation (CELG), are really only dependent on one or two drugs for their profits.
Generally the patent cliff creates much more volatility around drugs that are small molecules as opposed to biologics. Because the profits of companies like Gilead and Celgene are dependent on drugs that are small molecules, the discussion around “patent cliff” is constant. When the drug is a biologic, there is generally viewed to be significantly greater terminal value due to an ambiguous pathway to approval and the high costs associated with even trying to develop a biosimilar.
In general, the sector has struggled with how to assign terminal value beyond a drug’s patent life. Assigning no terminal value to a company years away from generic competition has largely proven to be an overly conservative assumption, but growth beyond generic introduction has proven to be wildly aggressive. The range of valuations between the two scenarios is usually extraordinary, which highlights why this dynamic results in so much stock volatility.
About Brian P. Skorney, CFA
Brian Skorney is Baird’s senior analyst covering Biotechnology. Prior to joining Baird in 2012, he was a senior vice president in equity research at Brean Murray Carrett & Co, a vice president in equity research at ThinkEquity, LLC, and a research analyst at Susquehanna International Group, LLC, all in the biotech/pharmaceutical industry. He also worked as a coordinator and lab manager at the Howard Hughes Medical Institute. Brian received a BS in biological sciences from the University of Notre Dame and an MBA in finance from New York University.
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Baird’s Research Department consists of approximately 125 research professionals covering more than 700 U.S. companies. Baird analysts have been recognized repeatedly in The Wall Street Journal’s annual “Best on the Street” survey and honored by StarMine as top analysts.
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