I see a huge opportunity in the generic space as big pharma battle the "patent cliff". Over the next ten years, it is expected that approximately $100 billion of revenue will be lost to generic substitutions. To mitigate these pending revenue losses, branded pharma companies have implemented price increases over the past five years for popular drugs such as Floxmax, Advair, Nexium and Lipitor - some almost doubling. As a result, consumers & companies offering benefits have been pinched. PBM's (prescription benefit managers) have recently started advising their clients to promote the use of generics by either waiving or reducing the co-pay's to the employee and this trend is really starting to gain traction.
So, how do you cash in on this trend? One could invest in companies that produce generics - the bigger ones being Teva and Mylan. However, Watson Pharmaceuticals (ticker: WPI) has a more compelling story for the reasons discussed below.
Watson is much smaller than Teva & Mylan with roughly 8% of TRx, or total number of drug prescriptions, in the US. So, product approvals and launches can move the EPS needle much more due to its small size. For instance, the major drug launches mentioned in the following paragraph will help Watson propel their revenue size from $2.8B in 2009 to $5.4B by 2012, some analysts believe.
Upcoming Drug Launches
Watson has recently partnered with Johnson & Johnson through 2014 to produce a generic version of Concerta, an ADHD drug, with approx. $1.2B in '09 sales. This drug has no approved ANDA's (abbreviated new drug applications) and J&J has 'no tamper' language on the label, which will block other generic entrants until November 2012. The drug is set to launch in May 2011.
Watson also acquired Arrow, which has the generic rights to Lipitor (Cholesterol), the #1 drug in the United States. '09 sales for Lipitor were $5.4B and the drug is set to launch in November 2011 w/ exclusivity rights shared with another company (Ranbaxy).
In 2012, generic versions of Plavix (Blood Clot Preventative) and Actos (Type II Diabetes) are set to launch with '09 sales of $4.2B and $2.5B, respectively. However, both drugs will have several players launching generics as well.
With these successful generic drugs in the pipeline, this also paves the way for Watson's branded drug business. With branded drugs, gross margins are much higher and product lives are longer.
Watson drugs are weighted toward extended release formula, patches and injectables, which make these drugs harder to replicate. This is crucial since the generic drug industry is highly competitive with low barriers to entry, which can create pricing pressure.
Currently, Watson has very limited international exposure which is both good and bad. On the good side, Watson is not exposed to western Europe price cuts. However, emerging markets offer tremendous growth. The company will likely need to look at future acquisitions or joint ventures to increase their exposure. With the stock trading close to a 52 week high as I write this, its obvious this is not pinning down the stock. So, this could be a huge catalyst in upcoming years if Watson secured a presence in emerging markets such as India/Latin America and developed countries such as Russia.
If we get that much anticipated pullback in the market come January and February, I'd definitely pick up some WPI for the long-term account. There is no doubt the generic drug wave will be huge in the upcoming years - especially with our nation's largest generation moving into retirement age, which will drastically increase the # of scripts written by doctors. Don't get me wrong, the generic drug wave is much anticipated and its obvious this is baked into the stock at 1.9 PEG ratio. However, the Street's valuation does not include the huge opportunity in emerging markets that Watson just hasn't touched yet and thats what makes it much more compelling then Teva and Mylan as a long-term investment.
Stay tuned for more ways to play this boom in generic drugs.
Sources used: Verispan, VONA; Credit Suisse; AARP