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- Fundamentally, the outlook for biotech is as strong as ever.
- Drug price controls are unlikely to happen for the next decade despite the political rhetoric.
- Political pressure combined with crowded quant positions and fund liquidations have created buying opportunities in biotech.
Fundamentally, the outlook for biotech is as strong as ever despite the recent political rhetoric on drug pricing that drove a 22% pullback in the NASDAQ Biotechnology Index. The pullback is analogous to the 20% correction which started in late February 2014 driven by politician concerns over the pricing of Gilead’s Sovaldi for chronic hepatitis C. Indeed, Sovaldi costs $1,000 per day, but what was left out of the conversation by politicians was that it costs 30% less than the standard of care and cures twice as many people. Despite politicians pointing fingers, I think that most would agree that a 9 in 10 chance of being cured for two-thirds of the cost is a better deal. It is also notable that Gilead’s drug is much safer than the then standard of care which had side effects including flu-like symptoms and a low risk of suicide.
What actually happened was that Gilead’s drug was sought after by so many that $2 billion in sales were generated in the first full quarter on the market. This remarkable feat was due to many patients deferring care, waiting for the new drug. This caught many medical director payers off guard. Although this was expected by many investors, the medical directors had been asleep at wheel and had to point fingers and get politicians involved.
The cost of drug development has increased and total R&D spend has risen, but this has fueled dramatic innovation. According to a recent study by the Tufts Center for the Study of Drug Development, the estimated cost to develop a new prescription medicine that gains marketing approval is $2.6 billion. In the last eight years, the members of the Pharmaceutical Manufacturers Association (which does not include all drug developers) have spent $376 billion on R&D. Revenues from branded drugs have to pay for this. According to data published by the FDA, nearly 8 in 10 prescriptions filled in the United States are for generic drugs. The use of generic drugs is expected to grow over the next few years as a number of popular drugs come off patent through 2015. This has led to huge savings. In 2010 alone, the use of FDA-approved generics saved $158 billion, an average of $3 billion every week. Another $44 billion will come off patent in 2015, the biggest number since 2012. Despite this staggering success, often forgotten in the calculus is average cost of post-approval R&D requirements to prove the benefit upon which the FDA based their approval. This adds $312 million in additional cost, taking the full product lifecycle cost per approved drug to $2,870 million. The reality is that drug price controls are unlikely to happen for the next decade despite political pressures. Why? Because there is value for the cost.
The biotech sector has meaningfully out-performed the broader markets the past 5 years, prompting talk of a “bubble”. However, the market success was driven and supported by breath-taking breakthroughs. A clear example happened this past week, with the first positive phase 3 trial for a gene therapy to treat a rare form of blindness. Once, thought to be science fiction, a single injection of genetic material, adeno-associated virus (AAV) carrying the RPE65 gene behind the eye, met the primary endpoint of improving functional vision. There were several other gene therapy success stories in recent months including a potential cure for sickle cell anemia, spinal muscular atrophy, acute leukemias and many more. Biotech breakthroughs discussed, but theoretical for decades are becoming reality and leading the way in overall healthcare innovation.
Since 1980, 83% of life expectancy gains for cancer patients are attributable to new treatments, including medicines. According to a 2013 statistics update by the American Heart Association, death rates for cardiovascular disease fell a dramatic 33% between 1999 and 2009. Since the approval of antiretroviral treatments in 1995, the HIV/AIDS death rate has dropped by 85%. Children with cystic fibrosis are projected to live decades longer, and the list goes on and on and on.
Sector appreciation over the past year driven by ETF fund flows increased cross-correlation in the sector. The correlation across the sector has spiked further in the recent selloff. This has created a chance to take another bite at the apple, as high-quality, innovation-leading names were sold off indiscriminately with the broader sector. In our view, the current political rhetoric combined with crowded quant positions and fund liquidations have created buying opportunities. Like the correction in early 2014, we now see an exceptional chance to position towards high-quality names in the space priced similarly to names with unproven, low-quality pipelines. The last time this happened was when Gilead pricing discussions weighed on the market in 2014, and the group is still higher than it was at that time despite the recent pullback, with true innovators leading the way.