With mid-term election just around the corner, politicians are focusing on key items that they can talk about as we ramp into voting ballot.
One of the popular items that politicians have long promised, but never got around, is the DRUG PRICING REFORM.
Due to macro-driven volatility in the market, drug pricing reform has yet to drive price action today, but it is sure to drive it once we are through current macro environment (big question is when does it end)?
However, good investor always looks at what is ahead. Many may have brushed off drug pricing given past failures, but it seems like it is different this time – with bipartisan support, the drug pricing reform is now a step closer to legislation and key item is giving the US government/ Medicare ability to NEGOTIATE PRICES.
It is interesting that Medicare has not been able to negotiate directly (although it has taken “best prices” in commercial segment) while other countries have driven down prices through direct negotiation with individual pharmaceutical companies.
The timeline for implementation of drug pricing reform is as follows (source: Kaiser Family Foundation).
The legislation is still influx, so I won’t be talking about details. However, I will discuss key points that are largely expected to stick. I will talk positive first, and then discuss negative.
CAP ON MEDICARE BENEFICIARIES OUT OF POCKET COSTS – POSITIVE FOR EVERYONE
This is highly positive on the volume growth for pharmaceutical industry. Currently, we see donut hole effect in 1Q every year for Medicare heavy drugs as Medicare beneficiaries cut back on spending in 1Q to save on out of pocket expenses.
Donut hole is the period between two coverage dollar levels (A and B) during which Medicare beneficiaries are responsible for high portion of their drug costs.
A) You enter the donut hole when your drug cost (both you and your plan) hits a cap ($4,430 in 2022).
B) You enter catastrophic coverage when your out of pocket costs reach $7,050 for covered drugs. During this period, you pay significantly lower copays or coinsurance for your covered drugs for the remainder of the year.
Between A and B, Medicare beneficiaries are responsible for a percentage of the cost of your drugs – during which many patients are focused to cut on drug use due to economic reasons.
With a cap of out of pocket expenses, Medicare beneficiaries should be able to use the drugs as intended – not having to save or extend doses. This would lead to higher compliance and persistence and hopefully longer survival for patients – all of which is positive for volume increase.
Key beneficiaries are likely high Medicare volume drugs that are already heavily discounted, including $REGN (Eylea), $NVO (diabetes franchise), $LLY (diabetes franchise).
SMALL MOLECULES WILL HAVE SHORTER EXCLUSIVITY PERIOD THAN LARGE MOLECULES – NEGATIVE FOR SMALL MOLECULE PLATFORMS AND POSITIVE FOR LARGE MOLECULE PLATFORMS
In biotech, where exclusivity is key to generate return from R&D investments, exclusivity is very important as it links directly to the numbers of years the drug will be cashflowing.
Drug development costs are not that different between small molecule and large molecules as manufacturing is often a small fraction of drug development. However, shorter exclusivity means that a small drug will lose a few years of peak sales years (last 2-3 years are the highest revenue generating years of any drugs) vs. large molecules.
This has implications for M&A as well – large cap pharmas are always solving for loss of exclusivities of its current blockbusters and used DCF analysis for target valuation. Small molecule biotechs suddenly become less interesting due to this regulatory setback.
One notable exception is for rare diseases – their regulatory exclusivity period remains largely intact.
Key beneficiaries are large molecule focused drug companies, including $BMRN, $FOLD, $SNY, $SGEN among others.
Many small molecule companies that are developing drugs for non-orphan/rare diseases will get hurt from this – those that are developing oral GLP-1s. Even RNAi platforms could get hurt from this – RNAi drugs are on the borderline – they are not as simple as small molecule drugs, but they also file NDA (new drug application) – instead of BLA (biologics license application). So this could have negative implication for terminal value of $ALNY, $IONS, $ARWR.
PHARM BUSINESS LEADERS SEEK TO IMPROVE PATIENT LIVES REGARDLESS OF REGULATORY ENVIRONMENT
Don’t hate the players – hate the game. however, it does not mean we should stop playing!
How are you repositioning your biotech portfolio?
