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Is Healthcare No Longer Investable?


Biopharma is done. Big pharma has been done for years. There might be some love still to be found in the generic space...


As we move to the final stages of the Prescription Drug User Fee Act (PDUFA) renewal and accelerate into the Presidential election season, it's a question I have to ask.

So I don't bury the lead, my general conclusion to the question of whether you can invest in healthcare (from the long side), is "no" with two exceptions:

1. The next two years for most any development-stage biotech company, driven by acquisitions.
2. Early-phase development-stage companies who have market caps below $100 mln and who are just entering into meaningful Phase II trials.

Biopharma is done. Big pharma has been done for years. There might be some love still to be found in the generic space, but those trades have been crowded for some time and they will get even more crowded as the Democrat candidates start ramping up their drug cost diatribes.

I'm aware it's popular right now to be flogging big-cap pharma and biopharma as great "undervalued" investments. Their pipelines are pathetic and $40 bln in sales (~20% of the $230 bln in total sector sales) will go off patent in 2009, creating huge holes in the balance sheets of the sector.

Because the price of a stock and the value of a company are only coincidentally related, it is possible to make money on big-cap biopharma and pharma. If you go long these time bombs, realize you're simply one more lemming in a sea of lemmings headed for the proverbial cliff. Since "lemming money" spends the same as "smart money", that's OK as long as you know where the cliff is and decline to follow your fellow lemmings over the edge.

While this might sound like a boon for the short-side guys, it isn't. After three years of shooting fish in a barrel, biotech has become heavily shorted enough that the risk/reward on binary events is starting to become more balanced. I've noted frequently over the last three years that risk/reward in biotech has become unbalanced. Good binary data causes a 20-30% jump while bad binary data causes a 50-70% decline. That disparity is icing on the cake for short sellers who are already benefiting from a 90% failure rate among biotech companies.

But just in the last few quarters, that disparity is closing. More than a few good binary events have seen stocks jump 100-300% with no appreciable pullback. In June, we saw a complete failure of Allos Therapeutics' (ALTH) Efaproxin, the company's lead drug, and the stock essentially didn't move. That hurts bad if you're short.

Toxic Regulatory Environment

I believe that at this point no first-in-class lifestyle drug will get first pass approval in front of this FDA. I also believe that no same-class (second-to-market or later) drug in a blockbuster class that has demonstrated some safety concerns to the FDA will get first-pass approval absent very, very large clinical trials directed specifically at any worrisome side effects. Even then, as demonstrated in the COX-2 space, your chances are iffy.

As I've been saying since 2004, and I've seen in a series of editorials and other communications from a broader group of advocates, executives, and doctors recently, oncology drug approvals seem especially broken.

Take the example of two recent prostate cancer drug approvals. In May, the FDA turned down Dendreon's (DNDN) Provenge because the drug did not meet a surrogate primary endpoint, even though it showed an advantage on a secondary endpoint of survival. In July, the FDA (ODAC) turned back GPC Biotech's (GPCB) Satraplatin because it has not shown an advantage on a secondary endpoint of survival, even though it met a surrogate primary endpoint.

Avoid At All Costs

There are investments that must be avoided as the items above come to pass. I should emphasize that there may well be money to be made on a few of these, but the risk on each is already markedly higher than it was even a year ago. If your investing focus is largely in these areas, you need to be especially concerned, regardless of how well you've done in the past, because you need to expand your strategies elsewhere – sometimes not an easy thing to do.

  • Late-Stage Lifestyle Drugs

    Lifestyle drugs may face difficulties. 20 patients out of 5000 may be considered an adequate "safety signal" to negate an approval or trigger post-approval safety surveys. I want nothing to do with this now and I believe it will get worse going forward.

  • Late-Stage First-in-Class

    Is the company bringing a first-in-class drug to the FDA? This may be difficult, particularly if the drug represents a paradigm shift in the established treatment for the disease. It will require an advisory panel, which means anything can happen. With the FDA often, it seems, overruling its advisory panels these days, even a positive vote from the assembled experts doesn't mean the drug has a free path to approval.

    Recognize that sometimes first-in-class is not paradigm-shifting. Let's say someone discovers a rainforest plant whose sap is the next chemotherapy drug (like the taxanes that were birthed from the Pacific Yew). While it may be first in class, this would not be a paradigm-shifting drug.

    To determine the difference, ask yourself if the new drug:
    • Markedly changes who in the healthcare community treats the patients
    • Significantly alters the economics of treating the patient
    • May encounter resistance from a substantial number of key thought leaders in the disease

If one or more of these, you likely have a paradigm-shifting drug and you need to be very, very careful because your risk just went up significantly.

Biosimilar Producers

With the 12-year exclusivity written into the proposed PDUFA legislation, don't bother. If you do bother, realize you are investing in a pack driven by perception and not fundamentals. Be nimble and don't get greedy.

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Position in DNDN

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