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Election risk


Politics, I don't need to hear no stinkin' politics


In our monthly newsletter at Biotech Monthly, I write a column about macro market events affecting the biotechnology space. Our research team occasionally addresses macro market issues in one of the many alerts we also publish each month. Each time we address the question of election risk, e-mails from both the right and the left arrive accusing us of letting partisanship affect our investment outlooks.

Since this article is about election risk in biotech, I want to head those e-mails off at the pass. Don't get me wrong, I love to hear from fellow Minyans. What I want to make clear is what follows has nothing to do with my particular political ideology. I offer the following only to help provide fellow Minyans a competitive advantage in the marketplace and not to advance any partisan point of view.

With that caveat out of the way...

In our October 2003 newsletter, I introduced the specter of election risk to our readers. In my column, I put forth the idea it was likely President Bush would lose the election. Furthermore, the Democrats would only be able to secure the win by promising certain things to the left wing of their party - one likely promise being serious input into the nominee to head the FDA.

While some disregard the impact of the FDA Commissioner on biotech valuations, I think the historical record is clear:

I know it is not exactly fair to lay the blame for the vaporization of nearly 50% of the value of this biotech index at the feet of Drs. Schwetz and Crawford, but anyone who knows anything about this industry knows the FDA drug approval process was essentially paralyzed under their leadership. Furthermore, in a recent letter to FDA personnel, Dr. Crawford made it clear that the policy initiatives and changes brought forth by Dr. McClellan would continue during his second shot at heading up the FDA. The point you should take away is the identity of the FDA Commissioner is very much a part of biotech valuations.

If President Bush wins the election, GOP sources are telling us there will be no replacement nominee until after the election - probably into 2005.

Under a Democrat administration, certain things become more likely. The caveat here, of course, is most will require Congressional action. Which party controls Congress is certainly material to handicapping the ultimate election risk for this sector.

Economic justification for approval

In the US, a drug generally needs only to be proven safe and efficacious to receive approval. In other countries, a drug must also show a positive financial cost-benefit analysis (also called pharmacoeconomic benefit). For example, a drug that prevents heart attacks must do so at a price that is less than simply treating the patient after the heart attack happens and/or at a price that is better than currently existing treatments. While showing pharmacoeconomic benefit is not usually terribly difficult, it is an extra burden.

Where pharmacoeconomics might have the most impact is in cancer treatments. Corixa's (CRXA:NASD) BEXXAR is currently reimbursed at $30,000. ImClone's (IMCL:NASD) Erbitux and Genentech's (DNA:NYSE) Avastin are also not cheap. I will grant you pharmacoeconomics on life-saving cancer drugs might be too touchy a subject. Nevertheless, this should be something to tuck in the back of your head come November.

Economic justification for reimbursement

If the FDA approves a drug, CMS (Medicare/Medicaid) is generally required to reimburse for it. Once CMS sets the reimbursement levels, the big private insurers generally follow suit. When the high-priced cancer drugs were first approved, noise was made by CMS that they might not reimburse these drugs. Their justification was they did not present a significant enough treatment advantage over existing drugs to justify the much higher price.

This notion was quashed quickly, but it will be back on the table when Congress gets back to looking at Medicare/Medicaid costs again next year. It has a better chance of succeeding if the Democrats control the White House.

Superiority required for approval

The FDA has no authority to reject a drug if it is not superior to another drug except in two limited circumstances: The Orphan Drug process and the Accelerated Approval process. In both these situations, drugs must prove superior to the currently approved product - if any. Otherwise, as long as the drug is safe and efficacious the FDA is required to approve it.

If Congress and the FDA feel uncomfortable about dealing with the idea of straight-out pharmacoeconomic issues directly, adding a superiority requirement would certainly be one way to get there. This would be a terrible blow to big pharma given their pipelines tend to be overly focused on the next derivative of a currently approved drug.

A requirement to demonstrate superiority would increase costs for approval, dramatically affecting the type and number of clinical trials needed. It would also tend to narrow the labels of follow-on drugs. For example, if a company is trying to get a new statin (cholesterol-lowering drug) approved, they would have to run multiple competitive trials to prove superiority. Since it is somewhat unlikely they would find across-the-board superiority, they might have to settle for a drug label showing superiority in a sub-group of the overall population. This would reduce sales considerably.

This might be good news for many biotech companies. They tend to do a better job than big pharma developing first-in-class drugs for indications without good treatment options. A superiority component in the approval process would dramatically increase the value of any drug targeted to a disease with no good approved treatment options.

Reimbursement risk

This is the most obvious of the electoral risks and the one affecting drug stocks the most at the moment. A Democratic administration will almost certainly look at ways to reduce reimbursement costs for drugs. Whether that is opening up Canadian imports (which will be a short-term solution as big pharma will simply equalize prices) or instituting price controls is anyone's guess.

It's not partisanship

You can vehemently disagree with my assessment that President Bush will lose. You can also vehemently disagree with my analysis of what the Democrats might and might not do if they win. What you shouldn't make the mistake of doing is ignoring the fact that electoral risk is affecting biotechnology and healthcare stock values right now. I know from talking to biotech executives it is affecting partnership negotiations. I know from talking to biotech fund managers it is affecting what they are willing to pay for stocks in this sector.

Make sure to separate your politics from your pursuit of outperformance.

Back in October at our site, I posted that biotech would rally though June and then begin to sell off as election risk became more obvious to Wall Street. The weakness has been accelerated somewhat due to Dr. McClellan leaving to head CMS and recent bobbles (or perceived bobbles) as the GOP launched their bid to retain the White House. We're in the sheep dip a quarter earlier than I thought. This is, in my view, a primary reason for the weakness in the sector over the last few weeks.

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