A Sobering PharmaChem Outlook

The pharmaceutical and biotechnology industries are facing difficult times. The industry is grappling with increased market penetration of generic drugs, the decline in US market growth, and reduced levels of productivity from research and development as measured by the number of new chemical entities (NCEs). These weak underlying fundamentals have been exacerbated by the economic and financial decline, which has hurt small pharmaceutical and biopharmaceutical companies, but which is providing the potential for Big Pharma to replenish its pipeline at reduced prices for acquisitions or licensing deals.

US pharmaceutical industry growth slows
US pharmaceutical industry growth is stagnating, and growth from Big Pharma is also expected to be sluggish. US sales of prescription drugs increased only 1.3% in 2008 to $291 billion, according to IMS Health (Norwalk, CT). Dispensed prescription volume in the US increased only 0.9% in 2008.

The sobering data continue a downward trend of the contribution of US drug sales to global pharmaceutical growth. Although the US accounts for nearly 50% of global pharmaceutical sales, its contribution to global pharmaceutical industry growth declined from 42% in 2000 to only 9% projected for 2009, according to Sarah Terry, president and global managing director of Life Science Analytics (Scranton, PA), a biomedical database company whose product is MedTRACK. She spoke at the Drug, Chemical and Associated Technologies Association (DCAT) “2009 PharmaChem Outlook,” an education program held last month in New York City. As the growth contribution of the US has declined, the contribution to global pharmaceutical growth by emerging countries (China, Brazil, India, South Korea, Mexico, Turkey, and Russia) and countries other than the US, member states in the European Union, and Japan have increased by one-third each.

Reflecting increased generic incursion, fewer NCEs, and smaller returns on NCEs, the compound annual growth rate (CAGR) of prescription drug sales from Big Pharma is expected to be only 1.8% through 2013, increasing from $366.6 billion in 2007 to a projected $407 billion in 2013, according to Datamonitor. As small-molecule drug sales are pressured, sales of biologics from Big Pharma are expected to rise, with biologics expected to account for 20% of Big Pharma’s prescription drug sales by 2013. At the same time, sales from its core products are expected to fall by nearly 50% to $47 billion by 2013.

In contrast, although representing a much smaller base, the CAGR of prescription drug sales from mid-sized pharmaceutical companies and biotechnology companies are expected to be relatively strong. The CAGR from mid-sized drug companies is projected at 6.1% through 2013, increasing from $44.0 billion in 2007 to $62.9 billion in 2013. Small molecules will continue to dominate mid-sized pharmaceutical companies’ revenues, accounting for 92% of their prescription drug sales by 2013, according to Datamonitor.

The CAGR from biotechnology companies is projected to increase 5.6%, from $34.6 billion in 2007 to $48 billion in 2013, according to Datamonitor. Biologics accounted for more than 50% of biotechnology companies' 2007 sales, and therapeutic proteins are projected to represent nearly 70% of sales by 2013.

Unlike Big Pharma and to a lesser extent, mid-sized pharmaceutical companies, biotechnology companies are not as vulnerable to generic incursion. “Although biotechnology companies will see 50% less return on their launches through 2013, they won’t suffer from patent expiries unless there is rapid implementation of a follow-on biologics pathways in the US,” says Terry. In contrast, of the top 15 pharmaceutical companies by revenue, more than $70 billion worth of products will be going off patent during the next four years. according to Datamonitor. Pfizer alone is facing patent exipiries totaling $17.1 billion, principally due to the the patent expiration of the industry’s and its top-selling drug, Lipitor (atorvastatin). Mid-sized pharmaceutical companies will be losing approximately $8 billion in revenues to generics through 2013.

Troubled times for biotech financing
Although there are positive signs from the biologics sector, the overarching issue now facing the biotechnology market is the impact of the economic crisis on financing.

Almost 60% of the 370 publicly traded biotechnology companies had their market capitalizations fall below $100 million in 2008, according to a recent analysis by Burrill and Company, a San Francisco-based private merchant bank. More than 100 North American public and private biotechnology and pharmaceutical companies announced corporate restructuring in 2008. By the end of 2008, 120 companies were trading with less than six months of cash on hand, a 90% increase compared with 2007, according to Burrill & Company. The mean number of years in cash for nonprofitable, public US biotech companies is 1.7 years, according to a MedTRACK analysis.

“We started to see a clear pattern evolving for these companies in the final quarter of last year,” said G. Steven Burrill, CEO of Burrill & Company, in a Feb. 25 press release. “Companies were shrinking to conserve cash and extend their runway. The more mature and blue-chip biotech companies weathered this period quite well since they have plenty of cash, product-revenue streams, strong pipelines, and Big Pharma partners.”

But for the small- to medium-sized US biotechnology companies, 2008 was a difficult year. Financing and partnering deals collectively brought in $30.1 billion for US companies in 2009, with $10.1 billion in financing and $20.0 billion in partnering. Although funds raised through partnering only slightly declined in 2008 from 2007 ($20.0 billion in 2008, $22.4 billion in 2007), private and public financing for US biotechnology companies declined by more than 50% ($10.1 billion in 2008, $22.0 billion in 2007), according to Burrill & Company.

Initial public offerings (IPOs) were hardest hit, with only $6 million raised through US biotech IPOs in 2008, compared with $2.0 billion in 2007. Again reflecting the devaluation in the stock market, the value of follow-on public offerings declined substantially in 2008, reaching only $1.7 billion in 2008 compared with $6.3 billion in 2007. Financing from publicly traded corporate debt also decreased significantly, from $6.7 billion in 2007 to $2.8 billion in 2008. Private investment in public equity also fell, from $1.6 billion in 2007 to nearly $1.1 billion in 2008, according to Burrill & Company.

Although venture capital funding for US-based biotechnology companies declined in 2008, its decrease was not as marked as the declines seen in public biotech financing. US biotech venture capital funding in 2008 was nearly $4.2 billion, a 5.6% decline from the $4.4 billion raised in 2007.

“Biotechs are tackling their funding crisis on two fronts, by cutting costs and reducing their high cash-burn rates, and by attempting to access cash from external sources,” says Terry. “However, this is becoming a tough task. Biotech is facing a funding crisis with many traditional avenues for accessing debt now closing or already shut off.”

Big Pharma sees opportunity
Facing pressure and difficulty in raising money through public and private financing, partnering deals have become an attractive, if not the only viable option for biotechnology companies. “Cash-hungry biotech companies are turning to cash-rich Big Pharma for funding,” says Terry. “With biotech’s position destabilized, Big Pharma now wields greater power when negotiating deals, both licensing and mergers and acquisitions, and will have the ability to access much needed late-stage drug candidates at knock-down prices.”

Terry points out that until the financial crisis, licensing was becoming an increasingly expensive and complex option for Big Pharma. The number of US licensing deals (both in-licensing and out-licensing) performed by the top global pharmaceutical companies (based on 2007 annual revenues) declined by 28% between the first quarter 2006 and the third quarter 2008, according to MedTrack. “But Big Pharma now has the upper hand and has been bargain-hunting for late-stage products,” says Terry. This situation is a reversal of early trends in licensing deals that favored candidates in early-stage development, which could be acquired at better prices. For example, in the third quarter of 2007, approximately 65% of licensing deals involved Phase I candidates and only roughly 16% of deals involved Phase III candidates. A year later, in the third quarter of 2008, these numbers reversed almost entirely, with roughly 58% of deals involving Phase III candidates and about 20% of deals involving candidates in Phase I.

The need to put up cash in deals is giving Big Pharma a decided advantage. “Given the current credit crunch, only Big Pharma can afford to pay for assets in cash,” says Terry. Smaller companies looking to deal outside of Big Pharma have to be more resourceful. “Small- and medium-sized companies will therefore try and negotiate milestone payments into the deal and/or the use of facilities such as manufacturing plants or expertise as part of the payment structure for the deal.”

Implications on outsourcing
These deals reflect an ongoing trend in the drug industry in which outsourcing, be it in research and development, manufacturing, or sales and marketing, has shifted from a tactical to strategic focus. At the same time, Big Pharma and medium-sized companies are interested in improving their balance sheets through cost-cutting initiatives, which include rationalization of manufacturing plants and increased outsourcing. Active pharmaceutical ingredient (API) manufacturing accounted for 15% of all divesture deals in the pharmaceutical industry between the first quarter 2006 and the third quarter of 2008, according to a MedTRACK analysis. “As pharmaceutical companies need to cut costs, this has led to the sale of API units and the outsourcing of such functions.”

The combination of increased outsourcing, tighter resource allocation, operational cutbacks, and the resulting pressure on drug-development pipelines is likely to shape the pharmaceutical industry during the next several years.