Big Pharma Teeters on the Patent Cliff

Good times for Big Pharma are over, folks. The patent cliff has hit, and its impact on profits for the largest drug makers will be felt big-time in the next few years.

Actually, the outlook for Big Pharma has been changing for the worse for quite some time, and I'll be getting into how and why in subsequent columns. But I just want to explain a major reason why the largest pharmaceutical companies will be crying the blues this year.

Patents for drugs last only 20 years. After that, anyone -- or, in this country, anyone the US Food and Drug Administration allows -- can manufacture and market generic forms of these drugs. That means that the high-end blockbuster drugs will face lots and lots of competition from copycat versions that will sell for a fraction of the cost of the originals.

Seroquel, the antipsychotic from AstraZeneca (NYSE: AZN), and Plavix, the anticoagulant from Bristol-Myers Squibb (NYSE: BMY) and partner Sanofi-Aventis (NYSE: SNY), are just two of the majors that are falling off patent -- going off the cliff -- this year. Other significant patents have already expired. Late last year, Eli Lilly & Co. (NYSE: LLY) lost patent exclusivity for antipsychotic drug Zyprexa, and Pfizer (NYSE: PFE) lost the best-selling drug of all time, Lipitor, its cholesterol-lowering statin.

Analysts say that by 2015, the total of losses in the industry that are attributable to the patent cliff could exceed $150 billion. While this is bad news for big drug makers, the patent cliff threat has been anticipated and, analysts note, priced into the stocks for some time. The question, now, is how these companies will reposition themselves for long-term growth. There are recurring rumors about spin-offs, break-ups, and sales of non-strategic divisions.

Of course, not everyone suffers when a drug manufacturer loses a patent. The biggest beneficiaries are managed care companies, pharmacy benefit managers like Express Scripts (Nasdaq: ESRX), and the company it just acquired, Medco Health Solutions, and patients.

A recent report from IMS Health, commissioned by the Generic Pharmaceutical Association, notes that last year, the average co-payment for a generic was $6.06, compared to $23.65 and $34.77 for preferred and non-preferred brand drugs.

The report estimates that generic drugs saved payers and consumers about $157 billion in 2010, and with more and more blockbusters about to lose their patents, that figure will keep rising. There are some caveats, though. Often, a consumer of a drug will choose the original version, even though a generic has become available simply because he or she prefers the name brand or because the generic, though nearly identical, has slightly different pharmacokinetics that physically affect the patient's tolerance.

So, expect managed care companies to drive the use of generics through formulary controls that restrict the use of higher priced, specialty drugs. By making it increasingly expensive for patients to obtain branded medication, they encourage the use of more widely available -- and cheaper -- generics.

Companies like ExpressScripts, which manage pharmacy benefits for employers, governments, unions, and health plans, also prefer distributing generic drugs because they make much higher margins on them than they do with brand-name medications.

Right now, most prescription drugs on the market are generics -- analysts estimate 70% to 80%, and that proportion stands to increase steadily over the next few years.

The contraction in pharma has been evident for the past few years now, as Big Pharmas have been laying off employees by the thousands. The sector most affected, by far, has been pharmaceutical sales reps. The patent cliff is going to hurt them even more in the future.

But for smaller specialty pharmaceutical companies that manufacture generics, the patent cliff will provide opportunities for growth. Even as large pharmas struggle to find new ways increase revenue and cut expenditures, generic manufacturers will benefit from not only the ability to manufacturer more drugs but from an aging population with greater likelihood to take them.