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Three Ways to Profit from Big Pharma's Plight

By Rob Fannon, editor Phase 1 Investor
Friday, February 22, 2008

The drug industry's biggest players are in deep trouble...
It's no secret. Seventy of the top 100 selling drugs will lose patent in the next five years, totaling 50% of the entire industry's 2007 sales. Now, the industry is spending record amounts in research and development, while the FDA is approving fewer and fewer drugs each year...
But Big Pharma isn't giving up its glory days without a fight. Today I'm going to explain three strategies drug companies are using to shore up their balance sheets. Better yet, I'm going to show you how to directly profit...
1. Pay someone else to do the dirty work...
One-third of every dollar spent in research and development last year was outsourced, about $15 billion total. The primary beneficiaries on the receiving end of this trend are the contract research organizations, or CROs.
The CRO business model is brilliant... These companies run Big Pharma's clinical trials, analyze statistics for FDA drug applications, and generate new drug libraries faster and cheaper than traditional drug companies. The great part for CRO investors? They get paid no matter if a drug makes it to market or not.
I recommended the two biggest CROs in the business – Covance (CVD) and Pharmaceutical Product Development (PPDI) – to my readers about a year ago. Right now, we're up about 32% and 41%, respectively. Plus, I just recommended a tiny Chinese CRO, which conducts early-stage drug discovery work for nine of the top 10 drug companies in the world.
2. If you can't beat 'em, join 'em...
Johnson & Johnson and Pfizer recently succumbed to the "dark side," launching their own in-house generic drug shops.
One Swiss drug company, Novartis (NVS), was way ahead of the curve on this trend. Its generic drug division, Sandoz, is the third-largest competitor in the industry. Sandoz's revenues grew three times as fast as Novartis' brand-name business last year. It now accounts for 20% the company's top line.
I think Novartis is the only perfectly hedged big drug company out there, and it's worthy of your investment. But the most direct way to play this trend is to own the best generic drug companies at the right price. This list includes generic players Teva Pharmaceutical, Barr Pharmaceuticals, Mylan Labs, and Watson Pharmaceuticals.
3. There's one way to beat 'em...
Biotech drugs are immune to generic drug competition. The FDA has no regulatory pathway to approve copycat versions of biotech drugs. The FDA says it's too complicated to replicate these treatments, which are made from living cells unlike traditional chemical drugs.
This is just one of the reasons the biotech industry can get away with premium pricing. Genentech, for example, charges $60,000 a year for its cancer drug. And Genzyme sells a $200,000 treatment for Gaucher disease (a genetic disorder).
With prices like this, you can see why big drug companies want to get into the biotech game... and are willing to cough up big bucks to buy out the most promising biotech companies. Since 2005, Big Pharma has spent more than $80 billion gobbling up smaller biotech outfits, handing shareholders windfall profits in the process.
Good investing,
Rob Fannon

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