Replies to post #19611 on Biotech Values

[Biopharm investor]

This Merck restructuring really pisses me off.

Pharma is THE most powerful lobbying force in Congress, and I doubt many people realize what these companies are getting away with. The recent news of Merck’s restructuring is aa perfect illustration.

Pharma, more than any other industry, has positioned much of its IP oversees and transferred much of its production facilities to low-tax foreign countries. Although virtually everyone knows the US is, by a very wide margin, the most profitable market in the world for prescription drugs, through the use of sophisticated transfer-pricing schemes, the US entity within pharma acts solely as a distributor of prescription drugs made offshore, thereby resulting in very little profit from the sale of drugs being taxable in the US (i.e., distributor margins of 2% to 3% of sales).

Using Merck as an example, if you look at their 2004 Financial Statements, you’ll note that 58.7% of its 2004 sales were earned in the US, and yet the US only accounted for 30% of its consolidated income from operations. This clearly illustrates Merck’s effective use of transfer-pricing mechanisms to shift as much of its income from operations out of the US, thereby minimizing the taxes it pays in the US.

In fact, their Income Tax footnote to the 2005 Financial Statements states:

“At December 31, 2004, foreign earnings of $20.1 billion and domestic earnings of $880.9 million have been retained indefinitely by subsidiary companies for reinvestment. No provision is made for income taxes that would be payable upon the distribution of such earnings. These earnings include income from manufacturing operations in Ireland, which were tax-exempt through 1990 and are taxed at 10% thereafter. In addition, the Company has subsidiaries operating in Puerto Rico and Singapore under tax incentive grants that expire in 2015 and 2026, respectively.”

Now I’m all for US corporations availing themselves of whatever tax loopholes exist to minimize their taxes (and hence benefit their shareholders), but it pisses me off when this is followed by:

(i) the repatriation of $15 billion of foreign source income to the US under the American Jobs Creation Act of 2004 by Merck, for which it provided only $740 million of income tax in its second quarter 2005 financial statements (a rate of 4.9% versus the normal 35% US Statutory Rate), and then

(ii) the announced closure of 5 manufacturing sites that will result in 7,000 layoffs, one-half of which will be in the US.

With respect to (i) above, I think many people in the US (to the extent they’re even aware of the repatriation of foreign-sourced income under the American Jobs Creation Act of 2004 at a very low tax rate of about 5.25%), mistakenly view this as US pharmaceutical companies simply transferring money that was earned in foreign countries on the sale of product in those countries back to the US for investment here. What I suspect very few realize is that most of the money that will be repatriated will actually be profits that were earned on the sale of prescription drugs to US consumers in the US market but which was shifted abroad to avoid taxation via transfer pricing schemes facilitated by the transfer of IP offshore and the establishment abroad of manufacturing facilities.

So the repatriation of foreign-sourced income under the AJCA is really just completing the circle of brining home the profits from the sale of Rx drugs at very high prices to US consumers that was shifted offshore to avoid tax.

Now even that might be palatable if the repatriated money was really being invested in job-creating activities. But because money is fungible, the Treasury Department has basically acknowledged that it is all but impossible to really determine if the repatriated money is used for the job creating activities the one-time exemption provided for.

So you see pharmas like Merck, repatriating $15 billion of foreign sourced income back to the US and only paying 4.9% tax on that money, and then turning around and laying off 3,500 of its US work force!

The top 9 US-based pharmas will repatriate about $100 billion this year. Other than some acquisition activities (which don’t really create new jobs anyway), I haven’t seen any real investment (i.e., job creating activities) taking place in the US by pharma. In fact, as the Merck example illustrates, just the opposite is taking place, showing the AJCA is nothing more than the successful lobbying effort to basically give this sector an exemption from tax on about $100 billion of profits, the lion share of which was made from the sale of drugs to US taxpayers in the first place at very high prices.

[DewDiligence]

What’s Wrong With Big Pharma?
This graphic, from today’s MRK webcast, makes
a good companion to the article in #msg-8708384.

[DewDiligence]

The Value of New Drugs Is Dropping

[In other words, there’s a multiplicative effect going on: fewer new drugs being approved (compared to the industry’s best years) and fewer sales dollars on average for each of them. I’m making this post as a reply to a Forbes article from 3 years ago (#msg-8708384) to highlight the fact that the problems discussed in the new article are hardly new.]

http://www.forbes.com/2009/01/07/pharmaceuticals-sales-biz-healthcare-cx_mh_0108drugssales.html

›By Matthew Herper
01.08.09

Is the pharmaceutical industry's drought ending because more drugs made it to market in 2008 than the previous year? No.

Even if scads of new medicines make it through the Food and Drug Administration, it wouldn't solve another problem made clear by an analysis provided to Forbes by IMS Health, which tracks prescription data for drug companies. The amount of revenue generated by the average new medicine is dropping.

In 2008, the Food and Drug Administration approved 24 brand new medicines, the most in three years. But medicines approved through June produced lower sales than had been seen in the preceding decade.

New drugs approved in the first half of 2008 generated less than $40 million, one of the lowest numbers for any six-month period going back to the beginning of 1998. The average new drug generated only a few million in the first six months of 2008, a tenth as much as in a banner period like the first half of 1999. New medicines contributed much less than 0.5% to the growth of the global market, another way in which the first half of 2008 constituted six of the weakest months in a decade.

IMS' analysis looks at sales generated by new drugs during the six months in which they were approved, so it is possible that the data were skewed if a particularly big medicine was approved at the beginning of a six-month period. The second half of 2006 actually rivals the late 1990s in terms of overall and per-drug sales.

"There are good years and there are poor years," says Murray Aitken, a senior vice president at IMS. "The data definitely all show a trending down with some exceptional years." The problem for drug companies is that "relative to what's coming off-patent, the contribution from new drugs is much lower than what is needed."

The number of new drugs, the overall sales generated or the average sales generated in 1998 and 1999 are not rivaled by any year since. Companies launched bestsellers such as Merck's Singulair for allergies and Pfizer's Pfizer Viagra for erectile dysfunction. Vioxx, the Merck arthritis blockbuster yanked from the market in 2002 for heart side effects, and Avandia, the GlaxoSmithKline diabetes drug now under its own heart-safety cloud, were both also approved in 1999.

The big successes of the late 1990s coincided with a massive scale-up in the size of industry sales forces, so that in 2005 there was one drug sales representative for every nine doctors [!] Television advertisements for drugs, jump-started by a little-noticed FDA decision on Aug. 12, 1997, pushed sales of drugs like Pfizer's Lipitor, the industry top-seller, and Prozac to new highs. Advances in genetic science were supposed to lead to a flood of new medicines for all these representatives to sell. Those new breakthroughs never materialized, and most drug companies are having big layoffs.

Pfizer is one company suffering because of these dropping expectations. It sells cholesterol treatment Lipitor, the best-selling medicine with annual sales of $12 billion. But its labs have only produced one multibillion-dollar blockbuster, the pain medicine Lyrica, in a decade. Chantix, an anti-smoking pill, has been hampered by worries it causes suicidal thoughts; another research success, the cancer pill Sutent, hasn't passed the $1 billion mark yet.

Novartis' Tekturna is a blood pressure drug, formerly one of the industry's biggest sellers. The company has hoped it would help replace top-seller Diovan when that drug goes generic. But sales in the first nine months of 2008 were only $100 million [NVS’ game plan is to combine Tekturna with Diovan and various other CV meds: #msg-34492678.] Companies also used to get extra sales by coming up with slight improvements on existing drugs before patent expiration. But Johnson & Johnson's Johnson & Johnson anti-psychotic Invega, meant to replace the bestseller Risperdal, has been a big disappointment.

The next big drug to watch when it comes to meeting expectations is prasugrel, from Eli Lilly. It is meant to be a rival for Plavix, a medicine sold by Bristol-Myers Squibb and Sanofi-Aventis that prevents heart attacks by stopping the blood clots that cause them.

Lilly didn't give financial projections for prasugrel, but in 2005 then-Chief Executive Sidney Taurel told analysts at a Sanford C. Bernstein conference, "I will say that basically prasugrel holds the hope of being a superior product to a product which today is north of $4 billion and growing."

But when results came out in late 2007, prasugrel caused more bleeding than optimists had expected. The drug has been stuck in a yearlong regulatory limbo and will be considered by a panel of experts convened by the FDA on Feb. 3. If Lilly can't convince an expert panel that the FDA should approve the drug at a lower dose for people who are at a higher risk of bleeding, or if the panel asks for stern warnings, that could dull the drug's sales potential.

The success of prasugrel, which will be brand-named Effient, is "the wild card everyone will be watching," says Avik S. A. Roy, managing partner at Mymensingh Partners, a hedge fund. He argues that the drug should at least make it past the FDA because "the overall clinical benefit relative to Plavix is there."‹

[DewDiligence]

Drug reps soften sales pitches (WSJ):

http://online.wsj.com/article/SB10001424052970204331304577142763014776148.html

Eli Lilly decided to adopt its new [softer] approach after watching launches of new drugs like Strattera for attention deficit-hyperactivity disorder and the blood thinner Effient stumble, according to Mr. Ricks. One possible problem the company identified was a mismatch between what doctors expected based on sales pitches, and what the products delivered. [LOL. Effient may yet do ok, but Strattera simply doesn’t have much efficacy.]

Now, the company's sales team draws marketing lessons from how Disney keeps families coming to its amusement parks. Lilly's most recent national sales meeting, held at Disney's business training institute in Florida in February, was devoted to customer service, not product training. Sales representatives watched how Animal Kingdom workers greeted families at the gate and answered questions around the attractions [LMAO].

Note that this is an evolving but very old story—scan about halfway down in #msg-8708384t to the section called Is The Sales Model In Pharma Broken?; this was posted more than 6 years ago.

The following graphic may be somewhat out of date, but the basic problem hasn’t changed much: