Friday, June 22, 2012
The top-selling drugs in America are about to go on sale.
It's not because big pharmaceutical companies want to slash prices. These drugs are going on sale because their patents will expire.
A patent grants a company the right to exclude competitors from selling their product for 20 years. Once a patent expires, it opens up the door to new competition.
Over the next 12 months, pharmaceutical companies will lose "exclusivity" on some of their top-selling drugs. One industry that will be a huge beneficiary is generics...
According to EP Vantage, a research firm that analyzes patent data for health care companies, the drugs coming off patent in 2012 generated over $33 billion in sales last year.
Here a few of the names coming off patent...
"Big Pharma" companies like Pfizer, Merck, and Eli Lilly have been bracing for this huge risk for years. They bought smaller biotech companies with promising pipelines and increased research and development (R&D) costs to help produce new blockbuster drugs.
Most analysts lowered earnings estimates to account for a decline in sales. In other words, the fact that their top-selling drugs are coming off patent is well factored-in to their stock prices.
But I don't think the same is true for the big generic drug companies...
Generic drug companies are competitors to Big Pharma. Once brand-name drugs come off patent, generic companies are allowed – by law – to make nearly identical products. Since these blockbuster drugs have already been developed and marketed over their 20-year history, the generic companies don't have to incur these costs.
Lower costs allow generic companies to charge 60% less for a brand-name drug. That could save thousands of dollars in prescription costs for consumers. For generic companies, this results in an immediate boost in revenue.
If you apply that 60% discount to the $33 billion in annual sales that will be exposed to generics, you end up with more than $13 billion. And that's just for 2012. More billion-dollar drugs will come off patent in 2013. And all that "free revenue" is about to flow into just a few companies.
The three biggest companies in the sector – Teva Pharmaceuticals (TEVA), Watson Pharmaceuticals (WPI), and Mylan (MYL) – together generated about $32 billion in total sales last year. If they only end up with half the revenue from the newly off-patent drugs, their sales are going to jump 20%.
Teva Pharmaceuticals is the largest generic drug manufacturer in the world. The company trades at just eight times forward earnings. It also pays a dividend of more than 2%.
The company missed earnings last quarter. It saw slower sales in Europe. And shares have pulled back sharply over the past two months.
I suggest using the pullback as a buying opportunity. The company should see sales pick up in the next 18 months as European countries get bailed out and more brand-name drugs lose exclusivity.
Watson Pharmaceuticals and Mylan are the mid-cap players in the generic space. Both companies are trading for less than eight times earnings. Not only will they benefit from patent expirations, but these companies could be takeover targets by Big Pharma – who may look to reduce patent risk.
I suggest scaling into these companies on weakness. These generic plays are cheap. They will also see billions of dollars flow into the industry over the next 18 months.
Generic drug makers aren't the only ones poised to benefit from the "patent cliff." Biotech investors are seeing huge payouts as Big Pharma searches for the next blockbuster drug. Get the details here: Where I'm Looking for the Next 80% Overnight Gain.
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