Two sides of the story: "Big Pharma"In a monthly correspondence, Caspar Snijders and Ruud Hadders - each from their own perspective - highlight a topical issue.
Responsible Investment Officer
Recently, there was some commotion after research platform Follow The Money announced that pharmaceutical firm Roche had refused to share its formula for a liquid needed for corona tests with the government. Eventually, Roche gave in under immense pressure, but the news led to questions about “Big Pharma”’s role in this crisis. Have we not become too dependent on a limited number of manufacturers and would it be easier to combat the corona virus if we put an end to monopolies?
The reason for monopolies is embedded in the system that also provides the incentive to develop new drugs, i.e. patent law. A patent provides pharmaceutical companies with a 20-year exclusive right to produce and sell the drugs they develop (accompanied by bonuses for managing directors).
Patents cover the financial risk of research investments and accordingly provide an incentive for companies to innovate. One example of this is Humira, a drug to treat rheumatism, the cost of which increased in the space of six years from USD 19,000 to USD 60,000 per annum and thanks to 136 patents will protect the drug from competition until 2034.
"If you put knowledge into the public domain, you shoot yourself and your shareholders in the foot."
At the same time, however, patents pose obstacles to innovation. An analysis of the 122 new drugs that were launched on the market between 1999 and 2005 shows that less than 10 per cent worked demonstrably better than existing drugs. Patents also impede the exchange of know-how between researchers. A well-known example is the accusation against pharmaceutical firm Gilead of having deliberately delayed the development of new HIV medication to generate maximum profits from its patent right to PrEP, the HIV prevention pill. After the patent expired in 2017, PrEP’s price fell by more than 80%. Voluntarily relinquishing a patent right for the common good is therefore a rare occurrence. Under the current system, if you put knowledge into the public domain, you shoot yourself and your shareholders in the foot.
Roche’s initial refusal was therefore to be expected. Nevertheless, the pandemic does seem to be freeing up more information. Several pharmaceutical companies are providing free samples of products to health authorities and making experimental products available. New joint ventures between competing groups have also been set up to develop a vaccine against the virus as soon as possible.
It is however doubtful whether this new openness will continue after this crisis, unless alternative business models are created that eliminate the need for lucrative patents as a source of research funding. The Fair Medicine foundation has provided an example of this. This Dutch initiative is an open joint venture of all stakeholders in the chain freely sharing knowledge and expertise with one another and investing time and money. This may serve as a model for how we can develop better and affordable drugs more swiftly in the future and become less dependent on the good will of large pharmaceutical firms.
Until then, however, patent law will continue to exist and sharing knowledge will remain the exception. And although more information is being shared during the current pandemic, there is also a huge battle going on to be the first company to develop a vaccine against coronavirus. How do you anticipate this battle as an investor? Is it worth betting on a golden goose that develops the vaccine?
Best regards, Ruud
Portfolio Manager Equities
The pharmaceutical industry generates annual sales of more than €1 trillion with a profit margin of between 10 and 42 per cent. “Big Pharma” is however skating on thin ice. Why? Two important stakeholders, i.e. society and shareholders, have seemingly contradictory interests. Society wants affordable drugs while shareholders want a return on invested capital.
Many drugs require huge investments, which in turn means that the price of such drugs must be “ostensibly” high to recoup the investments and generate a profit. This is reflected in the immense amount of capital that is invested in the Research & Development (R&D) arm of the pharmaceutical industry. R&D compared to sales is for example 29% in the pharmaceutical industry. Occupying second place in terms of the R&D to sales ratio is the chip manufacturing industry, at 14%. Patents act as a kind of guarantee whereby pharmaceutical firms recoup their costs. Without them, they have little incentive to develop drugs. If other pharmaceutical firms can immediately copy them, developing them has no added value.
"Patents act as a kind of guarantee whereby pharmaceutical firms recoup their costs."
COVID-19 could be a hypothetical exception to the rule. Social disruption and the impact that this virus is having on the financial markets might coax the usual rivals into creating a united front. Their interests in relation to the current crisis are seemingly the same. The further spread of COVID-19, with its adverse impact on both society and financial markets, must be brought to a stop. Sharing knowledge and collaborating with an accelerated roll-out of a vaccine must be the prime focus. Patents for and profits on a potential vaccine must, for now, take a backseat. Besides, this is an excellent opportunity to smooth over some past reputational damage. The first steps towards this have already been taken by Roche, Johnson & Johnson and Abbvie (among others) who tackling COVID-19. They are relinquishing patent rights, wholly or in part, and looking to collaborate with governments in developing a vaccine.
You asked whether we as investors can anticipate a manufacturer with the golden formula for a vaccine, but the answer is ‘no’. That is well-nigh impossible. Not only would it require advanced knowledge of the virus, one would also need to know where the knowledge and specialists are concentrated and how far they are in developing a vaccine. And even if one had all this information as an investor, it would still be far from clear whether such a drug would in fact be the solution. Added to that, it remains to be seen whether such a firm would be able to derive maximum profits from the drug given the global crisis and the pressure coming from governments.
As for the patents themselves and the stigma that may be associated with them, these in fact serve as one of the most useful cornerstones of a financial analysis of a pharmaceutical firm. The quantity and quality of patents are a sound indication of a firm’s financial health and stability as well as future prospects.
One thing we should, however, take into account as investors is that globalisation will take a hammering in this crisis. More Western countries may well adopt President Trump’s “Our Country First” motto. This crisis has painfully exposed our dependence on China and the surrounding region. We will therefore have to take a fresh look at chain management.
For now, we share a common enemy and fighting the virus will overshadow everything else. Only later will the financial and economic long-term effects become clear.
Best regards, Caspar