Biotech Values

[DewDiligence]

Musings from Forbes on Pfizer and the new Congress…

http://www.forbes.com/2007/01/05/congress-democrats-pfizer-pf-guru-in_pt_0105intrepid_inl.html

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Congress Won't Whack Drug Makers

By Peter Topolewski
01.05.07, 4:30 PM ET

Democrats are now back in control of Congress, ending a 12-year stint as the minority party. They have an ambitious agenda for the first weeks of the newest session, and right near the top of the list are proposed changes aimed at reducing drug costs.

The pharmaceutical industry has been spared a great deal of scrutiny over the last decade thanks to close ties to the Republican party, with some critics going so far as to suggest that Republicans gave the industry a gift with the Medicare Part D program.

The changing of the guard would suggest that the honeymoon is over for drug companies. Instead, we see some bickering inevitably straining ties between these two sides, but drug companies aren't likely to suffer as much as the breadth of the Democrats' legislative agenda would hint.

Congress is taking aim at lowering drug costs under three main initiatives. The first of these is to scrap the 2003 law that bans the government from directly negotiating Medicare drug prices with drug makers. With proponents of this change projecting that it would save $60 billion over the next 10 years, it looks like a straightforward move.

That's being presumptuous, however. Although it appears such a measure will have a good chance of success in the House of Representatives, that's a bit deceiving. Political analysts, meanwhile, already note that passage in the Senate could be a much tougher nut to crack. [You need 60 votes in the Senate to cut off a filibuster.]

A prime obstacle standing in the way of Congress on this front is the surprisingly strong success of the Part D program. Politicians are going to have a tough time finding the will, and political upside, to mess with a program that has worked better than expected for all sides.

As mentioned in a recent overview of the health insurance sector, the bark in this case is likely to be worse than the bite. Democrats can make a case for fiscal responsibility, which doesn't translate into success at the polls. They can also take up the fight for the sustainability of the health care system, but attacking drug costs is only one part of this. Drug companies have to be a partner in a solution, a point they'll be happy to make via their trade groups.

Lastly, health insurers have done a decent job operating Part D to the satisfaction of those who use it. Democrats could argue for lowering medical costs for seniors, but changing the plan drastically could throw the whole thing awry, forcing health insurers to alter plans in ways ultimately unfavorable to seniors who are mostly satisfied at this point.

This isn't to say that drug companies are going to get a free pass through this session of Congress. Far from it. They'll be on the defensive plenty. Still, the decision by Pfizer to recently hike drug prices is indicative of the room drug companies feel they have to negotiate when it comes to setting prices. The company recently said it boosted prices nearly 5%. Industry analysts suggested the increase was motivated by the need to meet revenue targets, but that's likely only one factor, albeit an important one.

The hike was also likely demonstrative, an example to lawmakers that, even when under scrutiny, the company will increase prices because it has to in order to meet the costs of drug development. Lastly, the increase also gives Pfizer room to offer concessions if and when it enters into direct negotiations with the government.

There are also political reasons for expecting that Democrats will ultimately go easier on the drug industry than might be feared. The party's hold on Congress is tenuous at best. Quickly making enemies of one of the country's biggest lobby groups isn't a way to ensure survival in Washington. With loads of drug political action committee money available, Democrats stand to make up some good fundraising ground on Republicans by introducing moderate, not radical, drug policy changes.

As mentioned, Congress does have means other than just drug price negotiations to reduce health care spending. Congress is going to look at pushing through legislation to speed up the introduction of generic drugs and to open the door to the first generic versions of biologics. [This is the most consequential open issue for biotech investors, IMO.]

The former is more of a potential game-changer than the latter, but given that the future of the industry rides on the increasingly complex world of biologics, the passage of meaningful generic biologics changes could be tough. Here, the issue really is about the lack of an economic incentive and the heightening of economic risk-crippling innovation.

As to the issue of accelerating generic approvals for regular drugs, we've seen companies like Pfizer and Merck already respond to the loss of patent protection in part by increasing their own generic production lines. We also expect that legislative advances in this area could be linked to the industry's desire to speed up the drug approval process and find greater Food and Drug Administration support for adaptive drug trials, both of which could dramatically reduce development costs.

For all the talk coming from Congress, the proposed changes the Democrats have on the agenda aren't the biggest challenge facing drug companies. Instead, for Pfizer and others, the headwind is revenue growth and pipeline wins.

We know, for instance, that Pfizer still has plenty of opportunity to cut costs and that the pipeline looks OK for 2010 onward, but cost-cutting only goes so far and its biggest potential blockbuster, Torcetrapib, is now out of the running as a commercial candidate. Recently introduced drugs like Exubera and Champix could provide pleasant surprises, but they won't make up for revenues lost to recent and imminent patent expirations.

The stock continues to come back from its Torcetrapib-related drop, highlighting that the Democrat agenda isn't a main worry for the market. Following a dividend hike, we're looking for signs of growth-inducing action at Pfizer (and we suspect the market is too), perhaps a sizable acquisition of a pharma or biotech firm.

As long as Pfizer's stock continues to ease upward, we'll be patient waiting for a medium-term growth plan to come into focus, but we're not going to sit on the name indefinitely because of cost-cutting alone.
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