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