The big threat to Big Pharma

NEW YORK (CNNMoney.com) -- The threat to Big Pharma is real - the nation's drugmakers stand to lose nearly seven percent of their sales to drugs going off patent this year - and more CEOs who don't get ahead of the problem could end up losing their jobs.

"Three of the six U.S. pharma company CEOs have been terminated over the last year, and new managements understand that the status quo is NOT an option," Barbara Ryan, analyst for Deutsche Bank North America, wrote in a recent note to clients.

Many of the nation's biggest drugmakers are taking a hit from expiring patents to top-selling drugs.

Big brand-name drug makers are not keeping pace with patent expirations of key products, threatening the near future of the brand-name industry. At the same time the trend has given a lift to makers of generic drugs - both at home and overseas.

This year, brand-name drugs that generated $23 billion in sales are going off patent worldwide, according to the research firm IMS Health, followed by another $16 billion in 2007. The lion's share of that comes in the United States, where $19 billion worth of prescription drug sales are losing patent protection this year followed by another $10 billion in 2007, according to IMS. That's about 7 percent of U.S. drug sales losing protection this year, with about 3.5 percent going off patent in 2007.

While the industry is still profitable and is far from going bankrupt, Big Pharma is undergoing some of the most staggering changes drugmakers have faced in recent years.

Pfizer, the world's biggest drugmaker, and Merck, the No. 4 U.S. drugmaker, are cutting billions in costs by laying off workers and shutting down plants. Pfizer's new CEO Jeffrey Kindler recently said he's ramping up company cost-cutting.

While the wave of patent expirations gives pause to investors with funds parked in Pfizer Inc (down $0.55 to $26.65, Charts). and Merck & Co (down $0.22 to $45.42, Charts)., it also gives them reason to take a closer look at generic competitors such as Teva Pharmaceuticals (up $0.38 to $32.97, Charts) and Barr (up $2.32 to $52.37, Charts), as well Novartis AG (up $0.33 to $60.73, Charts), which is palying both sides of the street with a big brand-name as well as generic business.

"There's the huge wave coming behind the [generic] pharm companies and every single one of them is going to benefit from this wave," said Casey Alexander, analyst for Gilford Securities. "It's not a little whitecap. It's a tsunami."

When patents on brand-name drugs expire, sales usually plunge as generic firms make the drugs at sharply reduced prices. That means big losses for companies like Pfizer, which lost patent protection on the $3.3 billion antidepressant Zoloft in June; Merck, which lost protection on the $4.4 billion cholesterol drug Zocor that same month; and Bristol-Myers Squibb (up $0.42 to $24.75, Charts), which lost protection on its $2.3 billion cholesterol drug Pravachol in April.

Bristol earnings tumbled 64 percent in the third quarter, partly from the Pravachol loss, and partly because the drugmaker Apotex produced generic versions of Plavix, a blood-thinner under Bristol's patent protection. Apotex produced Plavix without legal clearance to do so, until Bristol managed to get the production blocked by a court ruling. The failure of ex-Bristol CEO Peter Dolan to handle that problem more effectively was one thing leading to his ouster in September.

But while the losses to brand-name drugmakers can be painful, the gains for generic drug makers aren't comparable. Sales for brand-name drugs often plummet about 80 percent after patent expiration, and what remains of these sales are often divided among numerous producers.

Jon LeCroy, analyst for Natexis Bleichroeder, said generic makers can sometimes secure significant sales, at least for a few months, by successfully challenging patents in court and winning temporary exclusivity. (This is probably what happened to Apotex, but the privately held firm doesn't publicize its sales.)

LeCroy said "natural expirations," which occur when generic drugmakers start producing a drug after the patent expires, are less profitable because so many companies divide up the pie.

"Generics is a tough business because unless you get exclusivity the margins tend to be low," he said. Natural expirations aren't huge profit drivers for generic firms "because you have five or six players right from the get-go."

But the generic sales do add up, even if they pale compared to big brand-name drugs. Generic sales are expected to grow 13 to 14 percent in 2007, according to IMS, versus industry-wide growth, including brand name and generic drugs, of 5 to 6 percent. That last number is down from projected growth of 6 to 7 percent for the industry this year.

And sales at Teva, the Israeli company that's the world's biggest maker of generic drugs, are expected to jump 50 percent this year, partly from its acquisition of Ivax, a Miami-based generic drugmaker, and grow another 11 percent in 2007. Novartis of Switzerland is expected to grow sales 14 percent in 2006 and 8 percent in 2007.

But sales for New York-based Pfizer, the biggest name brand maker, are expected to drop 7 percent this year and another 1 percent next year. For New Jersey-based Merck, analysts see sales down 1 percent this year and next.

Although more and more drugs are becoming so-called blockbusters every year, growth in the number of $1 billion drugs on the market won't help big drugmakers keep pace with patent losses, IMS senior vice president Murray Aitken said in a statement. The number of blockbuster brand name drugs on the market is expected to grow to 112 next year from 94 in 2005, IMS said.

Growing generic pressure to name-brand companies has led, in part, to the recent termination of several Big Pharma CEOs, including the ouster of ex- Bristol CEO Dolan. This has led to a new culture in Big Pharma, where relatively new CEOs like Kindler at Pfizer and Dick Clark at Merck are cutting billions in costs.

But while cost-cutting takes the sting out of patent losses temporarily, investors want to see replacements for the outgoing products. New products mean growth, and that's what investors want to see.

"What can they do to grow?" said Barbara Ryan, analyst for Deutsche Bank North America, referring to big brand-name drugmakers. "In the short run, they are reducing their cost bases and they will improve the earnings outlook. Ultimately, they'll have to be successful in producing new drugs."

So far, the wave of patent expirations is well known - and so it's "baked into the cake" for Big Pharma stocks, Ryan said.

But that could change. The situation for brand-name companies may actually improve once Big Pharma works through the bulk of patent expirations in the next couple years, and potential drugs in the pipeline start coming to fruition, said LeCroy of Natexis Bleichroeder.

"Once you get beyond 2008, things are looking better and the pipelines are starting to fill up," said LeCroy.

The Food and Drug Administration approved several drugs in 2006 that are expected by analysts to become blockbusters within the next couple years, including Pfizer's kidney cancer drug Sutent and inhalable insulin Exubera, and Merck's cervical cancer vaccine Gardasil.

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