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Feature

Dealing in Drugs...

...the key to financial success Posted on: 17 Jun 02

Summary

By Hallucigenia June 11, 2002
"Drugs are a delusion" claimed George Bernard Shaw in The Doctor's Dilemma. Some might argue that drug development companies are only for deluded investors, who dream of investing in the new GlaxoSmithKline (LSE: GSK), but are more likely to end up in a British Biotech (LSE: BBG). Certainly the odds are long -- of every 15 drugs that enter clinical trials, just one will end up being marketed and making money.
But the rewards are great. AstraZeneca's (LSE: AZN) ulcer drug Losec alone brings in net profits of £1bn a year. Good patent lawyers can give you an effective monopoly for years, skilful marketing can extend your franchise even further, and you have many years' warning of competitors entering your market, as they endure the long and expensive road to drug approval. With such massive barriers to entry and an almost unlimited demand for the products, it's not surprising that the Rule Shaker is attracted to drug companies.
We've all heard stories like that of Rosa Hargreaves, a factory girl who held Glaxo shares for 47 years and left £6.3m to her heirs. But it's easy to forget the hundreds of companies that have tried to follow the same path over the decades and failed. As always, great rewards only come to those who take great risks -- these companies come as close to pure gambles as any on the market.
Would you have invested in Glaxo when it came to the market as the offshoot of a New Zealand milk powder company, dabbling in some newfangled wonder drug called penicillin? While I think it's a great idea to gain exposure to the sector via a biotech fund, or some of the service companies I mentioned in this article, I think most investors should avoid small cap drug developers. If you do fancy a gamble, spread your risk over several projects. You can do this by investing in several small companies, or in a bigger company with several drugs in development. There is somewhat less risk associated with the drug delivery companies such as SkyePharma (LSE: SKP), Powderject (LSE: PJP) and Maelor (LSE: MLR). They reformulate existing drugs to reduce side-effects or make them easier to take, but like many of the service companies I mentioned last week, the drug delivery companies are now chasing the big bucks by developing new drugs from scratch. The basic principles of the drug development process are the same for all these companies, so let's have a quick look at them.
Drug dealing First of all, there must be a market for a drug developer's product. Trials are so expensive that, in general, a drug needs peak sales of £100m-plus just to recoup development costs. Only 30% of marketed drugs manage to break even in the long term, so assessing the potential market for a drug is vital.
There is a lot of information available about the prevalence of diseases -- the UK's Department of Health, the US National Cancer Institute, and the WHO websites all have useful data. If you're interested in a particular disease, a simple web search will usually turn up a host of information, including the websites of patient groups. You also need to know how well served that market is, and what competing drugs are in development -- the Recombinant Capital website is a wonderful resource for this kind of data. Cancer, sepsis and stroke are the big markets that are crying out for good treatments. You can also judge the professionals' view of a drug by a company's partnerships --are big pharmas queuing up to get involved, or is there not much interest? Finally, you have to ask how much money can be made. Patients will pay more for a life-saving cancer drug than for a coldsore cream, and from the company's point of view, the repeat business from a long-term disease is better than a disease cured by a single shot of a drug.
The long road to market
Stage   % Marketed   Duration   Cost   Description
  • Preclinical 0.1%-10% 4-5 years £0.5m Is it safe and does it work in the lab?
    • Phase I 20% 1-3 years £1m's Is it safe for healthy people to take the drug? <
      • Phase II 28.6% 2 years £10m's (small scale) Does it work in sick people?
        • Phase III 60.6% 3-4 years £100m's (big scale) Does it work in sick people?
          • Approval 90% 1-1.5 years Do the regulators believe your data and let you sell it?
            • Marketing Can you and your partners sell enough to make a profit?

            This is only a rough guide -- the details vary for each drug. For instance, it takes less time to see if an anaesthetic works than an Alzheimer's drug. New technologies may reduce the time needed for preclinical trials. "Me-too" drugs have a greater chance of being proven as safe and effective than novel technologies such as gene therapy. Regulators -- the United States' Food & Drug Administration (FDA) and the European Agency for the Evaluation of Medicinal Products (EMEA) -- can 'fast track' a decision in 6 months for an additional fee. Companies may combine phases, or split them up -- it's quite common for Phase II to see trials of different formulations and doses of the drug. But the following general comments can be made:
            The odds are against drugs in Phase I and II. If a company has five drugs in Phase I, it might get one to market. In general, I would avoid companies that don't have at least one drug in Phase III; at least you know something works in humans. It takes a long time. Even a drug in Phase III trials might not bring in any money for four years. When you're valuing a company, ignore anything in Phase I or earlier. Patents on a drug last for just 20 years, yet it might take 15 years to get a drug on the market, so anything that speeds up the testing process can make a big difference to the final profitability of the drug.
            It costs a lot of money. Typically, a small company will pay for preclinicals & Phase I/II trials, then get a big pharma to pay for the expensive Phase III trials and distribute the final product. In return, the biotech might see 15-25% of total revenues from the drug. Terms have been improving of late, as Big Pharma gets more desperate for products, and biotechs have been better able to afford to take drugs to a later stage of development. Biotech companies with strong balance sheets get a better cut, as they can develop a drug further before sharing it with a big pharma. They are also less likely to dilute existing shareholders by issuing more shares.
            Be ruthless I think the easiest mistake to make in this field is to invest in a company "because it is doing some good". The only time a small investor directly supports a company is at the initial public offering or during rights issues. If you want to contribute towards a cure for cancer, make a donation to Cancer Research UK. Investing your precious capital is not a matter for sentiment, although it's obviously nice to think that you are doing some good with it.
            As always, the critical questions to ask are, "Is there a market for this product?", "Is this a good business?" and "Will this investment make money for me?" Concentrate on these essentials and you might just find 'the next Glaxo'.
            This article was orginally published in July 2001. At the time of writing, the author had a beneficial interest in GlaxoSmithKline. Click here for Detail-Direct, Detail-Direct.com is the premier location for product-based information that is relevant to the practice of medicine, or for more information contact Colin Williams, e-Marketing Manager on +44 (0)1344 667430

Hallucigenia

Last updated on: 27/08/2010 11:40:18

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