RISK AND REWARD CONSIDERED

All and all, only about 12% of drugs make it from phase 1 testing all the way to FDA approval. And even then, a significant proportion of newly approved FDA drugs flop in the market place, never recouping the millions invested into them.

Based on that fact, you might reasonably be saying to yourself, “Forget this! I’m going to invest my money in McDonald’s instead, or stick it under my mattress, or even just take my savings to Vegas…..apparently I would have a better chance of winning at Black Jack!!”

 The raw math can be daunting. But please stick with me for just a few more paragraphs before you run out of the room screaming.

If you had invested $7,000 in Pfizer stock in 1990 (27 years ago), today you would have $145,000.( 9) If you had done the same with Merck, you would have had a stunning 1,184.37% total return on your investment. (10)  What if you had “taken your hands off the wheel” and just invested in a routine, well established MUTUAL FUND that invests in a basket of Big Pharma stocks? Well, a $10,000 investment in the Fidelity Select Pharmaceuticals Portfolio, a basket of the largest, most common pharmaceutical stocks, would have become an astounding $33,200 in just 10 years. (2006-2016). (11) All of this, by the way, in the context of two gut wrenching stock market crashes (2001, 2008), conflict with Al Queda and ISSIS, and some very questionable political leadership (on both sides of the aisle).

How is this possible? How can the magicians at Big Pharma turn a mere 12% drug approval rate into reliably world beating profits, year after year, decade after decade? Simply put, when drugs finally do work, they really, really, work. Drug patents last about 20 years in the United States (I say “about” because there are a vast variety of factors that can lengthen or shorten this time period, and legions of pharma lawyers are constantly doing battle regarding these issues….). If Big Pharma finally does score a hit, the patent can become a license to print money.

Consider for example Januvia, one of the greatest selling drugs of all time. Currently Januvia sells roughly $6 billion globally per year (yes, billion with a B!). It was approved by the FDA in 2006, and sales have grown every year since, in a reliable, predictable, linear fashion (look up a sales chart on the internet…..talk about a pretty picture!). This growth isn’t surprising when we consider all the factors that went right for Merck’s little darling.

First of all, the TOTAL ADDRESSABLE MARET (TAM) is massive for Januvia, since it treats diabetes, and there are currently 371 million diabetics in the world (and growing rapidly).12 As an added bonus, an outsized proportion of these diabetic patients live in the industrialized world, so they are often able to pay for better treatments and innovations.

Second, the drug was proven to have modest side effects at worst, and reliable, solid efficacy (typically lowers blood sugar enough to clearly benefit a certain “sweet spot” of early stage diabetic patients).

Most importantly, Januvia demonstrates obvious, tangible benefits over existing therapies. Before Januvia, the standard therapy for early stage diabetic patients was a generic drug known as sulfonurea. While sulfonerea is cheap and generally known to be effective to a point, the drug was notorious for causing hypoglycemia (low blood sugar) and weight gain. The last thing doctor’s want to encourage with a diabetic patient is weight gain. So, even though Januvia came with much higher price tag than the old sulfonerea, there was an obvious benefit that could be sold.

And sold they did. Merck employees approximately 7,000 sales representatives just in the United States, (13) and that well paid army of reps relentlessly pursued the nation’s prescribers until the much more expensive Januvia eventually pushed the entrenched generic incumbent (sulfunuerea) out of the way. Consider this: while generics are cheap, there is no one to sell them or represent their merits to prescribers or patients. So, a bright, well dressed, well spoken Merck sales rep would basically never have anyone selling against her.

But Merck didn’t rely just on attractive reps with high lunch budgets and low moral standards…..Merck took its message directly to the people. The United States is one of the very few nations that allow DIRECT TO CONSUMER ADVERTISING. Big Pharma as a whole spends $5.2 billion per year on advertising that skips the doctor altogether and goes straight to the patient. 14. Videos of chubby, happy people grilling up healthy meals with friends and family gave Merck yet another edge over outdated generic competitors that no one bothered to promote anymore.

There was one more special advantage that helped to make Januvia a gold mine for Merck (and for me, by the way, I am a long time Merck shareholder). Truth be told, any licensed physician will tell you that for the high price, Januvia just doesn’t work that well. It works well next to other similar competing pills, but most diabetics that take the medicine never really met the clinical definition of “well controlled.” Many doctors will tell you that due to the cruel biology of the disease, the only agent that works well for the long term is insulin. Although insulin actually has very few negative side effects, the hormone is injected rather than taken in pill form. Many patients just can’t face the perceived horror of being “sick enough” to need injections every day for the rest of their lives. They prefer to focus on the images of happy healthy grilling in the Merck ads, and less on needing hormone injections to stay alive. Whether it works well enough or not; advantage, Januvia!

So as we move onto our actual investing strategy, please just keep a few things in mind from the above conversation.

1. In today’s day and age, “Big Pharma” is not really great at innovating. Remember the “big fish swallowing the little fish” analogy. Today’s Big Pharma management teams are more like investment fund managers seeking to acquire promising molecules or promising companies, but the big fish seem to have a hard time truly inventing things from scratch.
2. While they aren’t necessarily great at raw innovation, Big Pharma successfully musters the vast resources in man (or woman) and material that are necessary to push drugs through the final stages of development and FDA approval.
3. Once Big Pharma does have a “hit” on their hands, they are masterful in their ability to grind every last penny out of a patent. Much more than any small pharma or university or individual could, Big Pharma manages an army of lawyers, sales people, operations executives and advertising agencies that help tiny acorns grow into mighty oaks. Remember that the eye popping investment returns that we discussed above occurred DESPITE two gut wrenching recessions.

This is the enduring allure of betting your hard earned cash on America’s well oiled pharma machine; good drugs are hard to find, but once found, they literally print money for decades.