Morningstar Advisor - August/September 2010 - 30

Spotlight

Reform’s Impact on Other Health-Care Industries
Managed Care While a significant amount of uncertainty still exists for managed-care organizations, health-care reform’s insurance mandate will likely bring a large group of new customers. These new customers help offset the higher fees and costs that the government is forcing on health insurers. Further, we believe that the large and diversified managed-care organizations, such as UnitedHealth Group UNH and WellPoint WLP, offer strong upside—investors are focusing more on the negative implications of reform rather than the complete outlook for managed-care organizations. Medical Devices We believe that medical-device firms are in a position to pass on some of the higher taxes and fees associated with health-care reform to payers. Hospitals, however, are under increasing pricing pressure, and they will be targeting device companies for price concessions. Therefore, the increased volume that reform will likely bring may not offset the medical-device industry’s increased costs. Medical Instruments The large group of new patients demanding health care should increase the demand for medical instruments. Because medical-instrument companies face only minor cost increases under the new regulations, we expect that the group will largely benefit from increased use of the health-care system. Biotechnology Similar to our analysis of the pharmaceutical industry, we expect health-care reform to have a neutral impact on biotech companies. Increased industry fees will likely be offset by higher demand for biologic drugs. However, the magnitude of the fee increase and offsetting biologic demand is smaller than it is for the pharmaceutical industry. Regarding generic biologics, the 12-year exclusivity period was a major industry win and should help keep generic biologics at bay for a long time. Services Like the diagnostics labs, most companies in the services industry should feel a significant tailwind, because demand for health-care increases as the amount of insured patients increases. Also, most services firms face only minor increases in fees and costs under the new regulations.

very significant products. According to pharmaceutical consultant Syamala Ariyanchira, 12 out of 19 leading orphan drugs had just one approval for a niche disease but became blockbusters by expanding their labels or increasing off-label use.
The Orphan-Drug Leaders

As a group, biotech firms own the most orphan-drug designations. But big-pharma firms own three of the top four spots: Novartis, Glaxo, and Pfizer. These firms are leading the way into the development of orphan drugs.

Firms That Hold the Most Orphan-Drug Designations, 1983–2009
1 2 3 4 5 6 7 8 9 Roche RHHBY Pfizer PFE GlaxoSmithKline GSK Novartis NVS Amgen AMGN Merck MRK Johnson & Johnson JNJ AstraZeneca AZN Genzyme GENZ 50 48 46 44 30 29 28 25 23 22

10 Bristol-Myers BMY
Source: Food and Drug Administration, Morningstar.

much more favorable pricing for mainstream drugs. Government payers are also demanding better drug prices to reduce health-care budgets. But in this hostile environment for prices, the price tags for orphan drugs have remained high. Unlike the treatment options for more-common diseases, orphandisease therapies often have no viable alternatives, making demand very inelastic. And orphan drugs typically treat life-threatening or debilitating diseases, where the value of treatment is very high. Another reason why orphan drugs can earn big profits is that effective drugs can expand a patient base just by treating the disease. If

no treatment options exist to pull patients and physicians forward, diseases can appear to be more rare than they are. As new treatments emerge, reported incidence rates can increase. For example, when Novartis introduced its cancer drug Gleevec, it targeted 50,000 patients with chronic myelogenous leukemia. Largely based on the success of Gleevec to treat the disease, the number of patients using the drug has grown to 120,000. Launching an orphan drug for a rare disease also can lead to treatments of related but more widespread diseases as the drug gains legitimacy. This “label expansion” opens the door for orphan drugs to develop into

Novartis is well ahead of the curve in turning orphan-drug designations into approved, profitable drugs. Several of the company’s most important drugs were launched with orphan status, including Zometa, Gleevec, Sandostatin, and Exjade. Each of these drugs became a blockbuster after starting out with a small patient base, but strong pricing power and high efficacy boosted their market potential. The drugs now represent more than 16% of Novartis’ total sales. Novartis is also developing franchises around its orphan therapeutic areas. Because of its work with chronic myelogenous leukemia and Gleevec, the firm’s understanding of the science behind the disease led to the

30 Morningstar Advisor August/September 2010

Morningstar Advisor - August/September 2010

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