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Executive Summary

Pfizer is "Z" most attractive of the financial community's pharmaceutical darlings as the new trading year begins. The company's dramatic 23% surge in market valuation during the last month of 1991 stock trading marks it as a stand-out in a stand-out sector. The company's two fourth-quarter approvals for a pair of "Z"- branded products -- Zithromax (azithromycin) and Zoloft (sertraline) -- added renewed vigor to a year-long upward ride for the stock. For the full-year, the company's stock doubled in value: beginning the year at 80-3/4; splitting two-for-one at the end of the first quarter; and then climbing back again to close 1991 at 81-3/4. Pfizer was one of 13 stocks in the F-D-C Index to show a gain in 1991 trading of 100% or greater over its 1990 close. The 30- issue Pharmaceutical Component posted a 52.4% increase -- its second best performance in the 30 years that F-D-C Reports has maintained indices tracking pharmaceutical stock performance. In 1985, the Pharmaceutical Component advanced more than 53%. In a year in which the two hottest sectors of the U.S. economy arguably were health care and the stock market, the NYSE/AMEX- traded pharmaceutical companies were perfectly positioned for broad investment interest. The 52.4% jump by the F-D-C pharmaceutical group compares to a 20.3% gain by the Dow and a 26.2% bound by the S&P 500. FDA's approval pace helped also. The agency approved 30 new chemical entities during the year -- with less than a third of the approvals coming in the traditional end-of-the-year wave. The FDA approvals were not heavily skewed toward low-market potential products: a number of products, such as Abbott's Biaxin, Lilly's Lorabid, Marion Merrell Dow's Seldane-D and Merck's Zocor, give major marketing companies new entries to categories in which they already have a sizeable presence but could use new product support. The FDA was viewed generally as a tough enforcement adversary in industry circles during 1991 because of the crackdowns on alleged promotion violations. But the FDA under Commissioner Kessler is not a one-dimensional agency. It is playing to both sides of its mission statement, enough so on the approval side that the investment community appears to project reasonable approval paths for pipeline products. The rush to pharmaceutical and pharmaceutical-related stocks stretched from the largest of the established firms to the more speculative companies: Merck and Glaxo were each up over 85%; Bolar was up 465% and ICN jumped 526%. Among the few major firms to be left behind by the upswing were the two leading U.S. drug wholesalers. McKesson was up 7.4% on a 2-1/2 point gain to 36-1/2 and Bergen-Brunswig was off 19% to close at 22-7/8. Also lagging behind the crowd in 1991 were Lilly (up 14% on a 10-1/4 gain) and Marion Merrell Dow (flat at 36-3/8). While their own stock performances were mediocre, they are interesting examples of a new phenomenon in pharmaceutical investing. Both Lilly and Marion Merrell Dow (MMD) had the odd, but noteworthy, distinction of having investment porfolios made up of stakes in other drug companies that outperformed the growth of their own stocks in terms of percentage increases. MMD, for example, has equity investments in at least four publicly-traded start-up companies. These positions, purchased for a total of $47.5 mil., had already shown good appreciation by the start of 1991, carrying a valuation of $83.3 mil. at that point. By the end of the year, those holdings had more than quadrupled in value, closing 1991 at $356.7 mil. Similarly, Lilly's investments in five public companies, purchased for a total of $20.3 mil. and valued at $19.8 mil. at the start of the year, closed the year worth $40.5 mil., a 104% increase. The eye-catching performances of the MMD and Lilly portfolios reflect both the 1991 run-up in biotech stocks and, more interestingly, the increasing role of major drug companies as investment firms in the drug business as well as their more traditional roles as R&D, marketing and production companies. The investments in start-ups by larger firms are primarily aimed at gaining a tie-in to a particular research or product development area, but a new side benefit is developing in the short-term appreciation of stock positions. The run-up in 1991 presents companies like Lilly and MMD with the possibility of a substantial short-term payoff from agreements with R&D firms years before the deals yield marketable products. While companies may be unlikely to cash out their investments in small start-ups during an active collaboration, the past year provides a precedent for the realization by an established firm of a significant return on a biotech investment. In February, Abbott liquidated its Amgen holdings and returned over $200 mil. on an initial investment of $5 mil. ("The Pink Sheet" Feb. 18, T&G-11). Abbott did not receive any products from the Amgen deal. The big growth for MMD's portfolio in 1991 was triggered by the company's 19.6% (2.5 mil. share) interest in U.S. Bioscience. Like the Abbott investment in Amgen, that investment is not directly attached to any product objectives. MMD's U.S. Bioscience stake quadrupled in value during the year; the cancer chemotherapy company was one of the stars on the F-D-C Index. From an opening price of 19-1/2, U.S. Bioscience shares soared to 78, a whopping 300% increase. At the end of the year, U.S. Bioscience carried a market valuation of $1.5 bil. (only slightly less than the $1.58 bil. valuation carried by the 30-year-old Mylan generic drugs business). The financial community did not reflect U.S. Bioscience's glamor back onto the major investor, but at least one major Swiss company, Sandoz, appeared willing to bet that its investments could help create a new image for the firm on Wall Street. Sandoz embarked on an apparent strategy of using sizeable investments in U.S. start-ups as a way to draw investment attention to itself -- and thus increase its own potential to raise money from the public markets. Beginning with the announcement of a $1 bil. "Innovascan" biotechnology discovery initiative in February, the Swiss company was an active investor during 1991. After a series of small deals, the Swiss company capped the year with the Dec. 16 purchase of 60% of SyStemix for $392 mil. The Swiss company has been taking the first steps towards making itself a more publicly-oriented firm outside its home country. In a presentation to U.S. analysts in early November, the firm explained that it perceives a need for new sources of capital from outside Switzerland. Sandoz ADRs (American depositary receipts) began trading in the U.S. on Nov. 7. If Sandoz can build on the attention that it garnered from the SyStemix deal and parlay that attention into a following on Wall Street, it may have increased access to the public markets outside Switzerland. The scientific and commercial prospects of SyStemix aside, Sandoz may be able to ride that deal into a period of greater equity funding. Whether as investors or investments, the drug companies were hot in 1991 and particularly hot during the general December market rally. The pharmaceutical industry enters 1992 with numerous positive ratings from general investment surveys. The ValueLine survey, for example, rates the drug industry No. 1 out of 98 industries covered by rank of probable performance over the next 12 months. Among the high expectations for drug stocks, some of the loftiest have been set for Pfizer and U.S. Bioscience. In its year-end issue, Financial World magazine reflects the current enthusiasm for Pfizer by placing the company into competition with Merck for the preeminent position in the industry. "Pfizer...has long vied to unseat Merck as the industry's leading manufacturer," the financial magazine states. "Many analysts," the financial trade publication maintains, "say Pfizer's long-term growth potential is better." The financial community is estimating short-term earnings per share growth for Pfizer and Merck (through 1992) at about 18%. Zoloft, Pfizer's entry into the antidepressant category, is one of the products behind the new high. Zoloft will come into the market as the second serotonin-reuptake inhibitor in the wake of Lilly's Prozac brand. While Zoloft will carry much the same labeling language as Prozac (especially in regards to suicidal ideation), the appearance of a second product without the wide publicity of Prozac may have a strong appeal to prescribing physicians. Alex. Brown's Adele Haley maintains that the Pfizer product may have a pharmacokinetic profile advantage over Prozac. FDA's approved labeling for Zoloft says that the product has a terminal half-life elimination of about 26 hours and steady state plasma levels can be reached with about one week of once-daily dosing. Prozac has a longer half-life (2 to 3 days for the active ingredient fluoxetine) and "steady state concentrations are only achieved after continuous dosing for weeks," the Lilly drug's labeling states. Combined first-year sales predictions for Zoloft and Zithromax run in the range of $300 mil. and should offset the anticipated decline in Feldene (piroxicam) sales when that product loses exclusive marketing protection in early April of this year. Between the shift from Procardia to Procardia XL in 1989-1990 and the introduction of a new group of products to coincide with the expiration of protections on Feldene, Pfizer appears to have made a significant product generation shift without missing a beat. Procardia XL may face a me-too challenge from K-V (up 295% to 33- 1/8) which received an okay from FDA, in the fall, to file an ANDA for a different form of extended-release nifedipine capsule. The antifungal Diflucan (estimated at about $380 mil. in sales in 1991) and the alpha-blocker Cardura (estimated in excess of $100 mil.) also are providing substantial new sources of drug growth for Pfizer. Further new product excitement for 1992 centers on three products: Norvasc (amlodipine), a calcium channel blocker which has already been recommended for approval by an advisory committee at FDA; Reactine (cetirizine), a non-sedating antihistamine; and E5, the Xoma monoclonal for sepsis. Like Pfizer, U.S. Bioscience is entering 1992 riding a wave of late market momentum. The firm had a 26% gain in the first two weeks of December trading and finished the year at 78, up 28% for the final month. At the year's end, the company announced a two- for-one stock split, effective in mid-January. U.S. Bioscience began 1991 with the launch of its first product, Hexalen, for the treatment of ovarian cancer. While estimated 1991 sales of about $3.5 mil. are not enough to make the company profitable, Hexalen helped differentiate U.S. Bioscience from other start-ups by giving the company a tangible regulatory success and an established medical and marketing presence. When the company completed a secondary offering in May, its shares had climbed to the low-30's. The Oct. 1 filing of an NDA for U.S. Bioscience's second product, the chemoprotective agent Ethyol, drove the stock into the 40's. Analysts were impressed by U.S. Bioscience's handling of the 20-year-old drug, licensed from the U.S. Army in 1988, and projected sales (for both chemo- and radioprotective indications) of $350-$500 mil. per year at maturity. The smoldering interest in the company caught fire on Nov. 17, when President Philip Schein, MD, told the Robertson Stephens annual healthcare conference that FDA's Oncologic Drugs Advisory Committee would review the drug at its Jan. 31 meeting. Investors celebrated the rapid movement of the product to an advisory committee as a sign of an accelerating development schedule for the product and an increased chance for it to lead the company to profitability. The stock, which had slumped to 36- 3/4 as part of a biotech sell-off the week before, added 15 points (and over $350 mil. in market valuation) during the week of the 17th. U.S. Bioscience was suddenly valued at over $1 bil. and thrust into the spotlight. The stock flourished with the attention. Investors attracted by the Ethyol announcement also saw a pipeline with other possible near-term product opportunities, including trimetrexate for AIDS-related pneumonias and PALA, AZQ, and rogletimide for cancer indications. Investors also reacted positively to the company's November overseas licensing deals with Schering-Plough (for several products, including Hexalen and Ethyol) and with Rhone-Poulenc Rorer (for Hexalen). Alex. Brown's David Webber summarized the market's reaction to the Ethyol announcement. The scheduling of the advisory committee and the announcement of the licensing agreements "broadly validates the U.S. Bioscience investment thesis and reflects in a masterly fashion the maturing of the U.S. Bioscience strategy" of licensing oncology products already in the clinic. Webber forecast a third quarter 1992 approval for Ethyol and estimated that its sales would make U.S. Bioscience profitable for the year. Webber also projected that an NDA for trimetrexate would be filed in January, with expedited approval by year-end. The Alex. Brown analyst forecast a 6-12 month share price of $100 for the company. Some of the threats to Pfizer and U.S. Bioscience are interesting as examples of the dark side to the gilded prospects for the industry. One pressing issue at Pfizer is the delay in the marketing of Zithromax. The company said at the end of the year that it is "voluntarily" withholding introduction of the product until FDA can review information on 19 adverse events omitted in submissions to FDA. The delay is dangerous to Pfizer for two reasons: (1) there are three new antibiotics, in addition to azithromycin, ready to enter the market; and (2) the suggestion of withheld information may stimulate the attention of previous critics of Pfizer's regulatory dealings. Pfizer has grappled several times in the past with the Public Citizen Health Research Group over Feldene and the Shiley heart valve. The fights are messy public relations events that often spill over into the congressional arena and the courts. A second threat facing Pfizer, U.S. Biosciences and the rest of the industry is the continued attention to pharmaceutical pricing. U.S. Bioscience faces the most troublesome aspects of pricing with its product Ethyol: how to explain and justify the high-cost of a product licensed from the U.S. government. The estimated per treatment price for Ethyol is being projected in the $2,000 range. While much of the political attention on drug pricing is being focused on the established drug companies and their existing products, more concern in the marketplace appears to be directed to the new biotech products and to the replacement generations for traditional drug products. The pre-approval preparations for the anti-sepsis monoclonals (Centocor's Centoxin and the Pfizer/Xoma E5) are an extreme example of the current cost awareness among hospitals. Hospital pharmacies are projecting that the anti-sepsis products could represent between 10-20% of an average hospital's annual drug budget in one year. Prominent hospital groups are getting together prior to the anti-sepsis approvals to determine treatment guidelines ("The Pink Sheet" Dec. 23, p. 14). Politicians, however, are missing the thrust of that marketplace concern and remain locked on the issue of yearly increases in old product prices. It now appears as a truism that most drug prices are increasing at above inflation rates. The extent to which that argument is accepted was reflected by Sen. Hatch's (R-Utah) remarks in early December to the annual Food & Drug Law Institute meeting ("The Pink Sheet" Dec. 16, p. 8). Hatch, who often represents the brandname industry's views on Capitol Hill, declared that recent information brought to the attention of his staff appear "to validate the criticism that PMA companies are not pricing their products appropriately after patent expiration in what should be a competitive market place." In contrast to the drug pricing image in Washington and in the general media, there is a recognition in the trade that pricing patterns have already changed. For more than six months, major wholesalers have been openly commenting on the slowdown in price increases and what that slowdown will do to their profit potential. In an early November interview between Robert Walter, the chairman of Cardinal Distributors, and an analyst from Smith Barney, the wholesaler said: "Price increases have moderated, and we are assuming that these increases will remain 1-2 percentage points less than the increases during recent years of about 7-8% annually." Hatch's remarks in December illustrate the frustration he felt about failing to get a resolution on the size and extent of industry rebates to government programs at the end of the last legislative session. He noted that the issue remains on the Capitol Hill agenda for 1992. His pessimistic tone on the outcome of the renewed debate and his predictions that industry critics may take the initiative are filtering into some public prognostications on the industry. Indicative of the wide currency of the concerns about price restraints, a Reuters financial service wrap-up piece on 1991 tempers the good financial news for the drug industry in the past year with a prediction that the industry may "face a tougher 1992 because they may have to swallow the bitter pill of government price regulation." The fact that the Capitol Hill debate still focuses on prices of old products may be a blessing in disguise for the industry. As long as the political debate remains centered on the pricing patterns for existing products, the long-term effect can be ameliorated by the R&D pipelines and relatively unfettered "access" for new products. The more serious attack will evolve from any attempts to determine price limits for new products. While that type of attack sounds far-fetched, that is exactly the type of issue behind such public debates as pricing for Retrovir, and it appears to be emerging as the new theme for the high-price biotech items. Bristol-Myers Squibb carefully dodged a potential pricing issue late in the summer when the company introduced Videx (ddI) at a price calculated to fall just below the annual cost of Retrovir. The Videx pricing indicated a long-term view of the company's drug portfolio, protecting the taxol cancer drug development project. BMS is working with a government license and government harvest rights on that project. A flap over misuse of an NIH- licensed drug in the AIDS field might have raised significant problems for the cancer project. The Videx pricing also fit the new trend emerging in the industry for follow-up compounds. The days of the premium price for the subsequent compounds in a class seem to have passed quietly. BMS had a big year at FDA with four approvals for new chemical entities (Videx, Pravachol, Monopril and Cefzil) and at least one interesting new formulation product (Stadol NS), which could be positioned for any increase in the awareness of migraine treatment. BMS trailed the index average in increase, however, up 32% for the year. With Pravachol, BMS joins Merck and Warner-Lambert as a major force in the lipid-lowering field. BMS is projecting a huge increase in the potential patient population for lipid treatment. With an NIH Consensus Conference coming up on the topic in February and a new set of treatment levels to be issued by another NIH institute later this year, the possibility for rapid market expansion appears likely. Merck's Zocor approval and the co- marketing agreement with SmithKline Beecham assure that there will be a lot of noise in the cholesterol/lipid treatment field in 1992. Abbott had two approvals in 1991: the antibiotic Biaxin and an orphan drug, the surfactuant Survanta. Biaxin excites some analysts as a way for Abbott to trade up its $120 mil. U.S. erythromycin market to the higher price product. With the "coming soon" approval for Omniflox (temafloxacin), analysts hope that Abbott can revive its antibiotic business. Abbott's attempt to pull off the trade-up should be a noteworthy test of price resistance in the new market conditions. Biaxin, with a better gastrointestinal effects profile than standard erythromycin, is priced at about $5.00 per day compared to $.80-$1.00 per day for its current erythromycin products. Abbott's breadth across the health care business earned it a profile piece in the Frobes financial review of 1991. Its 53% gain in 1991 trading on top of a 32% gain the year before make a good backdrop for financial magazine features. J&J (up 42-3/4 points, almost 60% for the year) is also getting more lively coverage for its drug business, after the very successful approval year in 1990. With a rare Dec. 6 investor seminar, the company is cultivating some of that attention more actively. At least one analyst came away dazzled. Shearson Lehman's Mimi Willard enthusiastically issued a post-meeting report declaring that J&J "left people with a clear impression that it has the potential to accelerate its EPS growth rate fromthe past five years' 18%." Willard, a strong proponent of J&J's opportunities as the other EPO company, noted that the firm did not report much on its progress with that product. That fits the current situation of extensive off-label use of for the J&J brand Procrit. It would be risky for J&J to play up the success of the product. The extent of that success was indicated recently when one major Texas cancer center reported using $60,000 per month of J&J's EPO, all for off-label uses. Carter-Wallace continued its astounding second half market ride: from 90-3/4 at the end of the third quarter, the stock climbed another 32-3/8 points to close the year at 123-1/8 (up 130%). The wild upward ride, stimulated in part by the company's NDA application for an anti-epileptic drug (felbamate), may be a fitting last work on the uncontrollable enthusiasm for drug stocks during the year.

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