Big Challenges For Pharma

Back in 2000, I was really, really excited.

Had I got a date with Kylie Minogue? No. Had West Ham won the Champions League? Not likely. I was excited because I thought I had discovered the best investment sector in the market -- life sciences.

How could I lose? The potential of new technologies such as genomics and monoclonal antibodies appeared to be huge. On top of that, I knew that most people in the developed world were living longer and becoming richer too. Buying shares in drugs companies was close to a sure thing!

As time went on, I began to dig deeper. My then employer sent me to several conferences for the pharma and biotech industries, and I realised that pharma companies faced several big challenges in the 21st century. What's more, they were finding it tough to find solutions to those problems.

So when I went to another event last week -- The Economist Pharmaceuticals Conference -- I was keen to see if things had changed. Sadly, I reckon the overall picture for the industry has, if anything, worsened.

So what are the challenges?

Patent expiries

This has been a big problem for the drugs companies in recent years. AstraZeneca (LSE: AZN), for example, had to work very hard to keep its sales moving after the patents protecting its blockbuster ulcer drug, Losec, expired in 2001.

2006 will be no different. Indeed, IMS Health says that drugs with annual sales of $23bn (£13.2bn) will lose US patent protection this year. That's the largest figure for a single year so far.

And once the patents expire, generic drug companies quickly launch low-cost copies, and sales of the original branded drug fall rapidly. For example, sales of Pfizer's (NYSE: PFE) epilepsy drug, Neurontin, dropped from $2.7bn in 2004 to $639m in 2005.

Productivity

Of course, the solution to the patent expiry problem is to develop new drugs. But the pharmaceutical industry isn't finding that easy. In 1994 the worldwide industry spent around $30bn on research and development (R&D) and launched 40 NMEs (new molecular entities). By 2004, the R&D spend had more than doubled to over $60bn but the number of NME launches had almost halved.

Personalised Medicine

One area where researchers are having some success is personalised medicine. This is where drugs are developed that won't treat everyone with a particular condition, but will successfully treat some sufferers. Sophisticated diagnostic products enable doctors to know in advance whether a treatment will work on a particular patient.

This means expensive drugs need only be prescribed to people who will gain some benefit from that drug. Breast cancer drug, Herceptin, is an early example of such a product.

Clearly, personalised medicine is good for society, but it's not necessarily in the interests of big pharma. It's harder to create a blockbuster drug if you can only sell it to 30% of people suffering from a particular illness.

Pricing

This is perhaps the biggest problem of all. Governments in Europe are perpetually cutting back on the prices they're willing to pay for new drugs. The US has been a much more attractive market for the industry as there have been no price controls. However, the recent addition of prescription drugs to the US government's Medicare plan -- it provides healthcare for retired Americans -- could be a long-term problem.

True, prescription drugs on Medicare have provided a short-term boost to pharma sales as more drugs have been prescribed. In time, however, even the bastion of the free market may decide that taxpayers can't pay ever higher prices for drugs.

It's not all bad

Don't get me wrong. I'm not saying you should never invest in pharmaceutical companies. I just think you should be aware of the challenges I've outlined and ask yourself whether current valuations reflect these issues.

In a follow-up piece next week, I'll look at GlaxoSmithKline (LSE: GSK), and see how it's coping with the 21st century challenges. I'll also look at whether it's fairly valued right now.

Originally published on http://www.fool.co.uk