The concern with AbbVie’s blockbuster biologic Humira is the lost of patent exclusivity in the U.S. and Europe over the next two years.
The worry is revenue from Humira will drop off a cliff as generic drugs enter the market.
This would be a logical worry if Humira was a small molecule drug. A generic small molecule drug simply has to prove it is the same chemical formula as the branded drug. No new safety and efficacy trials needed.
Humira is a biologic, a large molecule, that is synthesized from living cells. The process to synthesize and isolate the biologic is the drug. A small change in the process can yield vastly different results.
A biosimilar is a company’s effort to reverse engineer the original process to create their own biologic. The new biologic should be similar to the original.
Because it is a new and different process, the biosimilar has to undergo safety and efficacy trials. This drives the cost up to produce the biosimilar.
Recent biosimilars are coming to market at 15-25% discounts to the original because of the extra costs. Unlike generic small molecule drugs that are 50, 60, 70% cheaper than the branded drug.
Biologics have some switching costs built into them.
If you are taking a biologic and your illness is under control with little or manageable side effects would you switch to a biosimilar? Knowing that it may work less effectively or not at all? And your side effects could increase to save 15-20%?
If you’re a doctor and your patient is responding well to the branded biologic will you suggest switching to the biosimilar? Knowing that it isn’t the exact same drug and it may not treat your patient as effectively or may increase the adverse side effects?
The Real Threat
The real threat is a new patient trying the cheaper biosimilar first and responding favorably to it. Then there is no reason to switch over to the more expensive original biologic.
There is a common misconception with AbbVie (ABBV) in regards to its blockbuster drug Humira. Sure Dividend outlines this misconception below.
That’s where the risk with AbbVClie comes in.
The company’s composition-of-matter patent for Humira expires at the end of 2016 in the United States. It expires in 2018 in Europe.
When these patents expire, Humira will lose its competitive advantage. Amgen (AMGN) has already submitted a biosimilar version AbbVie to the FDA (they did so in November of 2015). It is likely that other pharmaceutical companies will follow.
It’s difficult to know exactly how far revenue and profit will slide for Humira once it experiences competition.
The image below shows the effects of generic drug competition on Claritin to give an idea of what happens when a drug loses market exclusivity:
Humira is going off patent and will experience a dramatic drop-off in sales once generic drugs get the green light just like Claritin did. For AbbVie it could be even worse because so much of its current revenue and profits come from Humira.
And it would be very scary if not for the fact that Claritin and Humira are two drastically different drug compounds.
Small Molecule Drugs
Claritin is a small chemically synthesized drug whose structure is well defined. When a small molecule drug loses its patent a generic drug maker only has to prove that their generic drug is the same drug structurally. The generic drug maker does not have to run new efficacy and safety trials. For good reason, the generic and the branded drug are exactly the same.
Making generic small molecule drugs is relatively cheap. This is why generic drug makers can charge such low prices in relation to the branded drug and take market share away.
Large Molecule Biologics
Humira is a biologic. It is a very large molecule that is made through the use of microorganisms. The entire process of making a biologic, from creating the genetically engineered cells to the isolation of the finished product, is the drug. A change in any step can produce a different molecule.
Because different biologic making processes can produce different drugs, any company that wants to make a generic biologic, a biosimilar, has to undergo new efficacy and safety trials for its drug. Bringing a biosimilar to market is about the same as bringing a new branded drug to market. It is costly. A biosimilar’s discount to the branded drug is not as great as a generic small molecule’s discount is to its branded drug. Novartis’ Neupogen biosimilar sells at a 15% discount.
Higher Legal Hurdles
The legal hurdle for bringing biosimilar’s to market will be high too. As Amgen just found out with U.S. patent officials refusing to review two of their Humira patent challenges. The patent challenge mentioned by Sure Dividend above. Amgen was thought to be the first company able to bring a Humira biosimilar to market. That timetable has been pushed back.
Biologics are a little more protected than chemical small molecule drugs to generic competition. It doesn’t mean biosimilars can’t come to market and compete with Humira. However, if biosimilars only offer a 15% discount it will be tough to take significant market share away from the branded drug. If Humira is working well for a patient with little side effects then it will be hard for the prescribing doctor to switch from a medication that works to an unproven biosimilar.
Current portfolio holding AbbVie (ABBV) is taking a hit today after announcing a $21 billion cash and stock deal to buy Pharmacyclics (PCYC). The sell-off is due in part to the terms of the deal. The shares being issued in the deal could potentially dilute current shareholders by 10%. The other reason is the high price AbbVie is paying for Pharmacyclics.
Pharmcyclics main drug is Imbruvica for leukemia. It received a fast track approval because of what it does for leukemia patients that have relapsed.
Imbruvica inhibits Bruton’s Tyrosine Kinase (BTK). BTK plays a big role in the cellular signaling pathway to prevent a cell from undergoing a self inflicted cellular death called apoptosis.
One of the defenses that a human body has against cancerous cells are the signaling pathways to cause an abnormally growing cell to self destruct. Cancerous cells express high levels of BTK that prevent these signals. Leukemia is cancerous B-Cells. Current leukemia treatments are pretty effective but patients who relapse have cancerous B-Cells that are extremely resistance to current radiation therapies. Relapsed patients desperately need the self destruct signaling pathways in the cancerous B-Cells turned back on.
Imbruvica inhibits BTK turning back on the self destruct signaling pathways. This is why Imbruvica is on its way to blockbuster status. So good for AbbVie, right?
Johnson & Johnson (JNJ) co-markets the drug with Pharmacyclics and J&J receives 50% of the revenue from Imbruvica. AbbVie paid $21 billion for half a drug.
It doesn’t reflect well on mamangement to get caught in a bidding war right after walking away from the Shire Plc deal because it would be too costly. It very well could’ve been an act of desperation and we have to ask ourselves will management be good stewards of our capital going forward?
This is from the AMM Dividend Letter released February 28, 2014. If you want to see the latest “Dividend Stock in Focus” as soon as it’s released then join our mailing listhere.
You’ve probably never heard the story of Grace Groner but it’s an important one.
Grace lived in Michigan, worked as a secretary, wore secondhand clothes, never owned a car, and lived in a modest one bedroom house. Upon her death, this woman of modest means left Lake Forest College an estate of over $7 million to establish internships and study abroad programs. The donation is expected to generate over $300,000 a year for the college.
How was a woman of such modest means able to give away over $7 million upon her death?
After graduating from Lake Forest College in 1931, Grace started working for Abbott Labs (ABT) as a secretary. She worked at Abbott Labs for 43 years. The key to her wealth was a simple decision she made early in her career. At age 26 she took her savings, about $180, and bought 3 shares of Abbott Labs at $60 per share and then never sold.
Along its way to becoming a global pharmaceutical/medical device behemoth Abbott split its shares a dozen times, paid dividends, and grew its dividend year-in and year-out. Living below her means Grace didn’t have a need for the dividends, instead she reinvested them. Her initial $180 investment compounded into $7 million, 39,000 times her original investment, a compound annual growth rate slightly over 15%.
Yes, Grace was very fortunate in making an early investment in one of the great health-care and dividend growth companies of the 20th century. While Grace’s wealth may be considered a happy accident her investment strategy, dividend growth and reinvestment, is a proven way to build wealth over a long period of time.
According to Longrundata.com, a nifty website with a dividend reinvestment calculator, if you had bought $1,000 worth of Abbott Labs 20 years ago (January 1, 1994), well after Grace Groner’s initial purchase, you would now have $10,667 as of February 27, 2014. That’s over 10x you’re original investment and an annualized return of 12.46%. Because of Abbott Labs commitment to growing its dividend, the yield on your original purchase would now be around 24%.
Spending less than you earn, investing in dividend growth companies, and reinvesting those dividends is a tried and true path to building wealth over the long-term. Just like Grace Groner.
Your Portfolio Management Team
Dividend Stock in Focus
AbbVie (ABBV): $50.91*
*price as of the close February 28, 2014
In late 2012 Abbott Labs, in an effort for investors to better evaluate its two distinct business lines, spun-off its biopharmaceutical division, Abbvie, to existing shareholders in a tax-free corporate restructuring. Abbvie is an example of a “Restructuring/Special Situation” (as described in the last letter) that we feel has an opportunity to eventually become a dividend stalwart.
Following the spinoff, shares of ABBV declined in to the low $30 range on fears of Abbvie’s largest drug Humira losing its patent in 2017. Our opinion at this time was that these fears were overblown and that the market was mis-pricing the risk of the patent loss. The essence of this mis-pricing is related to the difference between a chemically synthesized drug (which is easier for generic manufacturers to develop and bring to market) vs. a biologic like Humira which is more complicated and costly to develop in generic form. More on this below.
Our initial time frame for an investment in a spin-off is at least one year. This allows us time to evaluate the new stand alone business as it pertains to management, strategy execution, and dividend policy. Additionally, research has shown that corporate spin-offs in general continue to outperform the broader stock market for 2-3 years following the spin-off. During our initial holding period if our outlook for the new stand alone company improves and our valuation estimate continues to increase we may continue to buy shares in the new company.
The strong growth and cash flow from Humira, the continued development of their drug pipeline, and management’s commitment to returning capital to shareholders through dividends has increased our estimate of fair value for the company and changed our holding period from one year to multiple years.
Catalysts for Dividend Growth and Price Appreciation:
Biologic vs. Chemical Compound:
Abbvie’s near term fortunes are heavily dependent on the blockbuster drug Humira. Over 50% of Abbvie’s sales and over 70% of their profits come from Humira. The main concern surrounding Abbvie is the loss of Humira’s patent in 2017 in the U.S. followed by the loss of its European patent in 2018. Once “off patent” there is a risk that generic drug makers will start selling their own form of Humira for much less than Abbvie, stealing market share and hurting Abbvie’s profitability. As discussed above, however, the fact that Humira is a biologic rather than a chemically synthesized drug provides a layer of protection or “moat” to help protect it from would be generic competition.
Chemically synthesized drugs are produced through a combination of chemical processes that can be repeated in a predictable and highly dependable way. Well known examples of these kinds of drugs include Tylenol, Lipitor and Viagra.
When a chemically synthesized drug goes off patent it is easier for a generic drug maker to get FDA approval for its version. The generic drug maker does not have to put its generic drug through clinical trials, it only has to prove that their drug is equivalent to the name brand drug and therefore will produce the same data as when the name brand drug went through its trials.
Unlike these drugs, biologics are proteins currently too large and complex to be created chemically. Instead, scientists enroll the help of microorganisms (plant or animal cells) by splicing the necessary DNA sequence coding the protein/biologic into the microorganisms’ DNA. Then the microorganisms produce the targeted biologic.
In contrast to chemically synthesized drugs it is difficult, and sometimes impossible, to characterize a complex biologic by testing methods available in the laboratory. Some of the components of a finished biologic may even be unknown.
In short, for biologics the product is the process. Manufacturers must ensure product consistency, quality, and purity by ensuring that the manufacturing process remains substantially the same over time. In contrast, a chemical drug manufacturer can change the manufacturing process extensively and analyze the finished product to establish that it is the same as before the manufacturing change.
The trouble with creating generic or “follow-on” biologics is that any deviation from the process in producing the original pioneering biologic, whether it be different cell lines, purification techniques, etc., can cause vast differences between the original biologic and the follow-on biologic. This can have dangerous consequences.
For example, Epogen and Eprex are both proteins of identical structure, Epotein, focused on treating anemia due to Kidney failure. However, they are each produced by two slightly different methods. The slight difference in productions leads to a dangerous reaction in patients taking Eprex. Patients taking Eprex began producing antibodies at a much higher rate than patients taking Epogen. Eprex patients experienced an allergic reaction to Epotein so severe that they also became allergic to the Epotein produced naturally by their own body. Instead of improving medically, Eprex patients became more ill.
As discussed above in the case of Epogen and Eprex, the potential differences between the original biologic and the follow-on biologic means the follow-on must undergo testing for efficacy and safety too. Per new regulations, the potential follow-on biologic must have animal toxicity tests performed and possibly animal immunogenicity tests if there are elevated concerns about impurities and excipients.
It is more than likely that follow-on biologics will be required to undergo clinical studies. The scope of these clinical trials will depend upon the uncertainty surrounding the biosimilarity after structural and functional characterization and animal studies.
More tests mean more time and more costs to develop a generic biologic. Humira is way too profitable a drug to not have potential competition but the complexity of production and the costs associated with bringing a generic competitor to market make it that much harder for generic drug makers to immediately cut into Abbvie’s Humira profits.
Hepatitis C: Abbvie has an extremely effective HCV combo being developed to treat Hepatitis C. The SVR12 rates (the undetectable amounts of virus RNA at 12 weeks after stopping treatment) in the early phase III trials are around 96%. While they will face strong competition from both Merck and Gilead, Abbvie is still looking to grab $2-3 billion in peak sales in the very attractive HCV market.
Leukemia: Abbvie is in partnership with Roche to develop ABT-199, a treatment for Chronic Lymphocytic Leukemia (CLL), one of the most common forms of Leukemia. It targets the Bcl-2 protein that prevents the CLL cell from dying. ABT-199 switches off the Bcl-2 protein allowing CLL cells to die naturally and making them more susceptible to chemotherapy.
In a recent Australian clinical trial people with an extremely poor prognosis achieved an 84% response rate and the bone marrow cancer was cleared in 23% of the people. From Anthony Steele the Head of Support Services for the Leukemia Foundation of Australia.
This drug means people with an incurable cancer, who undergo many periods of intensive treatment, periods of remission and with an expectation that the disease will relapse, now have hope that a treatment will be made available to end this life-long cycle.
Endometriosis: Elagolix is focused on the treatment of endometriosis and is currently in phase III trials. Compared to the standard care for endometriosis, Elagolix is as effective with less side effects, goes into effect quicker, and easily reversed. Ovulation returns after the first month of cessation, a key aspect for women who want to get pregnant. It is also a once day oral tablet versus an injection for the current methods. Elagolix is also in phase II trials for uterine fibroids, an indication that could be larger than endometriosis. JP Morgan Equity Research potentially sees a $1 billion combined market for Elagolix.
Abbvie is a company whose story is still lead by Humira but the narrative is turning into one about its pipeline. However, when calculating fair value we can’t base it on potential. We have to calculate fair value on what we can currently account for. Our estimate of fair value has risen over the year and currently sits at $58 per share.
The opinions expressed in “The AMM Dividend Letter” are those of Gabriel Wisdom, Michael Moore and Glenn Busch and do not necessarily reflect the opinions of American Money Management, LLC (AMM), an SEC registered investment advisor who serves as a portfolio manager to private accounts as well as to mutual funds. Clients of AMM, Mr. Wisdom, Mr. Moore, Mr. Busch, employees of AMM, and mutual funds AMM manages may buy or sell investments mentioned without prior notice. This newsletter should not be considered investment advice and is for educational purposes only. The opinions expressed do not constitute a recommendation to buy or sell securities. Investing involves risks, and you should consult your own investment advisor, attorney, or accountant before investing in anything. Current stock quotes are obtained at http://finance.yahoo.com. Prices are as of the close of the market on the date for which the price is referenced.