PHARMA: What the Zubillaga affair may suggest, by The Industry Veteran

We haven’t spent much time over here talking about the “buckets of cash” scandal that’s been keeping the pharma-focused bloggers very busy, and even less comment on the apparently expensive and rather bizarre purchase of MedImmune. Both concerning AstraZeneca. But The Industry Veteran has been wondering around on the grassy knoll and has come up with a very interesting explanation that links the two:

I spent a good part of the past two weeks in the unaccustomed position of defending AstraZeneca. Equity analysts and others in the pharmaceutical industry seemed astonished by the high price the company paid (a 52 P/E ratio) to acquire MedImmune. Their basic criticism amounts to a complaint that AZ acquired neither an auspicious, late-stage pipeline or a significant cash flow. Both observations are correct but AZ gained other benefits for this steep price.

What AZ bought was a place for themselves in two businesses when they acquired MedImmune. Companies typically have to overpay when they want to get into a new game. Ten years ago Abbott paid 40 times earnings when they bought MediSense to get into the blood glucose monitoring business. More recently Novartis paid through the nose to belly up to the vaccine business bar. A few weeks ago Schering-Plough overpaid to buy Organon but Fred Hassan gained stronger positions for himself in the women’s health and the dermatology businesses. Given the current trough in Pharma’s new product development, it’s simply a fact of life that anyone seeking to consummate a merger or acquisition must be prepared to overpay. Fifteen billion dollars for MedImmune is certainly no more outrageous than paying a 42-year old pitcher $15 million for half a season.

AZ placed a toe in the water of the vaccine business, something that does not resemble Pharma’s traditional goldmine because a high proportion of vaccine customers are public agencies. Nevertheless, the vaccine business is poised to grow, and if it receives a boost from a pandemic flu epidemic, it will grow enormously. It will also grow substantially if someone makes good on the effort to develop an oncology vaccine or immunizations for the many viral infections that threaten the length and quality of life.

In buying MedImmune AZ also acquired capabilities for entering the biologicals business. At this point the multi-billion dollar products of companies such as Amgen and Genentech do not face the precipitous revenue losses that occur when Pharma companies lose patent protection on their products. This is because most regulatory agencies have not developed guidelines for determining acceptable thresholds to approve generic versions of biological products. Congressional waterboys for the biotechs, such as Sen. Ted Kennedy, want makers of generic biologicals to conduct the same sort of clinical trials for their products as the original developers of the branded biologicals. Faced with such high development costs, the generic model of low cost equivalents becomes unsustainable. Nevertheless, despite the disingenuous concerns of Sen. Kennedy and others, Congressmen wise to Pharma such as Henry Waxman and Bernie Sanders will eventually succeed in creating some form of "bio similar" legislation. The country can only tolerate so many stories about people who died because they were unable to make even the co-payments on biological medications costing between $40,000 and $200,000 per year. At that point there will be a major demand for an entire industry of generic biologicals.

During the two weeks I was defending AstraZeneca’s purchase, CEO David Brennan and John Patterson, the VP for Clinical Development, did their best to undermine my claims about their wise purchase.

First Brennan hinted to UK media that he might sell the vaccine component of MedImmune. This apparently contradicted the explanation he made to his board of directors to gain their approval for the purchase, so he quickly denied the "rumor" a day after letting it thud to the ground. Then Patterson took a stab at calming concerns over the high purchase price by touting the prospects of MedImmune’s late-stage pipeline. His public comments favorably impressed recent arrivals from planet Mars, but few others.

While I was imputing more wisdom to AZ’s managers than they apparently possess, they were also mishandling a matter that made me question even their mundane, day-to-day competence, let alone their strategic thinking. For those THCB readers who have not been reading Ed Silverman and Peter Rost, AZ was confronted with a situation in which one of its regional sales managers in oncology made a tactless statement to an in-house newsletter for AZ reps. According to this buffoon, sales reps should act as if the offices of oncologists contain "buckets of cash" of which they might figuratively avail themselves by making their assigned calls. This disclosure was followed in rapid succession by revelations from several AZ reps, together with supporting documentation, that the poorly phrased exhortation to reps was part of a larger effort in which sales managers were training their charges to promote products outside of their approved indications, a direct violation of guidelines from the Office of the Inspector General in the Health and Human Services Department.

After reflecting on the situation for a few days, I now think this "buckets of cash" matter is not a case of mid-level, operational mismanagement. First of all, several companies besides AstraZeneca are under scrutiny for promoting their respective products off-label, i.e., for unapproved uses. Eli Lilly is alleged to have done it for several years with Zyprexa while within the past week, a Pfizer rep sent a letter to Peter Rost in which her company was encouraging reps to "pre-market" their not-yet-approved HIV drug, maraviroc. At first glance, off-label promotion that is either in the gray zone or a flagrant violation may seem merely the usual effort to flog more sales from available products. In a regulated industry that prohibits marketers from telling customers that use of an antihypertensive will make them sexually attractive, wealthy or intimidating to adversaries, it is usual for competitors to push that envelope. I now believe that such misdirection serves a larger, more strategic purpose.

Robert Langreth notes in an upcoming issue of Forbes that Novartis is making a focused effort to develop orphan drugs, those intended to treat rare conditions. Big Pharma had traditionally disdained such pursuits because they constitute an extreme dis-economy of scale. Novartis, however, received a pleasant surprise from its oncology drug Gleevec, originally approved in April 2003. At that time it was approved strictly to treat adults with Philadelphia chromosome positive chronic myelogenous leukemia and Kit positive, inoperable gastrointestinal stromal tumors. From this inauspicious beginning, Novartis subsequently gained successive approvals for Gleevec that vaulted it into the billion dollar, annual sales league. Although Langreth’s article did not make the claim, it led me to suspect Pharma is seeking to "oncologize" other therapeutic categories.

The oncology business within pharmaceuticals has long operated in an altogether different manner than other classes such as cardiovasculars, respiratory or metabolic. Based on the fact that most diagnoses in oncology reflect a condition that is "third down and long yardage," formally unapproved usage is warranted. For this reason an appreciable percentage of sales come from using products off-label. Oncologists have good reason to suspect that if a medication works effectively against one type of malignancy, it may possibly do so in others. So for example, at one time 80% of sales for Taxol, the leading breast cancer medication of the ‘90s, came off-label because the product’s sole indication was for the far less common condition of ovarian cancer.

For pharmaceutical companies the advantages of the orphan/oncology model are manifold. To start with, the small markets for orphan conditions offer minimal incentives to develop products and this allows those companies who do secure approvals to charge exorbitant prices. Genzyme makes Cerezyme for Gaucher disease and Fabrazyme for Fabry disease and it charges over $200,000 per year for each, a simple case of making more money by selling fewer units. Secondly, the orphan/oncology model offers the prospect of bringing products to market more quickly and at lower cost. Instead of conducting clinical trials on thousands of patients at an average Phase III cost of $25,000 per patient, regulatory agencies can grant approval to products that treat rare conditions after sponsors complete studies on a couple of dozen people. The key to expanding a product from an approval for treating 1,000 patients a year into a product that treats a million lies in off-label usage. If the off-label usage that occurs in oncology as a matter of necessity suggests usefulness in a new area, the company can slowly decide when it becomes cost-beneficial to seek a formal indication in that area, even as sales continue to expand.

The oncology specialty controls this process rather carefully with institutional tumor committees, protocols and data-driven reviews. Cheerleader reps in short skirts and ex-jock louts who offer ski trips play a relatively smaller role when the stakes are life and death. It remains entirely possible that at least some industry strategists believe they can burrow their way out of the current R&D doldrums by applying the oncology model to other therapeutic categories. Off-label usage remains key to this. In oncology, however, off-label uses often occur as part of publication studies or "compendium indications" that are conducted with some formal rigor. In the primary care categories, by contrast, "blatantly unapproved misuse" appears as the more fitting description of what’s likely to happen.