Washington Threatens; Wall Street Reacts

The biotech investment boom hit the brakes at the end of the first quarter when Rep. Henry Waxman (D-Calif.) publicly complained about Gilead’s pricing for the hepatitis C therapy Sovaldi. The fact that Waxman’s attack has little substantive impact didn’t seem to matter. Another Washington threat—to undo “tax inversion” strategies—is probably much more real, but may actually boost the sector for the rest of 2014.

When you are in the minority party in the House of Representatives, it isn’t very easy to have an impact. The majority party sets the agenda, deciding what bills move forward, what hearings are scheduled, and what investigations to support.

So you have to hand it to California Democratic Rep. Henry Waxman: he sure found a way to have an impact without controlling a committee gavel. All it took was a short letter to Gilead Sciences Inc. asking if the company would mind very much stopping by to explain the basis of their price for the hepatitis C therapy Sovaldi (sofosbuvir).

As Congressional letters go, Waxman, along with fellow Energy & Commerce Committee Democrats Frank Pallone (N.J.) and Diana DeGette (Colo.), were fairly restrained. The letter notes the “extraordinary” price pegged at about $84,000 per treatment, but generally avoids any aspersions or invective directed at the company.

But they sure got the attention of the investment community. Gilead shares dropped 5% on March 21 as investors digested the news. More astonishingly, the biotech sector overall fell along with Gilead, and there ensued a flurry of worried headlines about whether the incredible surge in biotech shares in the past two years is over. (Also see "Biotech Stocks Tumble But Fundamentals Strong, Analysts Say" - Pink Sheet, 26 Mar, 2014.)

That letter certainly had an impact – though Gilead hasn’t shown any signs of actually cutting its price, nor is there any obvious reason why the sponsor would.

Still, Wall Street’s reaction is important, reflecting an understandable skittishness about the sustainability of the pricing model in the US.

But it also suggests a significant misunderstanding of the political dynamics in play: Waxman’s letter is, in fact, a reflection of the complete lack of pricing regulatory mechanisms in the US – and an indication of his relative powerlessness to do anything about Gilead’s (or any other company’s) launch price.

Waxman is one of the great names in health care legislation in modern times, and his impact on the biopharma sector has been enormous. But he is still a Democrat in a Republican House – and a lame duck Democrat at that. (Waxman has announced his retirement after his current term ends in 2014.)

While investors were still debating the implications of Waxman’s letter, a completely different event occurred involving another product subject to pricing pushback, Questcor Pharmaceuticals Inc.’s Acthar Gel. On April 7, Mallinckrodt AG announced a $5.6 billion buy-out of Questcor (a healthy 27% premium over its April 4 closing price). (Also see "Mallinckrodt Looks To Increase Hospital Product Offerings With Questcor Purchase" - Pink Sheet, 7 Apr, 2014.)

The Acthar brand has been cited in media reports as an example of a company relying on aggressive marketing and extraordinary price increases to grow a product line of uncertain clinical value. The acquisition won’t end the debate over that strategy, but it may help trigger a rebound in biotech stock values based on speculation of an increase in M&A activity.

In fact, the transaction underscores a completely different “threat” from Washington: proposals for new legislation to prohibit so called “tax inversion” strategies, whereby US companies acquire an overseas firm and claim the tax status of the newly acquired business.

That threat is a bit more real than any perceived threat from Waxman’s letter to Gilead – but still a long way from policy. However, it is likely to have a very different impact: even if the odds of enactment are low, companies contemplating those sorts of transactions are likely to move quickly to capitalize on the current rules, lest they change – driving up the value of companies with favorable corporate geographic profiles above and beyond any other assets they may own.

Thus one Washington threat might cancel out the other when it comes to biotech stock valuations.

Price Sensitivity—Among Biotech Investors

The Solvadi situation underscores the reality that biopharma investors are very sensitive to any threat to free pricing in the US.

There are good reasons for that. The rapidly changing dynamics of drug development and health care reimbursement in the US make extremely high list prices a core component of the sustainability of the industry as it transitions away from the blockbuster model. And the ability to set launch prices remains fully in industry’s control, a key feature of the health care reform deal struck by the industry with the Obama Administration in 2009. (Also see "The Zaltrap Price Debate: Less Than Meets The Eye" - Pink Sheet, 20 Nov, 2012.)

That was an expensive victory for industry, but the fact remains: the US has no price setting or price negotiation authority. In fact, the government’s role is generally to regulate private insurers, where most interventions are likely to limit a payors’ ability to exclude a high-priced product from coverage. And in Medicare Part B, where government’s role in paying for pharmaceuticals is more direct, the formula actually incentivizes higher prices, by paying physicians a small “spread” above the average sales price of the drug. (Also see "Ending “Buy-And-Bill” in Oncology: The Question is How, Not If" - Pink Sheet, 24 Oct, 2012.)

But even as investors reward companies that push the envelope with ultra high prices, they seem convinced that the party is about to end. The sensitivity to pricing in fact feels more like hypersensitivity: it is not that investors are concerned about price controls per se, but just that someone will start talking about price controls.

Thus, Waxman’s letter—which, to be clear, doesn’t even mention the potential for lowering Gilead’s price – still struck a highly exposed nerve just by asking the company to justify its price.

Waxman also chose a particularly potent target. After all, Sovaldi isn’t just any new drug: it appears well on track to become an all-time record setter in first year sales – and perhaps in annual sales, period.

Still, the reaction to Waxman’s letter is overdone. The fact remains that no one who signed the letter can do much, if anything, to affect Gilead’s pricing decisions. In fact, not only is Waxman in the powerless House minority, he is also a lame duck – retiring at the end of 2014. No one expects the Democrats to reclaim the House in 2015, but even if they do, Waxman won’t be chairing any pricing hearings.

While Pallone is next in line to serve as ranking Democrat based on seniority, he is fighting for that slot against California Democrat Anna Eshoo – whose Congressional district included Gilead’s Foster City headquarters until redistricting in 2012. Her district now abuts the home district of Gilead. Eshoo has been endorsed for the Ranking Democratic slot by House Minority Leader Nancy Pelosi—whose home district is in San Francisco, just north of Gilead’s HQ. Eshoo was also a key supporter of longer exclusivity for biologics during the biosimilar debate, leading a successful majority in outvoting Waxman on that critical issue for biotech innovators.

A Seemingly Strong Case for Sovaldi

Gilead is no stranger to responding to Congressional concerns about its pricing practices, based on its long experience in the HIV market. The legacy of concerns raised about Gilead’s pricing in that very heavily subsidized market likely explains some of the response to the Sovaldi price.

The reaction is also being fueled by concerns raised by payors, including some of the biggest participants in the new federal health insurance exchange space, like Anthem Inc.

There, the issue may be less the price per se than the amazingly rapid uptake – and, in particular, the potential for a relatively small misjudgment in the rate of adoption to have a significant impact on performance of the new exchange plans and/or Medicaid/Medicare Part D products. Insurers may be hoping to maintain some flexibility on controlling the rate of uptake of the product as much as they are hoping to see some change in the price.

Nevertheless, Gilead should have (if anything) a stronger hand in the HCV market than in HIV: Sovaldi has the feature of being a short-term treatment compared to the long-term chronic therapy model in HIV (or, indeed, in most pharmaceutical markets).

Thus, the $80,000 price tag is misleading when it is compared to other products like TNF inhibitors (typically cited as costing about $20,000 per year). For a newly diagnosed patient started on treatment, Sovaldi costs four times as much in the first year – but the arthritis patient will (ideally) stay on therapy indefinitely, likely accounting for a much higher drug cost over time than the single course of Sovaldi.

And even if Gilead were forced to justify its price in some more formal setting, the value proposition for Sovaldi seems reasonably strong – at least relative to so many other expensive items in the US health care system. The per-pill cost may be unprecedented, but Sovaldi has an unusually robust efficacy profile, offering a cure—not chronic treatment, but a cure—for as many as 90% of people who receive it.

And in fact, when it comes to substantive policy steps at the federal level, the only action has been to encourage broader use of the therapy – not to restrain the price.

Just a few weeks ago, the Centers for Medicare & Medicaid Services proposed to cover hepatitis C screening for all baby boomers as they age into the Medicare program – a decision that recognizes the advantages of treating patients before they progress to transplant.

In a draft National Coverage Decision released March 4 (available here), the Medicare Part B Coverage & Analysis Group proposes that hepatitis C screening should be routinely covered for “high risk” patients – but also as a one-time screen for everyone between the ages of 49-69. That policy aligns with the standards now set for preventative services in the commercial market, after the US Preventative Health Services Task Force gave those uses a “B” rating in its 2013 review.

Assuming the proposed policy is finalized as is, Medicare beneficiaries will receive those screening tests without any cost-sharing under the program’s enhanced preventative services benefit (enacted as part of the Affordable Care Act).

Given the existing recommendations from USPSTF and the Centers for Disease Control & Prevention favoring routine hepatitis C screening, CMS’ proposal to grant coverage for FDA approved tests is hardly surprising. The agency opened the process in September in order to allow for inclusion of the test as a covered preventative benefit, since screening tests are generally not paid for by Medicare.

However, it is still noteworthy that the coverage policy endorses the value of screening in the context of highly effective treatment options, offering a substantive, policy-based counter-argument to the headlines like those generated by the Waxman letter.

“Screening for HCV infection provides direct benefit to the Medicare beneficiary,” CMS concludes. “Test results inform the treatment of an existing infection and such treatment can also prevent future health consequences.”

Undercutting “Breakthrough”

There is one new theme in the Waxman letter that may have implications beyond Gilead’s unprecedented product launch: the legislators assert that, because Gilead’s application was treated as a high priority by FDA, the company’s pricing should be discounted as a result.

“The extraordinarily high cost of your drug raises additional concerns because of the role of the federal government in speeding its approval,” the letter declares. “Gilead filed for and received a Priority Review and Breakthrough Therapy designation, which reduces the FDA goal date from 10 to 6 months.”

As part of its request for insight into the pricing decision, the committee specifically asks Gilead to explain “the value to the company of the expedited review…and how any savings provided by the expedited review factored into pricing decisions for the drug.”

That line of argument is reminiscent of claims that industry prices should be reviewed in cases where taxpayers funded some of the research through the National Institutes of Health. Those arguments have seldom had an impact, and the assertion that an accelerated review provides an obligation for the sponsor to reduce a price seems even more tenuous.

However, the depiction of “Breakthrough” as a favor to industry may catch on as a talking point, and could eventually tarnish the early enthusiasm for that new pathway. (Also see "Covering Breakthroughs: Payors in New Territory" - Pink Sheet, 17 Sep, 2013.)

A Victory for a Very Different Pricing Model

At the other end of the pricing debate are products like Questcor’s Acthar, where the issues are not how much to pay for an innovative new therapy, but instead how to address what amounts to a repricing of an old therapy. Acthar is in some respects the opposite of a “Breakthrough” therapy: it is a 50-year old brand launched before the 1962 efficacy amendments, which Questcor acquired from Aventis SA in 2001.

Questcor studied Acthar for some new indications—including an Orphan use for infantile spasms—and obtained approval for an updated label in 2010. The company also raised the price many times over, to about $30,000 per treatment.

The result has been strong growth in sales to more than $750 million last year – and growing controversy at least among some investors about the sustainability of the company’s model. Short sellers have circled the stock, pushing arguments about alleged marketing abuses (now supported by subpoenas issued by federal prosecutors in 2012), and highlighting adverse coverage decisions by payors like Aetna Inc.

The arguments against the product amount to the claim that it is a drug of dubious value being widely used in conditions where it hasn’t demonstrated much if any effect. (In fact, the most recent controversy came when Citron Research published a long analysis purporting to show that the drug does not contain the labeled active ingredient, citing lab results it said were presented to FDA. Questcor disputes that report, and it does appear to stretch the boundaries of plausibility – but it also shows the level of skepticism about the value proposition behind the price increase.)

In light of that controversy, Mallinckrodt’s buyout offer is being hailed as a “victory” for holders of the stock who believed the business model was viable, and will no doubt encourage others to adopt the “legacy product” rebranding model.

However, there is a completely different public policy issue in the background of the Questcor transaction: the ability of Mallinckrodt to take advantage of favorable tax policies based on its incorporation in Ireland to make Acthar even more profitable than it is under Questcor’s ownership. In announcing the transaction, Mallinckrodt noted that the favorable tax impact would help the transaction be accretive right away (in 2014), despite the hefty premium.

That makes it the latest in a string of industry acquisitions that involve moving US based companies to more favorable tax geographies. And it comes at a time when the Obama Administration and its allies in Congress are proposing to make it harder for US-based companies to do these so-called “tax inversion” deals.

The budget proposal would eliminate the current tax policy that allows “inversion transactions” where the US company ends up controlling 60%-80% of the combined and now ex-US company. In order to take advantage of foreign tax rates going forward, the acquiring company would have to end up being majority owned by the ex-US firm. In addition, the policy proposal states that US tax rules would still apply no matter how high the ownership is by ex-US shareholders, if “the foreign corporation is primarily managed and controlled in the US.”

The Mallinckrodt/Questcor deal is not technically a “tax inversion,” since Mallinckrodt is already incorporated overseas and will be the majority owner of the combined company. However, Mallinckrodt’s Irish incorporation is a big part of the financial logic of the deal and highlights both to investors and other corporate business development teams the advantages of the tax shelter strategy.

The proposal calls for the new rules to take effect January 1, 2015. That seems unlikely. After all, the Obama budget proposal is not really much more likely to drive legislation and policy than the Waxman letter: it is primarily a document about political positioning heading into the 2014 election.

But the potential for changes to tax policy are real, especially with a proposal like this one that has a bipartisan, made-in-the-USA appeal. And the recognition that “tax inversion” transactions may be tougher to pull off—or less rewarding when they are completed—could drive more companies to make deals while the favorable rules are still in force.