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WASHINGTON AND WALL STREET DON'T MIX: BRANDNAME FIRMS DIVE IN ANTICIPATION OF CLINTON ADMINISTRATION WAR ON LICIT DRUGS; GLAXO LOSES 25% WITH IMITREX COMING

Executive Summary

Biocraft's 51% net gain and Glaxo's 25% decline in 1992 stock trading epitomize Wall Street's simple formula for pharmaceutical investments in 1992: government activism in the drug business means a good growing period for generics and a time to abandon the brandnames. The financial community awoke abruptly to the building political threats in 1992. After virtually ignoring the simmering political activity and changing pricing patterns in the drug industry for several years, the market reacted precipitously to the threat posed by the Clinton election and the distinct change in public rhetoric about the industry. Headlines and major media feature stories turned more negative, more frequent and more visible: "Why U.S. Prices For Medicine Are Soaring Out Of Reach" (The Philadelphia Inquirer mid- December expose series) and "The Drug Industry's Worsening Headache" (The Washington Post Oct. 29). Arguing ill winds, investors prepared for a potential war by the Clinton Administration on the licit drug trade by adopting a broad, almost undiscriminating enthusiasm for generic companies and by recoiling from the brandname companies. Smith Barney analyst Christina Heuer, one of the last bullish holdouts for the brandname sector, converted to the new pessimism on Dec. 23, stating that it would be necessary to see the extent of the Clinton Administration's interest in the pharmaceutical sector in the first 100 days before the group could be reevaluated as a good investment. "Until investors have some comfort" about the extent of the new administration's plans for drug price controls, Heuer said, "drug stocks could languish." On the generic side, several securities analysts predicted a positive impact from the confluence of patent expirations and the possibility of price controls. Seeing generics as the politically correct investment for 1993, analysts increased their estimates for growth in that sector. Hemant Shah, an independent analyst often quoted in the financial press, portrayed the optimism for generics in sharply differing projections for 1993 unit growth between the brand and generic sectors. "In terms of units," Shah forecast in mid- December, "we believe that generic drugs will enjoy 15% growth, whereas branded drugs will experience a 6% decline in units." Biocraft is a striking example of how generic betting translated into market movement for one company. Biocraft survived a pair of FDA warning letters in March and November to come out a winner with Wall Street. The generic company's stock climbed 8-1/4 points for the year -- one of just seven issues among the 29 companies in the pharmaceutical component of the "F-D-C" Index of NYSE and AMEX stocks to post a net increase for the year. Glaxo, by contrast, represented the extent of the flight from the brandname firms. After a strong January, Glaxo ADRs suffered an 11-month decline during 1992 to close at 23-3/4, down 8 points for the year. Biocraft's prospects were viewed as impressive despite mixed operating results to go with the mixed regulatory reviews. The firm ended its 1992 fiscal year March 31 with a loss of $6.7 mil. on revenues of $92.3 mil. The company returned to profitability in the first six months of fiscal 1993, with earnings of $788,000 on relatively flat sales of $45.5 mil. A March announcement that Biocraft had retained Wertheim Schroder & Co. as investment banders to investigate the possible sale or merger of Biocraft no doubt helped to stimulate some of the interest. However, there has been no further word on the possibility of a change in control since the initial announcement. A year-end uptick for Biocraft coincided with a Dec. 22 approval of the first generic equivalent of Wyeth-Ayerst's $125 mil. nonsteroidal anti-inflammatory drug Orudis (ketoprofen). That approval is a sign that Biocraft is back in FDA's good graces -- an important prerequisite for any type of major deal affecting the firm. The Glaxo slide occurred in the face of the type of new product news that has had investors buying in recent years. One deterrent to enthusiasm about Glaxo at mid-year was an episode of wallet tightening in the financial community in reaction to reports of chest pains associated with Imitrex (sumatriptan) in the U.K. A second rally by the stock in the early autumn fell victim to the general concern for the drug industry under a Clinton Administration. Despite the U.K. report on Imitrex, Glaxo delivered on its development schedule and got the product through FDA in 30 months. Imitrex will be launched at the end of the first quarter of calendar 1993 to a market Glaxo conservatively estimates at 11 mil. migraine sufferers (5 mil. less than patient population estimates provided by FDA at the time of approval). A clearer picture of the potential size of the market is the number of companies trying to position themselves for a me-too ride for the increased attention to migraines. Sandoz is prominent with DHE-45 and Upjohn may be following with a new regimen of Ansaid. A Cleveland Clinic press release Jan. 5 maintains that flurbiprofen can be used as a prophylactic for migraines to prevent and reduce the severity of attacks. At the end of the year, Glaxo also cleared the oral formulation of its anti-emetic Zofran (ondansatron). That formulation could be a useful adjunct to the injectable version in the pending indication for post-op use. Zofran has been a relatively overlooked commercial success with $250 mil. in first- year sales in the U.S. ("The Pink Sheet" Sept. 14, 1992, p. 8). Falling between Zantac and Imitrex, the product has not appeared to elicit much excitement from the financial community. In Glaxo's case, the new product news comes as icing on top of the company's leading positions in the ulcer and asthma markets. Zantac continues to hold a healthy growth rate in the U.S. market against new competitors (Merck's Prilosec), managed care price controls and sizeable Medicaid rebates. Zantac produced its highest number of prescriptions in a month during October with 814,000 new scripts. Glaxo held a special meeting with analysts in New York in early November to expound on its prowess in the managed care market, from which about 23% of Glaxo's U.S. pharmaceutical sales are derived ("The Pink Sheet" Nov. 16, 1992, p. 16). As the H[2] category further matures, Glaxo will have more challenges from price competition (see related story p. 3). In addition to Glaxo's new products, the Street overlooked a number of significant new commercial arrivals for other firms in 1992. The 1992 class of approvals included an unusually large number of potentially major products -- on top of a significant year in 1991. The class of 1992 included Merck's benign prostatic hyperplasia drug Proscar (finasteride), Pfizer's calcium channel blocker Norvasc (amlodipine) and SmithKline Beecham's antidepressant Paxil (paroxetine). Other 1992 approvals with significant commercial potential include Bristol-Myers Squibb's Taxol (paclitaxel), Searle's nonbenzodiazepine hypnotic Ambien (zolpidem), BMS's imaging agent ProHance, Rhone-Poulenc Rorer's once-daily diltiazem brand Dilacor XR and the Organon oral contraceptive Desogen, which Johnson & Johnson will market as Ortho Cept. Several products approved in 1991 made commercial splashes when introduced during 1992: Pfizer's antidepressant Zoloft (sertraline), Merck's cholesterol-lowering agent Zocor (simvastatin), SmithKline Beecham's NSAID Relafen (nabumetone) and the nicotine patches, marketed by Marion Merrell Dow, Lederle, Ciba-Geigy and Warner-Lambert. New product stories, however, were clearly not the draw that they had been during the seven-year run (1985-1991) of uninterrupted advances by the pharmaceutical component of the "F- D-C" Index. The index average slipped 17.5% in 1992: the first drop since a slight .4% decline in 1984 -- the year the Waxman/Hatch ANDA Act was passed. The anemic 1992 performance reversed the sharp upswing in 1991 when the pharmaceutical component climbed 50.3%. The broad declines created unusual situations for investors and companies that had been lulled by success into a belief in unending upward movement. The sudden change in fortunes also created some memorable ironies in 1992. Merck (down 12 points, or 21.7%) created an unfortunate visual metaphor for its off year in one of its own financial reports. The company's third quarter interim statement, issued in the autumn, carries a cover page headlined with the company's 1992 theme "The Momentum of Merck." The picture beneath the headline portrays an elderly man and young boy careening down a slide -- an unintentional allusion to the performance of the stock during the company's 101st year. At SmithKline Beecham, 1992 trading provided an ironic comment on the company's recent corporate crusade in the name of globalization -- the Street in 1992 interpreted global reach as the negative effect of currency translations overshadowing the company's brightening prospects in the U.S. The top management of the Anglo-American company has been remaking the image of the firm as a worldwide competitor. While indisputably an attractive long-term objective, that campaign undercut SmithKline Beecham's strong performance in the U.S. in 1992 and held back the company's stock performance. The actively- traded SBE ADR shares dropped 6-5/8, or 16.7% during 1992. The drop came in the face of an impressive performance by Relafen, which was on track to exceed $100 mil. in sales worldwide after its introduction to the U.S. market at the beginning of 1992. Wall Street is also buzzing as the new year begins that SmithKline Beecham might have another overachiever ready for the U.S. market in the serotonin re-uptake inhibitor Paxil, which was approved by FDA on Dec. 30. That product is widely expected to be the product-to-be-named-later in last year's co-promotion deal between Merck and SmithKline Beecham on Zocor. There was a wry twist to the financial community's treatment of drug wholesalers in 1992. The two largest had strong performances: McKesson (up 6 points, 16.4%) and Bergen Brunswig (up 3-5/8, 19.6%). For two years, the wholesalers had complained about lower and less frequent price increases by manufacturers when the market was not ready to pay attention to the possibility of less pricing flexibility for manufacturers. In 1992, when the Street accepted the fact of de facto price restraints on manufacturers, the wholesalers were bid up. For much of the 1980s, a large proportion of the wholesalers' profits were derived from forward (investment) buying of inventory. Just when Wall Street accepts that that is no longer likely to be a source of future wholesaler gains, the market with a contrarian logic decided to make the wholesalers favorites. Even FoxMeyer, which watched the bubble break for its major customer Phar-Mor in early August, held steady for the year at 11- 5/8. Another touch of irony was hidden behind Schering-Plough's relative success in 1992 (down only 2-1/8 points or 3.2%). One of the most likely supports for Schering stock through the end of the year was the expected year-end approval from FDA for its long-pending, nonsedating antihistamine Claritin (loratadine). Expectations are high for Claritin based on the 1992 labeling problems experienced by the first-generation products Seldane (Marion Merrell Dow's terfenadine) and Hismanal (Johnson & Johnson's astemizole). But while the financial community expectantly waited for Claritin, eight other compounds reached the market during the year-end approval rush. Schering continues to carry a good image with the Street based on its reinvigorated consumer product business and its participation in biotechnology through the steadily-growing Intron-A. An interesting trend to watch on interferon, however, is the reduction in the amount of the drug used to treat specific conditions. One major cancer center is reporting treating twice as many patients in 1992 for the same amount of money as in 1991 (see related story, p. 4). While brandname firms floundered, four generic companies -- Biocraft, Mylan (up 51.8%), Halsey (up 42.6%) and Pharmaceutical Resources, Inc. (up 92.3%) -- all posted strong gains. Among pharmaceutical stocks on the Index, only Elan (up 15.6%), Enzo Biochem (up 96.7%) and Genentech (up 15.9%), joined the quartet of generics on the plus side for the year. Mylan combined a string of significant new approvals with solid sales and earnings growth to post a 10-3/4 point gain for the year, closing at 31-1/2. With back-to-back bullish years, Mylan is now trading at three-times its price at the start of 1991. Mylan is carrying a P/E ratio of more than 40 and a market valuation of $2.4 bil., close to half the current valuation for Syntex. According to Zack's Investment Survey at the end of December, of 14 analysts surveyed, 12 rated Mylan either a strong buy or a buy. Two were neutral on the issue. During 1992, Mylan was among the first companies to receive ANDA approval for five different drugs: piroxicam (Pfizer's Feldene), diltiazem (Marion Merrell Dow's Cardizem), gemfibrozil (Warner-Lambert's Lopid), metoprolol (Ciba-Geigy's Lopressor) and pindolol (Sandoz' Visken). Through six months ended Sept. 30, Mylan's sales were up 54.3% to $89.9 mil. and earnings were up 80.1% to $28.1 mil. Pharmaceutical Resources Inc. (up 4-1/2 to 9-3/8) also posted strong financial results, as the Par parent continued to win investors back to the company. PRI posted a 53% sales increase (to $52.5 mil.) for the fiscal year ended Oct. 3, with net income of $7.9 mil. While the firm is not yet eligible for approvals under FDA's application integrity policy, it is introducing new products via a November agreement with the Canadian generic manufacturer Genpharm. The performance of Halsey's stock (up 3-1/4 to 10-7/8) was helped by some positive press late in the year. In mid-November, just after the presidential election, Halsey was featured in an article in Fortune magazine and named one of the 200 best small companies in an article in Forbes magazine. Investors eager to substitute generic companies for their brandname holdings helped Halsey gain 3-1/2 points in the last two months of the year. Halsey also posted healthy operating results in 1992. For the nine months ended Sept. 30, sales were up 38.2% to $36 mil., while earnings jumped 42% to $1.8 mil. In June, the company's Houba subsidiary began selling bulk AZT to foreign manufacturers. Like Biocraft, Halsey has had its share of regulatory problems in the wake of FDA's investigation of the generic industry. The firm's compliance status was questioned by Rep. Dingell (D-Mich.) during his hearings on the industry. Halsey has also had several recalls this year, including a Feb. 3 recall of promethazine syrup due to lack of an approved ANDA and a Feb. 11 recall of fenopren capsules and tablets because the "source of raw material active ingredient cannot be verified." A November supplemental ANDA approval for doxycyline tablets, however, appears to indicate that Halsey is satisfying FDA's concerns. Halsey said it has "more than 10" ANDAs pending. The political appeal of generics in 1992 was heightened by the commercial potential of upcoming patent expirations for a number of major products. Among significant products losing patent protection in 1993 and 1994 are Upjohn's Xanax (Nov. 6, 1993) and Halcion (Oct. 19, 1993), SmithKline Beecham's Tagamet (May 17, 1994), Fisons' Intal (May 18, 1993), Ciba-Geigy's Voltaren (July 28, 1993), Lopid (Jan. 4, 1993), Lopressor (Dec. 21, 1993), Syntex' Naprosyn/Anaprox (Dec. 21, 1993) and Marion Merrell Dow's Seldane (April 15, 1994). In 1995, two of the top selling products in the U.S. -- Zantac and Bristol-Myers Squibb's Capoten (captopril) -- may lose patent protection. Glaxo is claiming that the relevant patent lasts into the next century. Depending on the results of litigation, ICI's Nolvadex (tamoxifen) and Burroughs Wellcome's Retrovir (zidovudine, AZT), may also be vulnerable to generic competition in coming years. Generic companies are also likely to introduce versions of off-patent drugs such as MMD's Carafate (sucralfate), Wyeth-Ayerst's Premarin conjugated estrogens and albuterol metered dose inhalers in the near future. Investors are also confident that generic companies will be able to receive timely approvals of major drugs. FDA's Office of Generic Drugs consistently approved 20-25 ANDAs a month in 1992. In 1990, the political maelstrom that brought the Medicaid rebate law into being did not knock the brandname pharmaceutical industry out of favor on the Street, in part because investors viewed the industry's patent position as strong. Generic companies also did not benefit at that earlier point, because FDA was in the middle of an ANDA approval slowdown as it reorganized the generics office. For two years prior to 1992, in fact, Wall Street had been looking past signs of political trouble facing the brandname industry. In 1992, the pendulum swung sharply to the other side and Washington woes and the loss of pricing flexibility became the dominant issues. It took the pre-election image of candidate Clinton standing in front of Merck's New Jersey headquarters to talk about drug pricing and the post-election appearance of some of the industry's Capitol Hill critics in key transition positions to shift the weight of Wall Street opinion against the brandname sector. There is no question that the nature of the political challenge has changed. The Clinton transition team's "questions" to the Pharmaceutical Manufacturers Association about drug pricing reads like a collection of what the brandname sector would consider the worst recent price control ideas. The Clinton transition group suggested * * the establishment of a "Prescription Drug Price Negotiation Commission"; * * the adoption of Medicare outpatient drug benefits with a cost control system such as a mechanism to permit private buying groups to negotiate drug prices on Medicare's behalf or a Medicaid-like rebate plan; and * * the development of guidelines for new product pricing to keep new products in line (in terms of price) with the same products in foreign countries or within the range of similar products in the same therapeutic category in the U.S. ("The Pink Sheet" Dec. 21, 1992, p. 22). Within the realm of the probable price control moves by the Clinton Administration, the likely actions do not look as drastic when examined more closely. For example, some of the options that Congress may consider as penalties to force companies to keep their price increases in line with general inflation may not be as hard on the industry as they initially appear. Cuts in Sec. 936 Puerto Rico manufacturing tax credits were suggested by Sen. Pryor last March as an enforcement stick to keep drug price increases low. The 936 credits also have been threatened on another front in the form of tax revenue enhancement legislation from House Ways & Means Chairman Rostenkowski ("The Pink Sheet" July 27, 1992, p. 7). Giving up a portion of those credits as part of price restraint legislation could actually be a political victory for the industry, preserving the full credits for some companies (those that can meet price increase targets) by forestalling Rostenkowski's action. Similarly, the Clinton transition team's suggestion to reduce patent protection for products on which price increases exceed inflation also may not be a significant threat. Most of the major drug companies appear to have found ways since the Waxman/Hatch Act to protect their leading products for up to 17 years or more of marketing exclusivity. Thus, Glaxo claims to have exclusive rights to Zantac through 2002 in the U.S. on a product that entered the U.S. market in 1983. On a more practical level, industry execs are more familiar with the new operating environment and appear inured to living with lower list price increases. They also appear to be more practiced and skillful at working with different classes of customers to minimize the effects of low price increases. Where the industry has shown less skill is in explaining its ability to deal with the price situation to the financial community. Smith Barney's Heuer expressed the perception that industry management is not facing up to the new climate in her Dec. 23 view of downgraded prospects. "Investors should be prepared," Heuer said with little patience, "to listen to lots of whining from drug company managements as they blame poor performance on the 'more difficult environment.'" There may, however, be a bright side to the current politically-driven pessimism towards drug stocks. Historically, brandname issues have rebounded sharply after periods of political uncertainty. In the second half of 1984, when the patent restoration/ANDA debate became the Waxman-Hatch Act, the drug stocks recovered strongly. While expressing doubt about the drug industry's ability to face up to the current challenges, Heuer acknowledged that most of the drug companies have the size and ability to create continued profit growth by focusing more closely on cost cutting. Prospects for the industry will be brighter, Heuer declared, if "drug CEOs face up to the 'new environment' and ruthlessly cut costs." That type of pressure from Wall Street may combine with continued pressure from Capitol Hill to push some firms to trim back on the sacrosanct sales and promotion budgets of the 1980s. The financial strength of the major drug firms coincides with depressed market prices for biotech stocks. That may presage a period of renewed consolidation and acquisition-shopping by the established firms. American Cyanamid's Lederle exemplified that strategy at the end of 1992 when it purchased a controlling interest in Immunex for $350 mil. Lederle is combining its existing oncology business with Immunex to create a new hybrid firm. One of the disincentives to other companies attempting similar deals is the many interlocking agreements and investments that the biotech firms have with different corporate partners. It will take clever and persistent dealmakers to unscramble or work around those constraints. Genentech's gains in 1992 indicate the emerging success of one of the early biotech acquisitions. Roche $2.1 bil. investment continues to insulate the firm from the vagaries of the market. Roche's option buyout schedule has established pivotal parameters for the minimum value of Genentech's stock. With at least one important new product on the horizon, Pulmozyme (rDNase) for cystic fibrosis, Genentech is beginning to draw attention as an investment prospect beyond those minimum values. Pulmozyme (which completed Phase III trials at the end of 1992) is an interesting project for the market to watch for several reasons. One is its commercial potential: Genentech has boldly annointed Pulmozyme, "the next major product" of biotech. Also, it can be watched as an indicator of the ability of biotech companies to set premium prices for new category products at mid- decade. Genentech has been moving the product to market with consideration for the political necessities of building a constitutency and economic arguments to support pricing for the product after its approval ("The Pink Sheet" May 11, 1992, p. 9). Two other products to watch in 1993 as models for how the political system treats pricing and acceptance of new therapies are Merck's Proscar and Carter-Wallace's anti-seizure drug Felbatol (felbamate). Felbatol, which was recommended for approval by an FDA advisory committee at the end of the year, was developed with support from the National Institutes of Health and so may force Carter-Wallace into a position similar to that of Bristol-Myers Squibb with Taxol. Bristol, under the watchful eyes of the National Cancer Institute and Congress, priced Taxol at the high end of existing therapies but not at a premium. It will be important to see how Carter-Wallace, a relatively small company, handles the pricing of the lower-profile Felbatol. The market has been keen on Carter-Wallace for 18 months because of Felbatol. In 1992, the issue slipped only 4 points to 37. Merck has been building the Proscar market more slowly than analysts expected, focusing on a long-term physician and consumer education program. The company has put a lot of effort into its ability to convince the government through the Agency for Health Care Policy and Research that drug therapy is the appropriate treatment for BPH. Merck's navigation of the AHCPR outcomes research could be a precedent for other companies seeking to add new drug therapies to categories dominated by other treatment modalties. While the Street's investment calculus in 1992 saw a black- and-white distinction between brandname and generic companies, the reality is that few pharmaceutical companies are concentrating exclusively on either multisource or proprietary products. Mylan, for example, has been diversifying away from its core generic business for the past several years. However, in 1992, its image as the largest public generic company helped its market valuation to climb more than one-third higher than that of Forest, despite similar sales and earnings projections for the year. Forest, which markets a line of branded generic and in-licensed proprietary products such as the Aerobid asthma inhaler, is perceived as a niche-market brandname company. Further complicating the generic/brandname distinction drawn by analysts in 1992 is the fact that the political and commercial potential of generic drugs has not been lost on innovator companies. During the year, Marion Merrell Dow, Upjohn, Warner- Lambert, Ciba-Geigy, Syntex, Sandoz and Merck all disclosed plans to launch pre-patent expiry generic versions of their own drugs. Chart omitted. Chart omitted. Chart omitted.
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