A Winning Biotech Strategy
For former drug researcher Raghuram “Ram” Selvaraju, picking biotech stocks is both science and art. It’s about understanding the competitive landscape and the mechanisms of drug action, and then making sure all the pieces fit together for a plausible investment case. In this interview with The Life Sciences Report, the managing director and head of healthcare equity research at Aegis Capital lays out his growth hypothesis for companies—several targeting orphan diseases—that he believes will nurture portfolios.
The Life Sciences Report: Ram, it’s hard to imagine a situation where orphan drugs wouldn’t be reimbursed, because the needs are so great and the optics would be very bad for both payers and drug developers. These drugs range from angiogenesis inhibitor Sutent (sunitinib/Pfizer Inc. (PFE:NYSE]), which is reimbursed at $48,000 a year ($48K/year) to the monoclonal antibody Soliris (eculizumab/ Alexion Pharmaceuticals Inc. [ALXN:NASDAQ]), reimbursed at more than $500K/year. Are we going to reach a tipping point where payers will balk and begin to reimburse at reduced levels, which, in turn, would suppress development of orphan drugs?
Raghuram Selvaraju: I think we’re a long way from a tipping point, primarily because orphan drugs are directed toward niche patient populations and have historically commanded high prices. Orphan diseases by definition only afflict small numbers of people, and reimbursement agencies can spread the costs associated with providing drugs to small patient populations across massive subscriber bases. Typically, the subscriber bases number over 100 million (100M) patients for the largest U.S. reimbursement agencies. From my perspective, there is no reason orphan drugs can’t continue to be successfully commercialized at current price points.
What we will not see is pricing over the highest boundary that currently exists in the market. That benchmark, in my view, has been set by Soliris, which is widely acknowledged to be the most expensive drug in the world today. It treats an orphan indication, paroxysmal nocturnal hemoglobinuria, which is not life-threatening. Yet Soliris is priced at more than $500K per patient annually. That is the upper boundary of orphan drug pricing.
I would anticipate that, as time goes on, companies will find it harder to demand pricing above $75K/patient/year. Right now, in the U.S., orphan diseases are classified as any disease that has 200K or fewer patients. An orphan disease with a relatively high prevalence has more than 50K patients. It is likely that prices for drugs aimed at those higher prevalence diseases is going to come down to the $30–50K/year range.
Drug purveyors have a lot of pricing flexibility, if the drug is a small molecule. Purveyors of orphan drugs can make money even if a small molecule is priced as low as $15–18K/year/patient. If the drug is a biologic, there is some justification for higher pricing because of the higher cost of production. But I think we’re a long way from seeing orphan drug pricing reduced to the sub-$10K level.
TLSR: Targeted medicine is about subtyping diseases. For instance, some cancers can be many different diseases, if we look at genotype and/or mutation status. Drug developers could orphanize diseases by segmenting them according to mutation status or genotype. Will there be resistance to that kind of orphanization and associated pricing?
RS: That’s an interesting question. I actually think we want diseases to be as orphanized as possible, because the more you segment into discrete patient populations, the more targeted the therapy, which makes favorable outcomes with each individual patient more likely. A given drug will be tailored to a specific genetic makeup and side-effect profile. Orphanization is a good thing because it’s going to increase the pharmacoeconomic benefit of newly launched drugs: the more specialized the drugs become, the more developers can justify higher pricing. We consider this a promising trend, and likely to improve the efficiency of healthcare, not act against it.
TLSR: You have observed what you are calling a “massive wave of tax inversions.” What’s it about?
RS: Simply put, we have a corporate tax regime that renders the U.S. corporations less competitive versus peers in other developed countries. Broad-based U.S. corporate tax reform is needed. The current U.S. statutory corporate tax rate is 35% at the federal level. If a company doesn’t employ tax mitigation strategies, it can wind up paying an effective tax rate in excess of 40% on corporate profits. Any corporation that pays that in this age would be regarded as woefully inefficient. Astute tax management strategies are going to be rewarded by shareholders.
TLSR: Give some recent examples of companies that have used this tax-mitigation strategy.
RS: Recent examples include Valeant Pharmaceuticals International Inc. (VRX:NYSE; VRX:TSX), AbbVie Inc. (ABBV:NYSE), Apple Inc. (AAPL:NASDAQ) and Pfizer Inc. (PFE:NYSE). These multinational corporations generate substantial profits outside of the U.S. on patents domiciled in the U.S., and it’s difficult for them to repatriate earnings they’ve accumulated outside of the U.S. without hitting the U.S. tax net. Instead, these companies make use of their ex-U.S. cash piles by acquiring assets domiciled outside the U.S. They are able to reduce their statutory corporate tax rates, and they don’t have to resort to expensive tax management strategies within the U.S. That’s why you’re seeing all of these inversion transactions taking place.