Ushering in a new era for the drug industry

April 2015

The drug industry ushered in a new era this past March with the first US approval of a biosimilar. While long discussed as a threat, most within the industry were dismissive until the eve of this approval. Now, with the precedent set, biosimilars present a risk to existing franchises, but also present an opportunity for companies seeking to manufacture biosimilars.

Biologics are hard to copy
Biologics are protein-based drugs that are manufactured inside living cells and delivered via injection or intravenous infusion. This is in contrast to chemical-based “small-molecule” drugs that most commonly show up in pill form. Other than the complexity of manufacturing a drug in a living cell, biologics also carry the distinction of being incredibly large molecules. For instance, the best-selling small molecule drug in the world has a molecular weight of 1,209 daltons, whereas the best-selling large molecule drug in the world has a molecular weight of 148,000 daltons. This 100-fold difference in size is just one reason that biologics are difficult to copy. Other reasons relate to the difficulty of matching the three-dimensional structure, purification and verification of similarity.

Biosimilars could be big business
When easily copied small-molecule drugs enter the market as generics, they tend to quickly erode the brand name’s revenue by 90% or more by competing on price. The difficulty in copying biologic drugs, however, has led investors to conclude that such an erosion would not occur with biosimilars.  This dynamic has historically led to biologic companies receiving a premium valuation because, unlike their small-molecule brethren, they had been thought to lack a “patent-cliff.” Further, before the Affordable Care Act was signed into law, there was no formal mechanism for the FDA to approve copies of biologic drugs.

Exhibit 1: Estimated global biosimilar revenues 
MSCI Emerging Markets Index relative to MSCI Frontier Markets Index January 2006 – February 2014
Source: Citi Research

The first US “biosimilars”
The Affordable Care Act established a path for the FDA to review and approve generic biologics. While not as explicit as it could be, it nonetheless established a route to market. The industry has come to call generic biologics “biosimilars,” because despite all the fancy technology housed in the drug industry, the capability to definitively copy such large molecules is still lacking. As a result, the hoops that must be jumped through by biosimilar manufacturers are greater in number than for small-molecule generics. Despite these extra hoops, the industry is now clamoring to understand how it will affect sales.

Europe provides roadmap, perhaps
Biosimilars have been available in Europe for many years. The penetration rate there may give clues as to how the US biosimilar market will play out. Within Europe, the penetration rate by country is highly variable, with some countries like Greece, Austria and Romania showing high biosimilar penetration rates. Other countries, like Sweden, Italy and Belgium, however, have been more reticent to adopt biosimilars. The reasoning for such disparate adoption is variable, however the key concerns of physicians around the world are whether biosimilars will be as safe and effective as their brand name counterparts. The experience in Europe has shown that their safety and efficacy can differ.

Exhibit 2: Biosimilar market share within Europe by countryBiosimilar market share within Europe by country
Source: Citi Research, IMS Health Incorporated and National Prescription Audit

Time will tell
While the regulatory process in the US should give physicians additional comfort over their European peers, there will be lingering questions that will only be answered with time.  Investors have long dismissed the future impact of biosimilars, but the tide is shifting.  We think that the pure-play biosimilar manufacturers are in the early innings of establishing themselves as real businesses, and as they do we anticipate a meaningful opportunity for astute investors.