CFA - The Pharmaceutical Industry

CFA INSTITUTE
INDUSTRY GUIDES
THE
PHARMACEUTICAL
INDUSTRY
ISBN 978-0-938367-81-9
9 780938 367819
90000
CFA INSTITUTE
INDUSTRY
GUIDES
THE
PHARMACEUTICAL
INDUSTRY
by Marietta Miemietz, CFA
2013 CFA Institute

This publication is designed to provide accurate and authoritative information with regard to the subject matter covered as of the date of publication.
It is distributed with the understanding that the publisher is not engaged in
rendering legal, accounting, or other professional services. If legal advice or
other expert assistance is required, the services of a competent professional
should be sought.
978-0-938367-81-9
October 2013
ABOUT THE AUTHOR

Marietta Miemietz, CFA, is a cofounder of and director of pharmaceutical advisory
services at Primavenue. Previously, she spent 13 years as a sell-side analyst of the
European pharmaceutical and health care industries and was consistently rated
among the top 10 pharmaceutical analysts from 2006. Ms. Miemietz holds an MBA
with a concentration in finance from WHUOtto Beisheim School of Management
and the Belgian Diplme dEtudes Spcialises in biotechnology from Universit
Libre de Bruxelles.
2013 CFA INSTITUTE
iii
CONTENTS
Introduction 1
Industry Overview
The Drug Discovery, Development, and Approval Process
Intellectual Property: Patents, Regulatory Exclusivities, and Other Forms of

Protection 18
Business Models
Industry Consolidation
Notable Trends
22
23
25
Financial Statement Analysis

Forecasting Drug Sales and Company Profits
27
31
Valuation of Pharmaceutical Firms

Portfolio Considerations
39
42
Industry Resources
Regulatory Agencies
Other Resources
Major Medical Conferences
46
46
46
48
2013 CFA INSTITUTE
INTRODUCTION
Among the most distinctive features of the pharmaceutical industry are the complexity and length of the product development cycle and the independence of pharmaceutical companies operating performance from industry trends. The earnings
outlook of individual companies is determined, first and foremost, by the products
they develop and market. Consequently, the industry is characterized by exceptional heterogeneity that notably complicates peer group analyses and often entails
divergent share price performance. These unusual characteristics are attributable to
the fact that the prospects of each player are linked to the prospects of the drugs to
which it has full or partial commercialization rights. Drugs are approved by regulatory agencies for specific indications, and their peak sales potential depends on the
prevalence of the conditions they are intended to treat, their efficacy and safety, and
the competitive landscape. In this context, it is worth noting that the conditions a
medicine is intended to treat are often narrowly defined; for example, a drug that
is licensed for the treatment of colorectal cancer is unlikely to compete with a blood
cancer drug, and even two different blood cancer drugs might be targeted at separate patient populations.
These dynamics have profound implications for pharmaceutical industry analysis
and investing. Top-down analytical approaches based on overall market growth
rates and market share development, often a good starting point in other industries,
add limited value at best and may often be misleading. The quality of bottom-up
analyses that take into account the clinical utility, cost-effectiveness, competitive
landscape, intellectual property, and economics of individual drugs is typically the
main success factor in selecting pharmaceutical and biotechnology stocks.
Following a brief overview of the industry, this primer delineates the determinants
of success in drug development and marketing and then reviews the implications for
financial statement analysis and forecasting, as well as valuation and portfolio considerations. Unless noted otherwise, analysis is confined to branded drugs for human
use, and conclusions may not apply to other areas of health care, such as consumer
and animal health care products or generics. The aim of this report is to provide
a general understanding of the complexity of pharmaceutical industry analysis and
the main issues involved. It is designed to enable the reader to critically appraise
research, corporate presentations, and other communications with respect to drugs,
companies, and the industry. It is by no means exhaustive. Myriad issues may arise
issues that are deeply ingrained in the scientific aspects of a molecule, the clinical
considerations pertaining to a particular disease, regional clinical practice and regulatory legislation, or specific patentsthat must be reviewed on a case-by-case basis.
2013 CFA INSTITUTE
INDUSTRY OVERVIEW
Given that introduction, it should come as no surprise that the pharmaceutical market is large and highly fragmented. In 2012, the global market for human prescription pharmaceuticals was valued at more than $850 billion. The four largest market categoriesthe central nervous system, cancer, metabolic and gastrointestinal
diseases, and cardiovascular disordersaccounted for slightly more than half the
market in terms of value; each of these categories can be subdivided into numerous
conditions that require separate treatment approaches. As depicted in Figure 1, the
largest players hold mere single-digit market shares, and many of them are active
in other segments of the health care market (note that revenues from activities
other than health care are not shown). Successful drug development today requires
a unique skill set that cannot be transferred to other industrial activities. Nonetheless, many of the leading pharmaceutical players are exposed to other areas of
health care for historical reasons and with a view to smoothing out the growth profile and cash generation on the group level as well as exploiting the modest synergies with regard to, for example, target markets, research and development (R&D),
80
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Figure 1. Branded Human Prescription Drugs: Key Players
Pharmaceucals (human branded prescripon drugs excluding vaccines)

Other healthcare
Pharmaceucal market share (RHS)
WWW.CFAINSTITUTE.ORG
Industry Overview
or production. These ancillary health care activities primarily include consumer

health, animal health, generics, diagnostics, and medical technology.
As noted previously, the dynamics of the market for patented prescription drugs
for human use are such that drug-specific attributes are a far more important determinant of success for individual companies than are general industry trends. In
most of the key pharmaceutical markets of the developed world, the majority of
patients are able to obtain the drugs they need; for the most part, their treatment
is paid directly or reimbursed by third parties, although restrictions often apply
(e.g., mandatory generic substitution or requirements to initiate therapy with the
lowest-cost medicines). Consequently, the pharmaceutical industry is among the
least cyclical of industries, but recessions may entail such austerity measures as
drug price cuts, and dwindling consumer confidence may, to some extent, result in
fewer physician office visits by patients or drug holidays (discussed later). Most
innovative drugs enjoy a period of market exclusivitybecause of either patents or
regulatory exclusivitiesthat may span many years, implying that a new molecular
entity will have monopoly status for a certain period. Thus, a pharmaceutical company that is commercializing a highly effective, patent-protected drug in a therapeutic area of high unmet need may be able to generate strong sales growth in the
same year that a competitor faces a rapidly declining top linefor example, owing
to patent loss and ensuing generic competition or as a result of emerging branded
competition or safety concerns about its main products.
Under the pharmaceutical industrys cost structure, positive revenue developments translate into significant operating leverage. Companies incur substantial
R&D and marketing expenses that are largely fixed in the short term; the variable
cost of producing and distributing higher volumes of any given drug is comparatively low. Consequently, the accuracy of forecasts of a pharmaceutical companys
profits hinges on the analysts ability to predict the future sales of each drug in the
companys portfolio and pipeline. Substantial errors in forecasting a companys top
line will almost invariably lead to even greater errors in forecasting the bottom line
and, thus, a bad call. Therefore, a thorough analysis of a companys drug portfolio, which frequently requires expert knowledge in various therapeutic areas, is of
paramount importance.
In addition, various megatrends and industry-specific themes affect the dynamics of the industry to a meaningful extent. In light of the pronounced changes in
pharmaceutical business models that have been implemented over the last five
years, a brief history of the pharmaceutical industry is in order before reviewing
its dynamics. Although the discovery of the first drugs was largely the result of
serendipity, increasing levels of insight into disease biology and the mechanism
of the action of drugs on the molecular level resulted in ever more targeted drug
discovery efforts, which bore fruit initially. The latter part of the 20th century saw
2013 CFA INSTITUTE
CFA Institute Industry Guides: The Pharmaceutical Industry
step changes in medical innovation; given the dearth of effective drugs available at
the time to treat such widespread conditions as diabetes and hypertension, many
newly launched drugs became blockbusters, attaining peak sales of $1 billion or
more. The pharmaceutical industry enjoyed high earnings growth, and the investment communitys expectation that the industry would continue to innovate at the
same pace was reflected in the industrys valuation: P/E multiples often reached
the high teens or greater.
Many companies put in place significant production, marketing, and administrative infrastructure in an effort to maximize the top line; as recently as 10 years ago,
some of the most successful primary care drugs were each promoted by thousands
of sales representatives in the United States alone. Most major pharmaceutical firms
dedicated substantial resources to such life-cycle management (LCM) activities as
the development of new formulations of existing drugs or clinical trials in additional indications or patient subgroups, all with a view to extending the lives of the
drugs patents. Although pharmaceutical companies generally do not disclose the
proportion of their R&D expenses attributable to LCM as opposed to the discovery
and development of new molecular entities, evidence suggests that LCM activities
proved to be highly lucrative.
The decline in new-drug approvals observed through much of the last decade,
despite rising absolute R&D spending, may be attributable in large part to the focus
on product LCM. Other possible contributory factors include rising hurdles for some
of the largest indications, such as diabetes and hypertension, in which improving on
existing drugs has become increasingly challenging, as well as a delay in the adaptation of R&D and business models to a changing regulatory and payer environment.
At the beginning of the new millennium, the industry placed much emphasis on the
development of primary care drugs with billion-dollar sales potential in order to
leverage their existing infrastructure and replace older drugs that were approaching patent expiration. To minimize the perceived risks of the costly clinical development phase of new drugswhereby pharmaceutical firms test the efficacy and
safety of new-drug candidates in hundreds, if not thousands, of patients over many
yearsmany firms developed new molecular entities that displayed only modest
structural variation and only minor therapeutic advantages over existing drugs. In
referring to these products, critics used the derogatory term me-too drugs.
Shifts in the regulatory and payer environment eventually derailed the industry.
In particular, the US Food and Drug Administration (FDA) displayed heightened
risk aversion in the wake of the withdrawal of Mercks painkiller Vioxx from the
market in 2004 owing to side effects, thus raising the bar for the approval of newdrug candidates targeted at non-life-threatening conditions. Payers grew increasingly reluctant to reimburse for expensive new drugs that offered only a modest
perceived benefit over older drugs, which were losing their patent protection and
4
Industry Overview
becoming available generically at much lower cost, a trend that was exacerbated
in the financial crisis of 2008. Collectively, all these trends resulted in high attrition
rates for new-drug candidates as well as some commercial failures.
Toward the end of the last decade, many large pharmaceutical stocks were trading on single-digit forward P/E multiples as patent cliffs loomed and investors
confidence that the industrys R&D engines would yield novel agents to offset the
imminent revenue loss plummeted. The realization that the past strategy might
no longer be viable, coupled with the markets disenchantment, triggered the
industrys quest for a new commercial model. Large pharmaceutical corporations
recruited managers who were industry novices but possessed extensive experience
in such fields as marketing and operational excellence. The major players embarked
on large-scale cost-reducing initiatives to ensure acceptable levels of profitability
beyond the patent expirations of key blockbusters; many companies reduced their
cost base by billions of dollars in a matter of years. Although some of these cost
reductions were attributable to synergies in the context of megamergers, various
companies achieved multi-billion-dollar savings in the absence of material M&A
activity. This outcome was achieved in part by scaling back primary care field forces
in Western markets, a step that was accompanied by changes in the commercial
model: Firms relied increasingly on key account management to drive the top line
and shifted their R&D efforts toward specialty care. The relative attractiveness of
specialty care over primary care lies in the fact that it can be served by a smaller
sales force and thus at a smaller fixed cost; at the same time, clinical and regulatory
success rates tend to be higher for drug candidates that target underserved niches
of debilitating and potentially life-threatening indications, such as cancer.
Previously neglected aspects of cost control were also addressed, including
excessive procurement bills that resulted largely from a lack of coordination of
group-wide purchasing activities. Furthermore, the industry reduced fixed costs,
especially those related to R&D, by outsourcing various activities. It proactively
identified incremental business opportunities; many companies rediscovered
ancillary activities (consumer and animal health) that are less prone to patent
loss and notably increased their presence in emerging markets. Although the drug
industry is global in natureregulatory approvals all over the world can usually
be obtained for drugs that have proved safe and effective in the treatment of the
targeted conditionsmany pharmaceutical firms have focused primarily on Western markets in the past. And although Western markets continue to dominate in
absolute termswith the United States estimated to account for approximately
40% of the global pharmaceutical market in 2012much of the majors growth is
now coming from the emerging markets.
Many pharmaceutical companies have made steady progress toward replenishing their pipelines, partly by tapping into external innovation provided, to a large
2013 CFA INSTITUTE
extent, by midsize and biotechnology companies. In the aggregate, pipelines comprise numerous molecules with novel modes of action that target medical areas of
high unmet need and are tailored to well-defined patient populations, thus implying that a genuine market opportunity is likely to materialize for compounds that
prove safe and effective.
In fact, many recently launched drugs and compounds in development are so
highly targeted that a debate has ensued whether personalized medicine, one
of the most extensively discussed megatrends of the health care sector, represents
an opportunity or a risk for the pharmaceutical industry. Proponents argue that
the more clearly a drugs target population is defined and the more easily it is
identifiedfor example, by the use of biomarkers that confirm the presence or
absence of a mutationthe higher the chance that such a drug can be developed.
This approach may, in turn, increase the chance of successful clinical trials and save
the firm the considerable expense of conducting negative trials. Although skeptics
are concerned that personalized medicine might shrink a drugs target market
to relatively small patient subgroups, proponents contend that highly targeted
drugs may gain traction rapidly in the treatment of conditions characterized by
a significant genetic component, such as tumors that bear certain mutations,
whereas patients suffering from such multifactorial illnesses as diabetes may be
more difficult to stratify.
Thus, personalized medicine should not be regarded as a threat per se to profitability; drugs that are more narrowly targeted and thus more effective have a
higher chance of obtaining regulatory approval as well as reimbursement at attractive price points, which may compensate for the potential volume tradeoff. Furthermore, payers are increasingly embracing value- and outcome-based pricing models.
For instance, health technology assessment bodies assign grades to a drugs benefit
in certain indications and patient subgroups, and some pharmaceutical companies
have agreed in some regions to refund the cost of drug treatment if the patient does
not benefit meaningfully, suggesting that they have nothing to gain from the administration of medicines to patients who are unlikely to respond.
In this context, it is worth noting that disease prevalence is only one of the factors that determine a drugs peak sales. A drugs efficacy, both in absolute terms
and relative to competing drugs, and the severity of the condition it is used to treat
have a significant impact on its price point as well as its penetration rate. Similarly,
the notion that the aging population in Western markets will be a key driver for the
pharmaceutical industry is a fallacy. A drug designed to treat conditions that arise
more frequently in old age, such as diabetes, will not necessarily achieve greater
commercial success than a drug aimed at severe illnesses that may manifest themselves earlier in life (e.g., multiple sclerosis). Some senior citizens may be well
controlled on generic drugs or considered too frail for intensive treatment, whereas
6
Industry Overview
a young patient suffering from a devastating disease may receive an expensive drug
for extended periods in the absence of generics. Effective treatments for some of the
most debilitating conditions frequently associated with old age, such as Alzheimers
disease, are still largely lacking.
Price pressure is another trend that has persisted for many years and has accelerated recently as government-linked payers have felt the brunt of austerity while private payers have been affected indirectly by austerity and recessionary tendencies.
Although one or more price increases a year remain the norm for many effective
drugs marketed in the United States, price cuts and concessions occur with some
regularity in many other regions. Pharmacoeconomic studies that demonstrate an
overall cost benefit to the health care system are gaining in importance. Although
they raise the cost of drug development and may be fraught with methodological challenges, they also allow for the price differentiation of highly effective new
drugs. Recent and upcoming expirations of blockbusters patents are expected to
result in tens of billions of dollars in savings for health care systems globally, thus
providing some flexibility to reward innovation in areas of high unmet need. Austerity notwithstanding, it thus appears fair to assume that a safe and highly effective drug for the treatment of a serious, underserved condition, such as Alzheimers
disease or heart failure, would likely achieve peak sales well in excess of $1 billion.
Where clinical differentiation is lacking, price pressure is likely to intensify further.
For example, some generics markets, including Germanys, are increasingly tender
driven, with significant negative effects on price and profitability. In the United
States, where substitution of generics is common, generics companies rely heavily
on first-to-market strategies that afford short windows of opportunity to maintain
relatively high prices until the onset of multi-source generics. The rising price premium of truly innovative drugs that address medical areas of high unmet need over
interchangeable products and those conferring only a modest benefit has resulted
in increasingly focused strategies, with the most innovative pharmaceutical companies pursuing differentiation rather than cost strategies in Western markets. Today,
only a few of the pharmaceutical majors have significant generics operations in
developed markets because the key determinants of successincluding time to
market, breadth of portfolio, and logistical capabilitiesdiffer markedly from the
core competencies required in the branded pharmaceutical space.
With respect to general industry dynamics, the relative lack of seasonality and
cyclicality is worth noting. With the exception of some categories (e.g., allergy
treatments and flu vaccines), most drugs are prescribed and administered yearround. The months of summer vacation as well as the holiday season are typically somewhat lighter than other times of the year. To the extent that there is an
element of patient self-pay, drug sales may be moderately cyclical. For example,
patient co-pay requirements per drug pack may induce some patients to take drug
2013 CFA INSTITUTE
holidays in a tough economic climate, while those patients who have to pay part
of the fee for physician office visits out of pocket may postpone a health checkup
and, by implication, the purchase of medicines for the treatment of conditions they
are unaware of. Where employers are a key source of private health insurance,
rising unemployment rates may negatively affect consumption. Self-medicating
individuals may replace expensive over-the-counter (OTC) brands with white label
products in times of declining consumer confidence. However, all these factors
tend to have only a very modest impact on industry sales; rarely do they visibly
affect any sets of quarterly results.
Health care reform, usually in the form of price cuts, typically represents the
main fallout from a bleak macroeconomic picture. In recent years, many companies have experienced low- to mid-single-digit annual price pressure across
their European drug portfolios in the wake of austerity measures implemented
by various governments. The US market is dominated by private health insurance
and has thus been largely immune to government initiatives in most years. Beginning in 20102011, however, the US Affordable Care Act reduced companies US
drug sales by a low single-digit percentage as a result of increases in the mandatory Medicaid rebate rates and similar measures. It remains to be seen whether
improved access to health insurance will have a positive effect on industry growth
rates in the longer term.
Two key considerations in forecasting the impact of health care reform are worth
highlighting. First, reform measures usually need to be ratified by legislatures and
their implementation can be time consuming; it is possible that the first impact
on the industry will not be felt until a year or more after the first observation of a
decline in macroeconomic indicators. Second, the sensitivity of branded drug sales
to reform measures rarely differs among the majors; although some drugs may be
more negatively affected than others, the drug portfolios of the industry majors
tend to be sufficiently diversified for the net effect on branded human drug sales to
be similar across companies. Of course, exposure at the group level is partly determined by diversification into areas other than patented human prescription drugs.
However, care must be taken when assessing the impact of any reform measures on
small and midsize players, which may face substantial exposure with respect to a
particular drug or region. In extreme cases, health care reform has the potential to
negatively transform the earnings of such companies.
THE DRUG DISCOVERY,

DEVELOPMENT, AND APPROVAL
PROCESS
Prior to launching a new drug, the sponsor (i.e., the pharmaceutical company or
companies that own the rights to the compound) must extensively evaluate its
efficacy and safety in order to obtain approval from the appropriate regulatory
authority in each jurisdiction where it intends to market the drug. For example, US
approval must be obtained from the FDA; European approval is usually obtained
from the European Medicines Agency (EMA); and Japanese approval may be
granted only by the Japanese Ministry of Health, Labor, and Welfare. The drug
development process is lengthy, costly, and fraught with risks. Concerns over a compounds efficacy, safety, or commercial viability may emerge at any point in the process; if such concerns are sufficiently serious, the company may decide to terminate
development, which implies that the investment in the compounds development
will never be recouped. Pharmaceutical analysts regularly revise their forecasts in
response to R&D-related newsnotably revising sales forecasts for drug candidates
to reflect their launch probability (which rises as drugs progress through development), the expected commercial positioning in light of emerging scientific data, and
any potential changes to launch timelines. The progression of drug candidates to
the costly advanced stages of development may also have a bearing on short- and
medium-term R&D expenses. Since continuous rejuvenation of the drug portfolio is
of paramount importance to a pharmaceutical companys profitability, a thorough
understanding of the drug discovery, development, and regulatory process is crucial to the accuracy of forecasts. This section explains the basic drug development
process and the regulatory process in key geographic regions. Special emphasis is
placed on the key US market, where the regulatory process is highly transparent
and usually relatively speedy.
Drug discovery generally starts with ideas for a drug target and a lead molecule.
The choice of target (e.g., a cell surface receptor involved in sending messages
into the cell nucleus or a messenger molecule that binds to receptors as a ligand)
is typically driven by a companys understanding of the biology of a particular disease. For example, a tumor might express cell surface receptors that are absent in
healthy tissues, and a pharmaceutical company might endeavor to develop a medicine that selectively targets this receptor. Although many pharmaceutical majors
work on elucidating disease mechanisms, substantial outside workperformed, for
2013 CFA INSTITUTE
example, by academic institutionsis taken into account when choosing a target.

Translational medicine is the branch of science concerned with the clinical applications of basic research.
Once a target has been identified, the companys scientists study various
approaches to blocking or modulating the target to reduce or ablate disease activity. For example, they may use a compound that binds to and blocks the cell surface
receptors found on cancer cells, thereby preventing them from receiving further
growth signals. The compounds identified as having potential utility are classified
as leads. Leads must satisfy various requirementsfor example, they need to interact effectively with their target, but interaction with other molecules in the human
body should be kept to a minimum in order to avoid side effects that may arise from
off-target activity. Leads are often identified by screening molecules from existing
libraries against the target. Optimizing the most suitable compounds identified in
this manner typically requires substantial knowledge of chemistry or biochemistry.
Owing to the complexity of the process, it is not feasible for any company to identify and study each target and lead compound in-house. Therefore, co-operations
between firms are announced with some regularity. For example, one pharmaceutical or biotechnology company may supply the library to be tested against a target
supplied by another company, or two companies that have identified drug candidates targeting the same pathway may join forces to develop these compounds
together. Collaborations between the industry and academia are also common.
Furthermore, pharmaceutical companies frequently in-license drug candidates that
originated at biotechnology companies; the larger company thus bolsters its pipeline while providing financing as well as clinical and regulatory expertise and marketing prowess.
Once a lead compound has been identified, it proceeds to the pre-clinical stage,
which comprises various tests in vitro as well as in relevant animal models. Testing
in humans, also known as the clinical stage, requires approval from ethics committees, which is granted only after a compound has been fully characterized in the
pre-clinical setting. Clinical trials are designed to fully elucidate a drugs safety,
efficacy, and key characteristics in humans. Thus, the design of clinical studies
and the scope of the program vary with the type of compound being studied and
the condition it is intended to treat. Simplistically, the clinical trial process may be
divided into three phases. In phase I, the compound is typically tested in healthy
volunteers. Phase II studies enroll patients and are usually designed to give preliminary evidence of efficacy and safety while determining the best dose(s) to test
in phase III. Phase III trials are designed as pivotal, or registration, trials and are
powered to yield statistically significant results on a drugs efficacy and safety.
Although regulators review the totality of the data (including the full safety database available at the time) before approving or rejecting a new-drug application,
10
The Drug Discovery, Development, andIndustry

ApprovalOverview
Process
successful completion of phase III is usually a prerequisite for approval. Once a

drug has been approved, its safety is monitored regularly and the sponsor may be
asked to fulfill post-approval commitments; this post-marketing phase is sometimes referred to as phase IV. Exhibit 1 outlines the basic process of getting a drug
to market.
Exhibit 1 presents a conceptual framework; in practice, the drug development
process may vary substantially. For example, most cancer drugs are too toxic to be
given to healthy volunteers. Drug candidates for the treatment of conditions with
a poor prognosis may receive regulatory approval after a pivotal phase II study.
An adaptive trial design (e.g., a phase II study is rolled over into a phase III trial
if certain criteria are met) is increasingly being used for some diseases. Regulators
frequently provide sponsors with guidance and feedback on trial design in an effort
to minimize the risk of inadequate trial design. Clinical trials are often large, with
hundreds of patients typically enrolled in phase II studies and thousands, occasionally tens of thousands, recruited into phase III. Hence, the cost of clinical development is high: Depending on the therapeutic area under study, phase II trials may
cost tens of millions of dollars, and the bill for a phase III program often amounts
to hundreds of millions of dollars. The increasing focus on outcomes trials (discussed later) puts further upward pressure on the cost of clinical development.
Consequently, the industry has concluded that the cost of failure in phase III is
unacceptably high and has put in place extensive measures designed to identify
potential problems in phase II or earlier. Although the industry now appears to
Exhibit 1. Getting a Drug to Market
Drug discovery and
pre-clinical phase
Phase I
Phase II
Phase III
Target and lead

identification;
testing in vitro
and in vivo
(animal
model)
Tests in
healthy
volunteers
Efficacy and
safety in
patients;
dose selection
Registration
studies to
establish
safety and
efficacy
Multi-year
process
Cost:
millions
of dollars
Cost:
millions
of dollars
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Duration:
months
Duration:
typically
>1year
Cost: at least
tens of
millions of
dollars
Duration:
about 2 years
(varies)
Regulatory
review
Duration:
typically
1year;
expedited
review
maybe
available
Launch
Within days or
weeks of
approval if
reimbursement
negotiations are
not necessary;
otherwise, up
to a year or
more
Cost: often
hundreds of
millions of
dollars
11
appraise the clinical and commercial potential of drug candidates in early- and
midstage development more critically than in the past, the possibility of failure in
phase III can never be ruled out. It is therefore prudent to risk-adjust sales forecasts
until a drug has passed phase III and, ideally, received regulatory approval. Owing
to the high cost of clinical development, studies are typically sponsored by the pharmaceutical firms themselves. Occasionally, investigators or cooperative groups may
sponsor trials based on their own hypotheses. Although these studies may occasionally produce intriguing results, caution is warranted because they are not always
comparable in size and quality to industry-sponsored trials and are often unsuitable
as registration trials.
Because share prices tend to react to the results of pivotal trials, it is worthwhile
to briefly review the design of typical phase III trials and touch on the interpretation
of results. Many pivotal studies are designed as global trials, with clinical centers
across the United States, the EU, Eastern Europe, Asia Pacific, Latin America, and
other key regions. The FDA usually requires the inclusion of a meaningful number
of US patients in the pivotal study, whereas other regulators may accept data from a
smaller local study in addition to the pivotal data in order to ascertain that the drug
is safe and efficacious in the local patient population. Generally speaking, the patient
population enrolled in the clinical program must be representative of the patient
population that will receive the drug after its approval because such factors as ethnicity and standard of care may have a bearing on patients responses to a drug.
Often, a phase III program consists of two studies; however, regulators frequently
accept a sole pivotal study, notably for indications that require large and complex
trials. For other indications, it may be advisable to conduct more than two phase III
studies in order to demonstrate the drugs compatibility with other frequently used
drugs in different patient populationsdiabetes being a prime example.
The study sponsor typically selects one primary endpoint, although co-primary
endpoints are occasionally chosen in complex settings, such as acute care. The primary endpoint is usually an efficacy endpoint and reflects the main hypothesis that
the trial has been designed to test. For example, the primary endpoint of a diabetes
trial may be a reduction in blood sugar or a composite score of heart health. Trials
that assess a drugs impact on the mortality and morbidity (M&M) of the patient
population are often referred to as outcomes trials. Endpoints related to M&M
are considered harder than so-called surrogate endpoints, which merely measure
changes in a marker of disease severity, such as blood glucose or blood pressure.
However, M&M trials tend to be lengthy owing to the requirement to enroll a very
large number of patients and to follow them for a long period in order to observe
statistically significant differences in rare events, such as death. Therefore, they are
not usually part of the initial registration package. In addition to the primary endpoint, the sponsor chooses secondary endpoints, which often include safety.
12

ApprovalOverview
Process
Simply put, a study is considered positive if the primary endpoint is met

that is, if the main hypothesis is proved and the result is statistically significant.
Although a positive study bodes well for approval of the drug, the regulators evaluate the totality of the evidence and may reject a drug for other reasons, such
as observed safety signals or weak results on secondary efficacy endpoints. If the
primary endpoint is not met, the study is considered negative, making regulatory
approval extremely unlikely. Choosing the primary endpoint well and optimizing
other aspects of the trial design are thus of paramount importance to the success
or failure of a drug. Secondary endpoints are generally considered merely supportive, and even resounding success with regard to each secondary endpoint usually
does not make up for failure to meet the primary endpoint. Some drug candidates
have been doomed by poor trial design rather than by an intrinsic lack of efficacy
or safety. Other aspects of trial design that may have a bearing on a drugs chances
for approval include whether the design is for an open-label trial or a double-blind
trial (in which patients and physicians do and do not know, respectively, whether
they are receiving the study drug, a placebo, or another comparator); the choice
of comparator (a placebo or an active comparator that is commonly used to treat
the disease); the inclusion and exclusion criteria; the statistical analysis plan; and
numerous other factors.
Once the full clinical development of a drug candidate has been completed, the
sponsor usually submits the entire dossier to the relevant regulatory authorities in
the jurisdictions where it intends to market the product. Submission in the United
States, the EU, and Japan is now virtually simultaneous for many drug candidates,
although timing differences can arise from minor or major variations in regulatory
requirements with respect to either the clinical development plan or the data analysis. The regulatory review process starts upon receipt of the dossier by the agency.
From the publics point of view, the FDA offers the most transparent process. Normally, the agency formally accepts an NDA (new-drug application) file for review
shortly after its submission. On the rare occasions when a dossier is rejected
usually for technical reasonsthe sponsor typically resubmits within a relatively
short period. Under Prescription Drug User Fee Act (PDUFA) regulations, the FDAs
standard review time is 10 months, although the agency may extend the review
period by up to 3 months if it requires more time to consider the vast amounts of
data that generally need to be analyzed as part of an NDA review. Expedited review
procedures may be available for drug candidates that target a medical area of very
high unmet need, such as rare and lethal forms of cancer. Irrespective of the type
of review process, the FDA sets an action date, also known as the drug candidates
PDUFA date, by which the agency must communicate its regulatory decision. The
FDA may either approve a drug or send a Complete Response Letter (CRL) stating
that a drug application cannot be approved in its present form. On some occasions,
2013 CFA INSTITUTE
13
the deficiencies raised in the CRL may be addressed fairly quickly and the drug may
be resubmitted for approval within a relatively short space of time. In other cases,
new clinical trials may be necessary to establish a compounds efficacy and safety to
the FDAs satisfaction, which can delay the product launch by years.
Before making a regulatory decision, the FDA may convene a panel of experts
(also known as an advisory committee) who publicly share their views on the drugs
efficacy, safety, and overall approvability. The amount of drug-specific data and
other information made publicly available in the context of advisory committee
meetings typically far exceeds the amount of data that can be gleaned from any
other source. Extensive briefing documents are posted on the FDAs website, usually 48 hours before the start of the panels meeting. These documents contain the
FDAs questions to the panel (tough questions have, on occasion, rattled investors
nerves), both the sponsors and the FDAs detailed review of the data, and a preliminary assessment by the FDA reviewerall spread over hundreds of pages. The
meeting itself typically lasts a full day, with presentations by the sponsor and the
FDA as well as questions by the panel to both the sponsor and the FDA. The meeting
also includes an open public hearingwhere other stakeholders, such as patients
and patient organizations, may express their views on the suitability of the drug for
the targeted patient populationand a debate by the panel members on nonvoting
questions, followed by yes/no/abstain votes on the voting questions. Typical voting
questions seek to ascertain whether the drugs efficacy and safety have been established and whether the drug should be approved.
The entire meeting is usually webcast and provides not only a glimpse of the
FDAs main concerns and the likelihood of approval but also a general sense of factors that may have a bearing on the drugs commercial potential. Nonetheless, the
outcome of an advisory committee meeting should be interpreted with caution.
Importantly, the FDA retains ultimate responsibility for the approval of a drug; a
positive adcom vote does not guarantee approval, nor does a negative vote necessarily herald rejection. Pharmaceutical companies usually issue a press release
on the voting results shortly after the panel adjourns; however, the votes may not
give a full picture of the panels views on a drug. It is therefore advisable to watch
the panel itself and to note the explanations of panel members for their votes.
Some yes votes may be heavily caveated, while some no votes may relate to concerns that are easily addressed. The panel members opinions may not reflect those
of attending physicians in the field; the panel members represent different areas of
expertise and may include statisticians and practitioners of other disciplines who
would not necessarily prescribe the drug after approval. Conflicts of interest, such
as extensive consulting agreements with the pharmaceutical industry, may keep
some of the most renowned opinion leaders off the panel. Finally, the committee
is merely expected to weigh in on the compounds approvability in general terms
14

ApprovalOverview
Process
and does not consult directly on the label, although panel members periodically
point out that they struggle to discuss the issue of approvability in a vacuum. For
example, if a panel member believes that a drug should be withheld from patients
with renal failure and that it should be approved if appropriate monitoring of renal
function is mandated, that panel member would be expected to vote in favor of
approval and to rely on the FDA to address contraindications and requirements for
monitoring on the label. Therefore, a drug may receive approval, but a restrictive
label may effectively relegate it to later lines of therapy and thus limit its peak
sales potential.
The approval process of the European Medicines Agency (EMA) differs from that
of the FDA with respect to various administrative aspects and is often less transparent to the public. Many drugs are submitted to the FDA as part of the centralized
authorization procedure, which results in a single marketing authorization that is
valid throughout the European Union, Iceland, Liechtenstein, and Norway. Occasionally, national approval procedures may be choseneither the decentralized
procedure, whereby sponsors may file simultaneously in more than one country, or
the mutual recognition procedure, whereby a drug is approved in one country with
an option to subsequently request recognition of that authorization in other EU
member states. Like the FDA, the EMA formally accepts or rejects the dossier. The
actual review process takes up to 10 months; however, questions from the EMA to
the sponsor trigger clock-stops until receipt of the answers. These interruptions
are not formally communicated to the public, making the timing of the EU decision
on the approval of a new drug difficult to predict. If the EMAs queries cannot be
addressed in the time frame specified, the dossier is typically withdrawn and later
resubmitted. The EMAs Committee for Medicinal Products for Human Use (CHMP)
convenes monthly, usually after the 20th day of each month. Unlike FDA panel
meetings, CHMP meetings are nonpublic to shield the committee from any lobbying
efforts on the part of stakeholders. Following completion of the process, the EMA
issues a European Public Assessment Report (EPAR), which summarizes its conclusions with respect to a compounds riskbenefit profile. At the end of the review
process, the CHMP issues a recommendation to the EU to approve or reject the
drug. The EU generally follows this recommendation within three months of issue.
Whether the regulators, especially the FDA, have become more exacting and possibly more politicized is a subject of intense debate. The FDA might be forgiven for
being gun-shy, having taken flak from the US Congress in the wake of post-approval
safety concerns that have led to product withdrawals. In contrast, the EMA appears
to be relatively insulated from politics. The ethical dilemma faced by regulators is
inherent in their mandate to make new drugs available to patients to halt or slow
down disease progression and reduce sequelae while shielding them from druginduced harm. Even the largest clinical trials may not unearth all the side effects
2013 CFA INSTITUTE
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that may arise in the field, and imbalances in serious adverse events observed in
clinical trials between patients receiving a study drug and those on a placebo or
other comparator could either signal a potential safety issue or merely reflect the
play of chance. Ruling out unacceptable safety risks is thus one of the main challenges of both drug development and regulatory review.
Regulatory guidance documents that lay down the specific requirements to establish a drug candidates safety to the agencies satisfaction have greatly clarified the
statistical aspects of trial design and interpretation. For example, in the wake of
concerns over heart risks associated with anti-diabetic agents, the FDA established
clear rules on demonstrating the absence of unacceptable cardiovascular risk.
Another point of contention is the responsibility that regulators are expected to
assume for protecting patients from themselves. Although the EMA appears largely
to trust physicians to prescribe drugs to suitable patients only and patients to take
their drugs as prescribed, the FDAs role in this regard appears more ambiguous.
The question of whether FDA advisory committees ought to base their recommendations, in part, on the risks that may arise from off-label use and drug overdose has
cropped up repeatedly but has never been met with a definitive answer. The extent
to which sponsors are wary of FDA concerns in this regard is illustrated by the availability of safety studies of drugs intended for use in chronic obstructive pulmonary
disease (COPD) in asthma patients, who might conceivably be prescribed the drug
for off-label use.
It is important to note that the mandate of both the FDA and the EMA encompasses only the assessment of a drugs clinical riskbenefit. Economic considerations
are outside the scope of the regulatory review process, and regulatory approval
does not guarantee that a drug will receive reimbursement at a price acceptable to
the sponsor.
The drug discovery, development, and approval process is lengthy: More than 10
years can elapse between the first description of a potential drug target in the literature and the launch of the first drug to interact with that target. Clinical development alone is a multi-year process; the duration depends on the scope of the clinical
and analytical work to be performed, drug firms decision processes, and possible
delays caused by such things as problems with the stability of a drugs formulation
or having to put a trial on clinical hold while an observed imbalance in adverse
events is being investigated. Although timelines may vary widely as a function of
various requirements, the following guide may be used as a starting point: Phase
I studies can usually be conducted and analyzed in a matter of months, whereas a
full phase II program can rarely be completed in less than a year because it often
comprises multiple studies, with treatment durations of up to six months relatively
common and even longer durations under certain circumstances. The phase III program usually lasts at least two years, with treatment durations of at least one year
16

ApprovalOverview
Process
and additional time for patient accrual, follow-up, and data analysis. It may take
significantly longer in the case of very large trials for which patient recruitment
takes a long time or in the event of very long treatment durations or the need for
extensive patient follow-up. But pivotal trials can also be much shorter (e.g., for
anti-cancer drugs targeted at particularly lethal tumors).
Most clinical trials that are relevant to the analysis of the pharmaceutical industry majors are listed at http://clinicaltrials.gov, where expected timelines are usually provided. The regulatory review process may amount to six months or less if an
expedited or priority review is grantedfor example, for drugs that have received
the FDA fast track or breakthrough therapy designation. Standard review processes tend to take approximately one year in most key territories. In the event of
a rejection based on major clinical deficiencies, it may take years to address the
regulators concerns. Although a drug may be launched within days or weeks of
approval, a delay of one year is not uncommon in regions known for drawn-out
reimbursement negotiations.
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INTELLECTUAL PROPERTY:
PATENTS, REGULATORY
EXCLUSIVITIES, AND OTHER
FORMS OF PROTECTION
As discussed in the previous section, discovering a drug and getting it to market is
a lengthy and resource-consuming process. Manufacturing and distributing a drug
are relatively straightforward by comparison, although pharmaceutical production
has its own challenges, notably in the context of the industrys shift toward biopharmaceuticals, which are typically produced by genetically engineered cells. To
perform the significant amount of pre-clinical and clinical work required to establish a drugs safety and efficacy, originators of new drugs require incentives in the
form of periods of market exclusivity during which they can earn a return on their
investment. Essentially, there are two levels of protection: patents and regulatory
exclusivities. These forms of protection run in parallelthat is, an off-patent drug
may not be copied by generics players while regulatory exclusivities are in place,
and generics companies must demonstrate that existing patents are invalid or not
infringed by their product if they wish to launch a generic once regulatory exclusivities run out. The rules and legislation around both forms of protection are exceptionally complex, and readers should be aware that the following discussion merely
scratches the surface.
Patents are issued by patent offices. The strongest protection is typically
afforded by the patent on the active ingredient by which a drug exerts its biological effect. So long as the active ingredient is protected, the drug itself is protected;
any drug containing a different active moiety would be considered a different
drug, not a generic, and would need to complete a full clinical program before
obtaining approval. However, substance patents tend to be the first to expire in
the patent estate surrounding a drug. Although substance patents have a life of
20 years from the date of issue, they are normally granted at an early stage of the
lengthy drug discovery/development process. By the time a drug launches, the
active-ingredient patent is often less than 10 years from expiration. In the event
of severe delays in the drug development process, a substance patent can even
expire prior to launch.
Various provisions allow drug makers to extend their drugs patents by a number
of years. For example, products marketed in Europe may receive supplementary
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Intellectual
Industry Overview
Property
protection certificates (SPCs) that add up to five years of protection; under the
HatchWaxman Act patent term extension provisions, US patents may be extended
by up to five years to compensate drug firms for some of the time that compounds
spend in development or registration. Even so, the active-ingredient patent is
likely to expire earlier than weaker forms of patents, such as formulation, process, or use patents. A generics company may be able to circumvent these other
patentsfor example, by changing the drugs excipients or key steps in the production process. Use patents, which preclude generics from being used in certain
disease settings, can be difficult to enforce. For completeness, trademarks are
worth mentioning. Although they do not play a pivotal role in the protection of
most drugs against erosion by generics, they may add an extra level of protection
in some cases, especially for drugs administered in a device, such as an injection
pen or inhaler. Over time, patients may become loyal to their device and balk at
the notion of having to use a generic that comes in a device with a different look
and feel.
It is incumbent on the sponsor of a generic to assert that its product is not
infringing any valid patents. For example, when a company submits an abbreviated new-drug application (ANDA), or generic file, to the FDA, the application
must contain either a paragraph III or a paragraph IV certification. In the case of
a paragraph III certification, the FDA holds off on final approval until all the patents listed in its Orange Book database have expired; a paragraph IV filing reflects
the generic sponsors conviction that unexpired Orange Book patents are either
invalid or not infringed. The branded drug company is informed of all paragraph
IV filings that are based on one of its brands as a reference product and may sue
a generics company within 45 days of such notification if it concludes that its patents are valid and would be infringed by the generic. In the event of a lawsuit, the
FDA is banned for 30 months from approving the generic unless there is an earlier
court decision in favor of the generics company. This stay is often referred to as a
HatchWaxman stay.
The validity or invalidity, as well as the infringement or non-infringement,
of patents is determined by the courts. A court may invalidate patents on such
grounds as obviousness or prior art, or it may rule that a patent is unenforceable
owing to inequitable conduct. If a court finds patents to be valid and enforceable,
the generic may be launched only if it does not infringe them. The courts ruling may be appealed. If a generic is launched while litigation remains ongoing,
the launch is considered at-risk, meaning that the generics company may be
liable for damages if it is later found to have infringed any valid and enforceable
patents. Owing to the high level of uncertainty around the outcome of litigation,
it is not uncommon for the makers of the branded drug and the generic to settle
their litigation. Settlements typically result in a launch date for the generic that
2013 CFA INSTITUTE
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falls somewhere in between the assumed launch dates under various hypothetical
court judgments. Settlement agreements must be structured so as to ensure that
the health care system or consumer is not disadvantaged; pay to delay deals,
in which the branded drug maker pays the generics company to hold off on a
launch and delay the legitimate entry of its generic, are unacceptable because they
deprive the health care system of potential savings.
A pharmaceutical company that embarks on the discovery and development of a
new drug thus faces substantial uncertainty about its patent estate. The post-launch
life of the active-ingredient patent may be difficult to predict, and there are no
guarantees that the companys patents will be upheld in court or that key patents
will not be circumvented by generics companies. This uncertainty might conceivably deter the drug maker from investing in large-scale clinical trials, especially if
the patent estate appears relatively weak (e.g., in the case of a molecule that was
discovered and patented early), with the result that the active-ingredient patent
might expire before or shortly after launch. Similarly, a drug maker might refrain
from developing drugs for niche indications if there is a high risk that the drugs
sales might be too low to earn an adequate return on investment before their patents expire. Of course, decisions against the development of drugs that hold promise from a medical perspective risk being detrimental to patients who might face a
dearth of treatment options.
Regulatory exclusivities offer intellectual property protection independent of
patents in order to incentivize drug firms to invest in drug candidates. A plethora
of regulatory exclusivities are available; the following discussion is confined to the
most common forms in the United States and the EU. The FDA awards five years
of exclusivity for new chemicals and three years for a change, such as a new
formulation. If a drug maker establishes the efficacy and safety of its drugs in children, pediatric exclusivity is awarded, adding another six months to the exclusivity period conferred by patents or other regulatory exclusivities. So-called orphan
drugs, targeted at conditions that affect fewer than 200,000 people in the United
States, receive seven years of exclusivity.
The EMA awards 10 years of exclusivity to new drugs, including 8 years of data
exclusivity, during which generics companies may not reference the originators
data, and 2 years of market protection, during which generics may not be approved;
new indications may entitle the drug firm to a 1-year extension. Successful development of a drug for pediatric patients renders the applicant eligible for a six-month
patent term extension. Orphan drug exclusivitygranted for drugs that target indications affecting fewer than 5 in 10,000 Europeans or that would be unlikely to
yield a sufficient return on investment for other reasonslasts for 10 years, with a
2-year extension possible if a new orphan indication is added. Table 1 summarizes
the main forms of protection for new drugs.
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Intellectual
Industry Overview
Property
Table 1. Summary of the Main Forms of Protection of New Drugs against Generics
Patents and Trademarks
Active-ingredient patents
Formulation patents
Process patents
Use patents
Patent term extensions
Trademarks
2013 CFA INSTITUTE
Regulatory Exclusivities
New-drug exclusivities
Exclusivities with respect to changes (e.g., new
formulations or indications)
Pediatric exclusivity
Orphan drug exclusivity
21
BUSINESS MODELS
The industry majors vary with respect to their degree of and approach to diversification. Some firms are essentially pure plays that offer almost exclusively branded
prescription medicines for human use. Their success is thus inextricably linked to
the growth trajectory and longevity of their marketed drugs as well as the success
of their pipelines. The potential rewards are high, but so are the risks. Many players
therefore seek to balance their business through exposure to other, more predictable segments of the health care sector. Closely related fields that can be somewhat
synergistic with the business of branded human prescription drugs include OTC
drugs and products for animal health. These businesses are characterized by limited
patent exposure and significantly reduced R&D risk, with shorter payback periods
for R&D spend, steady growth, and organic growth rates typically in the low to midsingle digits. Thus, the management teams of large corporations tend to view these
businesses as a natural extension of their core pharmaceutical operations.
In contrast, the core competencies required to compete effectively in other fields
of health care, such as generics, diagnostics, and medical technology, may differ
substantially from the skill set and know-how acquired in the course of branded
drug development and marketing. Consequently, the industry majors tend to enter
these arenas selectively, and many firms operate in these market segments for historical reasons rather than as a deliberate move in recent years. Industrial conglomerates comprising both pharmaceutical and non-health-care operations are rare
and usually result from historical developments. For example, the pharmaceutical
industry was, to some extent, born out of the chemical industry; as a result, some
pharmaceutical players retain chemical operations today. In such cases, the gradual
divestment of non-health-care activities over time tends to be more common than
deliberate moves to diversify away from health care. Table 2 reports the degree of
diversification of various relevant business models.
Table 2. Pharmaceutical and Health Care Business Models: Degree of Diversification
Business Model
Pharmaceutical pure play
Brief Description
Focus is almost exclusively on branded prescription
drugs for human use
Balanced drug portfolio
May include OTC drugs and products for animal
health in addition to branded human prescription
drugs
Diversified health care company Includes other health care segments (e.g., generics, diagnostics, medical technology) in addition to
branded drugs
Diversified industrial company
Includes activities unrelated to pharmaceuticals
with a focus on pharmaceuticals (e.g., agriculture, chemicals)
22
Company Examples
AstraZeneca, Bristol-Myers
Squibb, Novo Nordisk
Eli Lilly, GlaxoSmithKline,
Merck & Co., Pfizer, Sanofi
Johnson & Johnson,
Novartis, Roche
Bayer, Merck KGA
Business Models
INDUSTRY CONSOLIDATION
Consolidation has been a long-standing theme of the pharmaceutical industry and
has given rise to a number of very large organizations with tens of billions of dollars
in annual revenues. Nonetheless, the industry remains fragmented, with even the
largest players commanding mere single-digit market shares. Although this situation leaves room for future megamergers, the combination of two pharmaceutical
giants is rarely the alternative preferred by the companies management teams.
Managing extremely large organizations is fraught with challenges. Although synergies may substantially decrease the combined cost basenotably, selling, general,
and administrative expenses (SG&A)the absolute amount of revenue expected to
be lost to patent expirations in future years rises dramatically, thereby increasing
the pressure on the combined pipelines to deliver. (For this reason, an ideal takeover candidate would typically be the mirror image of the industry majors, in the
sense that it would combine a modest current revenue base with a potentially transformational pipeline. However, such acquisition targets are few and far between.)
Antitrust considerations are another potential obstacle to M&A that should not
be underrated. Owing to the high degree of fragmentation of the pharmaceutical
market, there is a high risk that the combination of two pharmaceutical firms could
result in their having a dominant position in one or more market subsegmentsfor
example, multiple sclerosis or a specific type of tumor. This result would trigger
mandatory divestment of one of the drugs targeting that disease area, which could
dilute the shareholder value of the merger transaction. Antitrust considerations
are not limited to classical pharmaceutical businesses. In fact, the combination of
two animal health businesses could be exceptionally problematic from an antitrust
point of view, with mandatory divestments particularly hard to execute. A number
of the major players have exposure to animal health, and a situation could conceivably arise in which that business activity would effectively block mergers that might
otherwise appear attractive with respect to the firms human drug businesses.
In light of these considerations, many pharmaceutical executives in recent years
have expressed a preference for bolt-on acquisitionsfor example, to reach critical mass in areas where the company had previously been underrepresentedand
for drug-licensing deals over large transactions. Owing to an abundance of small
and midsize drug companies, this approach also offers more choice than megamergers do. Numerous biotechnology companies are working on drugs for the treatment of conditions with high unmet need or offer platform technologies that may
enhance the drug discovery process or the features of drug candidates themselves.
These players range in size from small venture-capital-funded start-ups and vehicles spun out of universities to midsize and large companies that own the rights to
cash-generative marketed drugs wholly or in part. Depending on the scale of their
operations as well as their focus and outlook, these firms may rely to a significant
2013 CFA INSTITUTE
23
extent on large pharmaceutical companies to provide funding and clinical expertise

in the drug development process and a commercial engine to sell the drug following approval.
Occasionally, the industry majors opt for the outright acquisition or purchase of
a stake in biotechnology companies. In general, however, full ownership of R&D
assets is not considered of paramount importance. In light of the plethora of scientific approaches being explored, it seems impossible to predict which technologies,
mechanisms of action, and therapeutic categories hold the greatest promise. Unsurprisingly, many large pharmaceutical companies seem content to part-own a large
number of different assets and are reluctant to place large bets on unproven scientific approaches. Therefore, licensing arrangements are common in the industry. In
a typical licensing deal, a large pharmaceutical player acquires commercialization
rights to a biotechnology companys drug candidate globally or in key territories. In
return, the pharmaceutical company makes an upfront payment to the biotechnology firm and commits to further success-based milestone payments and a royalty
on future drug sales.
The upfront payment usually compensates the biotechnology firm for work carried out to date and often amounts to millions or tens of millions of dollars. Milestone payments are typically linked to clinical, regulatory, or commercial milestones
(e.g., the transition to advanced stages of clinical development, regulatory approval,
or the achievement of prespecified sales targets following launch). Milestones may
be structured to compensate the biotechnology firm for future costs (e.g., expenses
for clinical development if the originator has agreed to bear part of the clinical costs
under a co-development clause) or as success-based milestones.
Royalty rates are subject to negotiation and are determined by various factors,
most importantly the drug candidates development stage, the quality of the preclinical and clinical data available at the time the agreement is entered into, the
compounds commercial potential, and the relative balance of the total economics
between upfront payments, milestones, and royalties. Tiered royalties, in which
the royalty rate itself depends on product sales, are relatively common. Singledigit royalties are often agreed on for compounds licensed at an early stage of
development, whereas double-digit royaltiesusually in the teens, occasionally in
the twenties or higherare the standard for compounds in the advanced stages
of development that come with impressive sets of clinical data. Although some
biotechnology companies prefer to leave drug commercialization to their pharmaceutical partners, others are keen to field a small force of their own, especially on
their home turf, and may negotiate co-commercialization and profit-sharing rights
or options. Licensing deals based on 50/50 profit sharing in major territories are
rare but not unprecedented.
24
Business Models
A major pharmaceutical firms activity with respect to the licensing of drug candidates and other collaborations with the biotechnology industry and academia
reflects its commitment and approach to innovation. Across the industry, the
majors acknowledge the impossibility of building in-house expertise in every scientific hot spot and increasingly rely on external innovation for that reason alone.
In light of the restructuring initiatives taken in recent years in anticipation of the
patent cliff, many players have sought to rebalance between fixed and variable
R&D spend and thus, by extension, internal and external R&D expenses. In addition, the jury is still out on optimal levels of R&D spend, both in absolute terms
and relative to pharmaceutical sales. Some players reinvest more than 20% of their
branded prescription drug sales in R&D each year, whereas others opt for an R&Dto-sales ratio in the low teens, with obvious implications for the budget amount
allocated to drug licensing.
NOTABLE TRENDS
Three general trends with respect to business models have been observed across the
pharmaceutical industry. First, geographic diversification has become a higher priority for the majors in recent years, as a combination of such factors as patent expirations and a changing regulatory and payer environment has called into question the
viability of a strategy that has historically been heavily reliant on Western markets.
Second, the composition of portfolios of marketed drugs as well as pipelines has
shifted away from primary care and toward specialty pharmaceuticals. Even such
therapeutic niche areas as rare cancers and orphan diseases have lately attracted
significant interest from the pharmaceutical industry. Although many firms remain
committed to the primary care business, they have embraced specialty care as a second pillar, with its lower marketing spend, higher margins, and often higher success
rate in clinical trials making up for the slightly more modest peak sales potential.
Third, the industry has reduced its infrastructure and generally cracked down on
fixed cost in recognizing that the top line may fluctuate over the years as a result
of patent expirations. The industry majors are now increasingly relying on external suppliers while seeking ways to achieve more with fewer resources. Excess
production capacity, duplication of infrastructure across countries, and even such
comparatively minor items as the discretionary purchase of excess R&D supplies
by individual teams are now buried in the past. Some companies continue to generate hundreds of millions of dollars in procurement savings each quarteran
impressive demonstration of the extent to which these firms are eliminating waste.
Whether this newly found cost-consciousness bears risks is open to debate. The
management teams of pharmaceutical firms maintain that adequate quality control procedures reduce the risk of outsourcing to the same level of risk as in-house
2013 CFA INSTITUTE
25
activities and attribute glitches (e.g., FDA warning letters or supply disruptions)
to such factors as human error and heightened regulatory scrutiny. In general, any
efforts to reduce the cost base or render it more flexible may carry an inherent risk
of opportunity costs and diminished control. Consequently, a modest reversal of
recent trends may be in the offing as the industry leaves its patent cliff behind
and as pipelines deliver.
26
FINANCIAL STATEMENT ANALYSIS

The structure of the drug industrys financial statements is relatively straightforward. The main challenge for the analyst is not the interpretation of historical data
but, rather, accurately forecasting the myriad influences on each line item. Sets of
financial results typically include detailed reports of sales by drug and region as well
as extensive product-related disclosures, such as key drivers of the sales development of individual drugs in the period under review and a pipeline update. Annual
reports usually also contain information on patents and regulatory exclusivities.
Owing to the sheer size of the industry majors as well as the nature of the business, quarterly results are often heavily distorted by such one-time items as
product-related impairment or restructuring charges. Many players have made
large acquisitions and recognize significant amortization charges, which limits the
comparability of results. Thus, in addition to the statutory accounts, most of the
majors provide adjusted results, often referred to as non-GAAP results by US companies and as core by their European counterparts. Although adjustments usually
include the add-back of impairment charges, other exceptional items, and amortization charges, subtle differences may exist between different players methodologies. For example, different companies might use different criteria (e.g., different
materiality thresholds) in labeling items as exceptional; some might add back all
amortization charges, whereas others might confine adjustments to charges concerning the acquisition of companies. Analysts should refer to the notes on each
companys methodology to ensure the correct interpretation of adjusted results;
analysts may consider making additional adjustments to ensure adequate comparability for their particular analytical purposes.
Even if two companies adjust their statutory results in a similar manner, their operating margins and margin structures are not normally comparable. As previously mentioned, pharmaceutical companies rarely own 100% of all their drugs and drug candidates. Depending on the specific clauses of licensing, collaboration, co-development,
and other agreements, a company may book some or all of a drugs in-market sales
and may make or receive royalty and other payments with respect to a drug under
existing cost- and profit-sharing agreements. Accounting rules for individual line items
may also vary across geographic regions, especially for R&D spend. Although most
stakeholders tend to think of the industrys R&D activities as an investment, in-house
R&D spend is generally expensed in the period when it is incurred under both US
GAAP and International Financial Reporting Standards (IFRS). Rules vary, however,
with respect to external R&D spend, such as upfront and milestone payments made
under licensing agreements. Although such payments may be expensed immediately
2013 CFA INSTITUTE
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under US GAAP if they do not relate to an acquisition, they are usually capitalized
and amortized over their useful lives under IFRS. Thus, an all-in measure of cash
R&D spend in any given period may not be readily available for European companies.
A rough estimate may be gleaned from asset schedules. Perusal of the press releases
and financial statements issued by a drug firms biotechnology partners (who may
be required to disclose the receipt of milestone payments that would be considered
immaterial by the pharmaceutical firm that owes the payments) is a cumbersome and
incomplete approach.
R&D productivity is a chief concern of analysts and investors who seek reassurance that the billions of dollars many of the majors plow into drug discovery and
development each year is money well spent. Unfortunately, disclosure around R&D
expenses is usually vastly insufficient for this purpose, and any measure of R&D
productivity based on financial statement analysis alone is bound to be a crude
approximation at best. Companies rarely provide a detailed breakdown of their
R&D spend by drug, indication, or type of molecule. Occasionally, drug makers
may separate out the contribution of the R (early research) and the D (clinical
development) to overall spend. It is virtually impossible to estimate the expense
incurred with respect to new molecular entities as opposed to such LCM initiatives
as new formulations. Furthermore, drugs may not attain their full sales potential
on the sole basis of clinical data from registration trials, and a significant portion
of a companys R&D budget may be dedicated to further characterizing a drug that
is already commercially available (e.g., by conducting outcomes trials designed
to prove that it increases life expectancy or delays heart attacks). Analysts should
also be mindful of the time lag between R&D efforts and regulatory approval. The
mere approval of a drug does not necessarily mean that a company is about to earn
an adequate return on the R&D spend incurred with respect to the molecule; for
example, modest market uptake or premature genericization may have a dampening effect on its net present value (NPV). In light of these considerations, jumping
to conclusions about trends in R&D productivity on the basis of such simplistic and
static measures as contrasting industry R&D spend in any given year with the number of new drugs approved by the FDA in the same year is ill advised.
It follows from the discussion thus far that a pharmaceutical companys operating margin is heavily dependent on key drugs stages in their life cycles, the proportion of drugs cash flows owned by the company, and the accounting recognition
of drug sales and profits, as well as the amount and recognition of discretionary
R&D spend that may or may not yield an attractive return many years down the
road. These factors render the comparison of margins and margin structures across
companies largely meaningless, although benchmarking individual line items,
such as the R&D-to-sales ratio or the administrative spend across companies, may
occasionally be useful in identifying potential inefficiencies. Business mix further
28
complicates such comparisons; for example, some of the majors generate significant sales with vaccines, a segment characterized by both lower gross margins and
lower R&D spend than most other branded prescription drug businesses. Similarly,
year-over-year comparisons of financial results are hardly insightful because most
pharmaceutical businesses are not seasonal, and year-over-year growth rates may
be heavily distorted by such factors as generics competition for key drugs that may
have set in over the past 12 months.
As discussed later in more detail in the section on forecasting, the most viable
analytical approach is to track the main influences on each profit and loss line item
and ascertain whether any future change should be expected. For example, gross
margins of classical pharmaceutical businesses often exceed 70%. The absolute
margin level is determined primarily by the operating leverage arising from blockbuster drugs that are simple to produce and pay-aways to third parties under licensing and similar agreements. Such factors as product and geographic mix, inventory
adjustments, variations in biopharmaceutical production yields, and fluctuating raw
material prices may entail modest fluctuations in gross margins; however, structural
change should usually be expected only in the event of significant sales growth or
declineor if pay-aways change as a result of a significant growth or decline in the
underlying sales of the related products or upon coming to a contractual end.
R&D spend is largely discretionary in the sense that it is not directly linked to
revenues. (Note that much of it is fixed, and a significant reduction would typically
require major restructuring.) For most of the majors, the R&D-to-sales ratio is in
the teens; occasionally, it may exceed 20%. R&D spend that remains far in excess
of 20% of sales over time would likely invite investor scrutiny as to whether that
level of spend is sustainable. SG&A spend, which may exceed 30% of sales, has traditionally been high in the pharmaceutical industry and has become a key source of
productivity savings in recent years. Analysts should regularly ascertain the scope
of further reductions in the absence of major investments in new-drug launches or
infrastructure in fast-growing geographic regions, such as some emerging markets.
Underlying operating margins north of 30% are by no means rare, and the margins
of the most successful companies that own most of their assets and/or receive substantial royalty income may even reach or exceed 40%. At the same time, operating
margins in the 20s are frequently observed in companies that have had major patent expirations, owe significant royalty payments to third parties, or have a strong
commitment to innovation that translates into high R&D spend.
Items below the line warrant careful analysis. Some companies may have significant associate income or minorities that cannot simply be extrapolated. As discussed later in the context of balance sheet structures, leverage differs widely, suggesting wide variations in the net financial result. Tax rates may also vary among
companies for structural reasons. Finally, most diversified health care companies
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report segments in substantial detail. Owing to the significant differences in dynamics and margin structure between segments, analysts would be well advised to
model each segment separately.
Analysis of the balance sheet and cash flow statement is typically straightforward.
Most successful pharmaceutical businesses are characterized by low capital intensity, high cash generation, and conservatism with respect to financing structures.
Although the required level of investment in new production sites has increased
somewhat as a result of a shift in product mix away from simple small molecules
to more complex biotechnologically produced drugs, growth is often possible in
the absence of major investments in property, plant, and equipment, and capital
expenditures are rarely a concern. It is worth noting that many firms have reduced
or are in the process of reducing their manufacturing footprint pursuant to the
operational excellence initiatives they embarked on to brace for the patent cliff.
Of all the restructuring measures announced and implemented by the majors, site
closures and divestments will require the most time because the continued supply
of medicines must be maintained and the transition to other factories or external
organizations requires regulatory approval.
Many firms, especially those that have made large acquisitions, have significant
intangible assets. It is not unusual for the majors to carry intangibles worth tens of
billions of dollars on their books, often dwarfing the value of tangible assets. Intangibles other than goodwill are amortized over their useful lives, often giving rise
to substantial amortization charges over extended periodshence, the industrys
focus on non-GAAP or core results. In contrast, the impairment of goodwill does
not normally occur with high frequency. The book value of the intangible assets
pertaining to the major individual products that were purchased in an acquisition is
typically provided in annual reports, giving the analyst a rough idea of the potential
impairment charges in the event of a severe problem with a flagship product.
When analyzing and comparing working-capital requirements, analysts should be
mindful of the length of biopharmaceutical production cyclesbiotechnologically
produced medicines and other complex drugs may take nine months or more
to producethe high opportunity cost of supply disruptions, and differences in
payment terms between geographic regions and distribution channels (e.g., retail
or hospital pharmacies).
Owing to the relatively low variable cost of the production and distribution of
blockbuster drugs, successful pharmaceutical companies tend to be highly cash generative, with free cash flow before acquisitions often on the level of net income. It
is not rare for drug firms to accumulate significant net cash positions in the absence
of M&A and to deleverage rapidly in the wake of major acquisitions. Consequently,
it may be possible for pharmaceutical firms to gear up with respect to acquisitions
without suffering major downgrades by the rating agencies. Share buyback programs
30
are a popular tool for raising structurally low debt-to-equity levels. At the same time,
most pharmaceutical firms are conservatively financed to ensure that they would
remain solvent under scenarios of extreme stress (e.g., the sudden withdrawal from
the market of a multi-billion-dollar product). It is also important to keep in mind
that bouts of innovation may not always coincide with major patent expirations;
executives thus prudently brace for potential periods of much lower sales and cash
flows. Many drug firms carry relatively high provisions (e.g., for pensions and other
post-employment benefits for their large workforces). Under IFRS accounting, European companies may also provision extensively for the expected cost of litigation.
Industry novices are often puzzled by the very high return on capital employed
(ROCE) generated by many of the industry majors despite sizable positions in intangibles; some even regard these supernormal returns (ROCE in excess of 20% is not
uncommon) as an indicator that drug prices are too high and thus unsustainable.
When analyzing return measures, it is important to recall that success or failure in
the pharmaceutical industry is a function of R&D productivity. By definition, the
industry majors are those that generate the highest drug sales and are thus the winners in the race to develop new drugs. Because pharmaceutical operations are not
capital intensive and a significant part of a companys R&D spend is expensed and
may thus be thought of as a sunk cost rather than invested capital, the denominator in return-on-capital calculations tends to be relatively low and the numerator is
essentially a function of past R&D success.
The industry is highly fragmented; although the largest and most successful players may be earning supernormal returns, those that have remained subscale because
of pipeline failures may struggle. Elsewhere, past R&D success does not guarantee
future success, and the ROCE of companies that fail to continually innovate would
likely dwindle in the wake of patent expirations. This situation was illustrated by
the investment communitys confidence crisis in 2008, when the valuations of the
majors plummeted despite high levels of profitability, and some investors exerted
substantial pressure on company management to downsize or shut down their R&D
engines. Thus, it seems a foregone conclusion that the gap between the industry
winners and losers will always remain wide and that the most important task of
a pharmaceutical analyst is to identify the most innovative companies that own the
most promising drugs, as discussed in the next section.
FORECASTING DRUG SALES AND COMPANY

PROFITS
It follows from the previous discussion that forecasting drug sales and profits of
pharmaceutical companies requires a bottom-up approach to modeling, with
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top-down approaches merely serving as a cross-check. Forecasting drug sales

product by productand if companies provide a geographic breakdown, territory by territoryshould be the starting point of pharmaceutical modeling. To the
extent that off-patent products that have passed their peak sales make a meaningful contribution to group revenues, it may be sufficient to extrapolate the modest
growth or decline they have exhibited in recent years. In the case of products that
are approaching their peak sales, considering the erosion to be expected upon the
expiration of key patents and monitoring the competitive landscape for emerging
threats may constitute an adequate approach. However, products at a relatively
early stage of their life cycle and pipeline projects require a full analysis if the accuracy of forecasts is to be maximized.
A complete analysis of a drugs or drug candidates potential requires an analyst
to consider all commercial, regulatory, and legal aspects of drug development and
marketing, including the timing of market entry in each region where the drug is
intended to be launched, the addressable target market in each of the indications
for which the drug is being developed, the drugs price point, the average treatment
duration and amount of drug taken, its penetration rate at peak, the growth trajectory to peak sales and beyond, the timing of loss of exclusivity, the expected decay
curve following the generics entry, and the likelihood that the drug will reach the
market. Once the projected sales trajectory has been included in an analysts model,
the analyst must continually revisit the underlying assumptions and actively monitor all trends and news flow that may have a bearing on these inputs. For example,
an evolving competitive landscape or an emerging safety issue may alter a drugs
projected peak penetration rates. The same is true for slower or faster uptake in the
marketplace than originally expected. In fact, many analysts track launches closely.
For the United States, weekly and monthly prescription data are available from
various sources and are widely used to form an opinion of a drugs acceptance in
the marketplace ahead of formal financial reporting by the company. A firm may
develop a drug in more than one indication, and the success probability in each
indication must be adjusted as the clinical development program progresses.
All these inputs must be derived from the myriad pieces of publicly available information that are characteristic of the pharmaceutical industry (please see the section
on industry resources). Although the analysis and conclusions vary by indication,
type of molecule, and other factorsand an exhaustive review is thus beyond the
scope of this reportit is worthwhile to briefly touch on the key determinants of a
drugs commercial success, chiefly to enable users of research to challenge the peak
sales assumptions of consensus and individual analysts.
The expected timing of market entry must be ascertained separately for each indication and territory. Although the pharmaceutical industry is increasingly aiming to
conduct global trials and to submit dossiers to regulators in key territories almost
32
simultaneously, regulatory or commercial considerations may result in significant

time lags. Because the efficacy and safety of new molecular entities must be ascertained separately for each targeted indication, a drug may initially be approved for
use in one indication only (e.g., rheumatoid arthritis), with other indications added
to the label at a later stage (e.g., psoriasis and other autoimmune conditions). Many
companies routinely provide information on the expected launch timelines of a
drug candidate for key regions and the most advanced indications. Although there
is usually a reasonable basis for this information, a quick plausibility checkbased
on the expected accrual rates, treatment duration, follow-up in the main clinical trials, and expected regulatory review periodis always warranted. Although drugs
are typically launched within days or weeks of approval in some countries, especially the United States, drug launches are preceded by lengthy reimbursement
negotiations in others. In some EU countries, drug launches may be delayed by
monthsoccasionally, even by a year or moreas price and reimbursement negotiations drag on. As a result, drug companies typically refer to the European rollout rather than launch of a drug.
Analysts are usually left to their own devices when forecasting the price point of
a new drug because pharmaceutical firms typically regard pricing as a highly sensitive detail of their marketing strategy. As a rule, companies will aim for the highest
price at which broad reimbursement can be secured. (Most drugs are reimbursed in
most key territories, with the exception of certain therapeutic categories. For example, most consumers pay out of pocket for many womens health products, such as
contraceptives or fertility treatments, implying that consumer behavior and price
elasticity play an important role in setting the prices for such medicines.) Pharmaceutical companies perform pharmacoeconomic studies to tag the savings that
health care systems stand to make by reimbursing drugs that can reduce the latestage complications of diseases, keep patients out of hospitals or nursing homes,
or reduce the length of hospital and intensive-care-unit stays. In most countries,
health technology assessment bodies and payer organizations verify these assumptions or conduct their own analyses.
For drugs that target conditions that were not previously amenable to drug treatment, the cost of such alternative treatment options as surgery may give a first indication of a realistic price point. Where competing drugs are already commercially
available, their price points may be used as a benchmark. New entrants may be
priced at a premium to the incumbents to reflect a superior value propositionor in
line with the incumbents or at a discount designed to gain rapid acceptance despite
a late entry. Because many drugs are launched globally, pharmaceutical companies must strike a balance between, on the one hand, harmonizing prices across
regions in an effort to minimize parallel imports, price pressure from interwoven
national reference price systems, and general frustration on the part of patients
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and prescribers and, on the other hand, implementing regional pricing strategies in
order to tap into additional volumes. Since rebates and access programs for uninsured or underinsured patients are common across the industry, analysts also need
to be mindful of the differences that may arise between list prices and average net
realized prices. In some territories, notably the EU, reimbursement of additional
indications that were added to the label after the launch in the lead indication typically requires price concessions.
Many drugs tap into potentially very large markets; numerous conditions affect
millions of patients in the United States and the EU alone, with tens or even hundreds of millions of sufferers around the world. Multiplying global disease prevalence with a reasonable price may thus yield target markets valued at tens of
billions of dollars. This approach thus carries a high risk of overstating a drugs
commercial potential. Eliminating patient populations that are unlikely to receive
the drug is of paramount importance in deducing the addressable target patient
population. Estimates of disease prevalence furnished by various organizations
often include patients who have not been diagnosed. There are many reasons why
conditions may go undiagnosed; for example, the patient may live in an area where
access to health care is poor, or the patient may be asymptomatic and the condition may not be diagnosed during routine exams. Unless there are sound reasons
to believe that future diagnosis rates will increase substantially, it is prudent to use
the number of diagnosed patients as a starting point for any market-sizing exercise. The inclusion and exclusion criteria of clinical trials and drug labels provide
valuable clues to patient eligibility. For example, use of a drug may be confined
to patients with a moderately severe disease who present with a specific disease
phenotype and certain biomarkers, who are in good overall health with good liver
and renal function, and who receive concomitant therapy that has been tested in
combination with the new drug in clinical trials, such as certain chemotherapy
backbones in cancer treatment.
It is equally important to keep in mind that not every patient who is eligible to
receive a drug from a certain class will necessarily be treated. Although physician
awareness of new drugs tends to be high because clinical results are routinely presented at key medical congresses and are published in peer-reviewed journalsand
drug firms employ field forces that provide detail to individual prescribersthere
are numerous reasons why patients and their physicians may decide against a certain course of treatment. Poor compliance may shorten treatment duration or dose
intensity relative to that tested in clinical trials. Depending on the condition, disease awareness campaigns may be required before drugs gain broad acceptance.
Competing drugs may either vie for share or expand the market. Usually, various
drugs in development have the potential to displace the incumbents, and analysts
34
need to monitor clinical trial news flow and the scientific communitys reaction to
clinical results.
The attribution of success probabilities to any drug candidate in any indication is
highly subjective. Although historical average values (less than 40% of phase II and
less than 80% of phase III assets typically reach the market) may be used as a guide,
analysts may choose higher or lower values for any drug candidate depending on
the published pre-clinical and clinical data, the therapeutic category and history of
the therapeutic class, the design of the pivotal trials, the companys track record,
and various other factors. It is important to remember that the success or launch
probability of a drug candidate is only an analytical tool to capture the risk associated with clinical development. The events are binary: A clinical trial will either
succeed or fail, and regulatory approval will either be granted or denied, implying
that the ex post success probability is always 100% or 0%. In the case of the industry majors, whose pipelines typically comprise dozens of assets in phase II or III,
the law of averages may apply, suggesting that actual peak sales for the pipeline
as a whole may approach risk-adjusted forecast peak sales, provided that all other
assumptions also prove correct. However, for a small biotechnology company, the
success or failure of a drug may make or break the investment case.
The purely mechanistic view that multiplying peak sales before risk adjustment by an assumed success probability yields peak sales after risk adjustment
does not truly reflect the ambiguity associated with forecasting drug sales, especially in the early stages of development. Analysts and investors should be mindful
of the feedback loop between success probabilities and other inputs, such as the
addressable target market, price, and penetration rates. For example, a phase III
trial may succeed in the sense that the primary efficacy endpoint is met, but the
side effect profile may be such that analysts feel compelled to revisit their assumptions with respect to the compounds suitability for different patient populations
and price point. In fact, in the early stages of development, the limited clinical
information available can make it hard to predict whether the drug is more likely
to be a mainstream or a niche product or whether it merits a price premium or
discount to competitors.
Essentially, two avenues are available for dealing with this ambiguity. The first is
to model a drugs risk-adjusted peak sales under various scenarios and then either
pick a base-case scenario or probability-weight the scenarios. This approach may be
suitable for drug candidates that have the potential to transform earnings in a bestcase scenario and that have a wide range of potential outcomes. A simpler approach
is to reflect the ambiguity with respect to such parameters as patient populations,
price, and penetration in the choice of success probability, which implicitly accounts
for the possibility that a drug may reach the market but fall short of its maximum
commercial potential. Table 3 presents an example of forecasting a drugs peak sales.
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Table 3. Forecasting the Peak Sales of a Fictitious Drug for Patients with a Certain
Mutation
Disease prevalence (in

millions of patients) (A)
Proportion of patients
harboring the relevant
mutation (B)
Target population in millions (C = A B)
Expected average drug
price/month (D)
Expected average
treatment duration in
months (E)
Expected revenue per
patient (F = D E)
Potential target market
(millions) (G = C F)
Expected peak penetration rate (H)
Expected peak sales

before risk adjustment
(millions) (I)
Success probability (J)
Expected peak sales after

risk adjustment (millions) (K = I J)
US
1.0
EU
1.4
Rest of
World
Commentary
A companion diagnostic test

to screen for the mutation
is under development
10%
10%
0.1
0.1
$3,000
$2,500
$21,000
$17,500
$2,100
$2,450
Based on market share

analysis in light of
competing products in
development
Potential assumed to
be similar to Europe;
bottom-up modeling not
feasible for rest-of-world
region
Based on clinical data
presented at a recent
medical congress
25%
$525
40%
$210
20%
$490
40%
$196
Based on competitor
product targeting a
different mutation of the
same disease
Based on treatment
duration in clinical trials
$490
40%
$196
Included in analysts
financial forecasts
As a rule of thumb, a typical drug attains its peak sales within five years of launch.
However, the growth trajectory may vary between indications. For example, cancer
medicines may reach their peak rapidly because the patient pool turns over rapidly,
whereas the uptake of new drugs for the treatment of such chronic conditions as
asthma tends to be slow owing to low switching rates between products. Predicting
the timing of a generics entry and the original brands subsequent revenue decline can
be a daunting task, with significant implications for profit forecasts. Determining the
36
earliest possible date of a generics entry on the basis of a drugs patent estate alone
may be anything but straightforward. The duration of patents and exclusivity periods
is not always known with certainty, and the level of protection afforded by formulation
and process patents, which often expire after the compound patent, may be difficult
to gauge. To the extent that at-risk launches by generics companies are possible, the
question arises whether they are likely to embark on such a course of action.
Once a drug loses protection, the question remains whether any copycat versions
can clear regulatory hurdlesa subject of intense debate with respect to complex
biologic drugs that may be difficult to copy. Although some biosimilars legislation
is now in place in the main territories, various biosimilars players have recently exited
the space, at least partly, but even seemingly simple generics of small-molecule
drugs may be delayed by supply disruptions and other factors. The erosion of the
branded franchise following patent expiration typically varies with the intensity of
generics competition. As a rule, revenue streams for such simple, small-molecule
drugs as pills and tablets tend to largely disappear in key Western markets within a
year of the expiration of the main patent or regulatory exclusivity, whereas injectable
biologic drugs tend to face slower and potentially delayed erosion. It is worth
noting that in some emerging markets, notably those characterized by significant
patient self-pay and high brand awareness, original brands may continue to grow
even after the entry of competing generics. LCM initiatives designed to improve the
convenience or tolerability of medicines (e.g., once-daily dosage forms to replace
twice-daily medicines or patches to replace pills) may go a long way in protecting
a franchise from a competing generic, provided that a large number of patients can
be switched to the enhanced product prior to the generics entry. Brand loyalty may
also partly shield a drug maker from competing generics and may be especially high
for drugs that are self-administered in trademarked devices.
Accurately forecasting the top line is by far the most challenging task pharmaceutical analysts face. Assuming variable costs of 30% for a fully owned drug, a 1%
error on the top line may translate into an error of 2% to 3% on the bottom line.
For the reasons already delineated, the peak sales of drugs at an early stage of their
life cycle are notoriously hard to forecast, and the gap between drug sales under a
realistic best- and worst-case scenario may be extremely wide for some companies.
Consequently, an analysts level of confidence in a set of forecasts may be of paramount importance to an investment decision.
It is equally important to realize that not every drug is fully owned by one company. Collaborations and licensing agreements are common in the pharmaceutical
industry, and analysts must track the proportion of in-market sales and profits that
accrues to each company. In some cases, a company may book only a portion of
in-market sales; in other cases, it may book 100% of sales but pay royalties to a
third party. And a companys economic interest in a drug may be limited to royalty
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income. To the extent that such pay-aways or income streams are material, forecasting them separately is recommended. For example, if a company is known to pay a
mid-teens royalty rate on the sales of a sizable drug to the originator through the
cost of goods sold (COGS) line, this aspect should be modeled separately. Extremely
lucrative drugs that are simple to make may have gross margins in excess of 95%,
whereas incremental COGS as a percentage of sales may exceed 20% for complex
biologics. Marginal COGS should also be modeled separately when the impact of
a top-line surprise on COGS would be material. It may be impractical to attempt
to model the COGS of other drugs with any precision because companies do not
normally disclose the exact manufacturing costs or minor pay-aways. Similarly, it is
virtually impossible to ascertain variable marketing and R&D expenses associated
with specific drugs.
On a short-term basis, many of the large pharmaceutical companies provide a fair
amount of guidance on the evolution of the individual line items. Analysts should
think of much of the operating cost as fixed, in the sense that the absolute amount
is unlikely to change dramatically from one year to the next absent major developments or restructuring. For example, R&D spend remains relatively constant over
the years. If a large number of pipeline projects were to show promise in early
clinical development, management would likely prioritize the development of some
assets over others, and R&D expenses may rise only moderately. Similarly, analysts should not erroneously assume that R&D spend would fall precipitously upon
completion of large, ongoing phase III trials because the clinical work conducted on
any one drug rarely ends with submission to the regulators and other assets may be
progressing through the pipeline. Most companies control SG&A expenses tightly;
nonetheless, new-drug launches may result in upward pressure on spend.
Most of the majors operate globally, often in more than a hundred countries, and
are thus affected by currency fluctuations. Although many companies operate R&D
centers and production sites in various locations around the globe, it is impractical
to cover the entire value chain of pharmaceutical operations in each country where
the companys drugs are prescribed, thus limiting the scope for natural hedges.
Although many companies hedge transaction exposure in major markets to some
extent, appropriate hedging instruments may be unavailable at an acceptable cost
in every market. Most companies provide ready reckoners and other measures of
currency sensitivity to enable analysts to gauge the impact of currency movements
on reported sales and profits. In contrast, the currency impact on individual line
items can be difficult to forecast.
Most companies clearly communicate their dividend policy and, where applicable,
their share buyback program. Pharmaceutical companies typically opt for a progressive dividend policy, meaning that dividends per share will remain at least at the
prior years level even in down years that may arise as a result of patent expirations.
38
VALUATION OF PHARMACEUTICAL
FIRMS
The value that investors ascribe to pharmaceutical companies and the industry as a whole is based on perceived innovative power to a significant extent.
With the exception of smaller, frequently off-patent tail products and ancillary activities, most revenue streams are finite. In fact, the largest revenue
and profit streams usually face rapid erosion upon the expiration of patents or
regulatory exclusivities, with an inherent risk of diseconomies of scale unless
they can be replaced through portfolio rejuvenation or the company substantially reduces its fixed costs in the wake of a pronounced top-line decline. Until
the middle of the last decade, one-year-forward P/E multiples in the mid- to
high teens reflected the markets expectation that the industry would be able to
innovate so as to maintain the historical double-digit growth rates indefinitely.
With patent expirations looming and following numerous clinical setbacks that
had left pipelines depleted, many of the majors traded on single-digit or lowdouble-digit one-year-forward P/E multiples in 2008 because the attractive
cash flows that the industry continued to generate were widely expected to
come to an end in the near future.
The structural issues described earlier decrease the utility of many of the
standard approaches to valuation that are used routinely in other industries.
Peer group analyses are complicated by the heterogeneity of the industry: The
marked differences in patent exposure, competitive threats, and pipeline maturity and depth translate into pronounced differences in the predicted growth
trajectory and riskreward profile of individual players. Furthermore, there
are relatively few pure plays whose exposure is limited to branded prescription drugs for human use; many of the industry leaders are engaged in miscellaneous ancillary activities, including OTC drugs, diagnostics, generics, and
products for animal health. Some of the midsize players even have exposure
to the fields of chemicals and agriculture, which may merit different sales and
profit multiples.
Owing to the substantial differences in margins and margin structure that
arise principally from the manner in which drug profits are shared between
companies and recognized in their financial statements, enterprise value (EV)/
sales ratios are rarely used in the valuation of pharmaceutical companies.
All things being equal, a company that books substantially all of the sales of
the products for which it has marketing rights but pays high royalties to the
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originators of those drugs does not merit the same EV/sales multiple as a company that owns 100% of its assets. Also, care should be taken in the case of
companies that receive substantial drug-related profits that they book through
the other revenues or other operating income line. Substantial differences
in profitability that may render the EV/sales multiple meaningless also arise
below the earnings before interest and taxes (EBIT) line, as in the case of stakes
in other companies and also tax rates, which can vary dramatically between
companies and fluctuate over time.
EV/EBIT multiples account for differences in margin structure but may be
distorted by high levels of amortization in the case of companies that have
made major acquisitions. EV/EBITDA (earnings before interest, taxes, depreciation, and amortization) may be a more suitable measure because it reflects
all aspects of current operating performance, with the caveat that the selection of a fair discount or premium of a company relative to its peer group
requires a judgment call on the companys future growth and risk profile relative to its peer group, in addition to a view on such below the line items as
taxes. There is no standard approach to deriving the premium or discount a
stock merits; relative valuations reflect both the perceived longevity of current
cash flows and the shareholders faith in a companys pipeline and innovative
power in general.
P/E multiples are generally the most popular metric used to assess relative
valuation, and stocks often revert to historical average premiums or discounts
unless a companys fundamentals have improved or deteriorated markedly
relative to its peer group. Like EV/EBITDA, P/E multiples reflect the markets
view of a companys current profitability and future fundamental prospects,
with the added advantage of incorporating such nonoperating items as taxes
and income from associates. Financial leverage tends to be relatively low in
the pharmaceutical industry and is unlikely to distort P/E ratios significantly.
A word of caution: There are slight differences between companies adjusted
EPS figures, and not every company provides an adjusted EPS figure. Brokers
who contribute to consensus forecasts may overlay their own standards for
adjusting and harmonizing EPS figures. Thus, care must be taken to ensure
that P/E multiples are calculated on the basis of, or applied to, comparable
EPS figures.
Cash-flow-based valuation approaches sidestep the issues arising from the
lack of comparability between pharmaceutical companies that hamper peer
group analyses. Such approaches capture the medium-term profit outlook with
a relatively high degree of reliability because the visibility on peak sales and
patent loss of key profit drivers is fairly high. Inevitably, they require a judgment call on the quality of a companys pipeline and its ability to innovate. By
40
Valuation
Financial
of Pharmaceutical
Statement Analysis
Firms
their very nature, methodologies based on discounted cash flow (DCF) tend
to be highly sensitive to assumptions about the terminal growth rate, which
include implicit assumptions about the long-term growth of cash flows from
ancillary activities as well as the ability of the companys branded prescription
drug business to continually reinvent itself following patent expirations. In
conclusion, DCF-based valuation approaches may yield the best approximation
to fair value, provided that investors and analysts have a high level of confidence in the company-specific forecasts that serve as inputs.
Reverse-DCF analyses that gauge the terminal growth rate implied in a
stocks current share price reveal the markets view of a companys long-term
innovative capacity. Investors may consider the likelihood that a company will
meet or exceed market expectations in the long term as well as the plausibility
of differences in long-term growth prospects priced into the shares of pharmaceutical companies.
Owing to drug firms relatively high dependence on individual drugs and
the operating leverage associated with large assets, project-specific NPV models are popular with analysts and investors. It is important, however, to be
aware of their limitations, especially concerning the uncertainty of forecasting
drugsat an early stage of development, a drugs peak sales potential and its
effective period of exclusivity may be very difficult to predictand the inherent
challenge of allocating the substantial fixed costs that continue to characterize
drug firms even in this era of in-licensing and outsourcing to individual projects. Bottom-up valuation approaches that consist of adding up project NPVs
may constitute a viable approach for biotechnology firms with limited infrastructure and few drugs in development. However, in the case of large pharmaceutical companies that rely on the continued success of marketed products
as well as permanent rejuvenation of their portfolios in order to maintain their
existing infrastructure, NPV models are better suited to sensitivity analyses.
For example, NPV models of potential blockbuster drug candidates or key marketed products that take into account only the variable cost associated with
these assets may provide a rough idea of the implications of clinical success
or failureor of the potential withdrawal of a product from the market owing
to safety issuesfor a stocks valuation and the business decisions a company
might be forced to make in the event of failure. Table 4 reports on the suitability of various valuation methodologies for the industry.
2013 CFA INSTITUTE
41
Table 4. Suitability of Standard Valuation Methodologies for the Pharmaceutical

Industry
Method
EV/sales
EV/EBITDA
Suitability
Low
Medium
P/E
High
DCF
High
Reverse-DCF
High
NPV models
Medium
Commentary
This multiple does not adequately capture
differences in margins that may arise as
a result of drug profit sharing between
companies.
This multiple does not capture substantial
differences below the line (e.g., relating
to associate income and variations in tax
rates).
This is the most widely used multiple;
because individual companies prospects
may differ materially, it requires the user to
consider the premium or discount merited
by a stock relative to its peer group.
This approach captures the analysts specific
views on a companys prospects and thus
sidesteps issues that may arise from the
industrys heterogeneity and resulting lack
of comparability across peer groups.
This methodology gauges the terminal
growth rate implied in a stocks current
share price and thus reveals the markets
view of a companys long-term innovative
capacity.
The use of drug- or project-specific NPV
models should be reserved for sensitivity
analyses. This approach does not lend itself
to bottom-up valuation, owing to the difficulties of allocating fixed costs to a large
number of individual projects.
PORTFOLIO CONSIDERATIONS
Because a pharmaceutical companys operating performance is determined largely
by the success of its drugs and drug candidates and may often be influenced only
marginally by general industry trends, stock picking is of the utmost importance. The
stocks of companies that generate top-line surprises and positive clinical news flow
usually tend to outperform the industry. Even so, it is advisable to spread pharmaceutical investments over a number of stocks so as to minimize idiosyncratic risk. Even
the best-managed and best-positioned company is not immune to the risk of extreme
events that are impossible to foresee or hedge. Such events can entail extremely large
cash outflows and can severely dent a companys profitability for extended periods.
42
Valuation
Financial
of Pharmaceutical
Statement Analysis
Firms
Examples include, but are not limited to, supply disruptions, the emergence of safety
concerns in relation to a large product, the failure of high-profile pipeline compounds,
product liability suits, and litigation of marketing practices. True hedges are rare, in
the sense that it is often impossible to identify companies that would benefit directly
and proportionally from a competitors setbacks, suggesting that diversification is
often the only viable strategy to reduce stock-specific risks.
It is worth noting that the heterogeneity of the industry, where fundamentals are
concerned, also extends to the characteristics of pharmaceutical company shares.
The listing currencies of the largest stocks include the USD, EUR, GBP, CHF, DKK,
and JPY, which further complicates hedging decisions. Size differences can also be
extreme. For example, the market capitalization of each of the five largest companies exceeds $100 billion, but there is an abundance of small and midsize companies valued at mere billions, hundreds of millions, and even millions of dollars. This
fragmentation reflects the high barriers to entry into any one segment of the pharmaceutical industry; many biotechnology players are one-product companies that
own the intellectual property to a specific molecule, which prevents their larger
peers from developing the same molecule and putting them out of business.
In light of the pronounced impact that such product-related news flow as clinical
data and regulatory approval decisions may have on a companys future profitability and investor sentiment, an understanding of key upcoming catalysts is a prerequisite for well-informed investment decisions. Uncertainty with respect to both the
timing and the outcome of any product-related news flow is one of the main challenges of investing in pharmaceutical firms. Companies often provide a rough guide
to the expected timing of news flow; for example, they might communicate that
headline results from a phase III trial are expected in the second quarter or second
half of the year. It is rarely possible to specify the month, let alone the day, when key
news flow is expected. Consequently, it is often virtually impossible for investors to
avoid exposure to news-flow risk when taking positions in pharmaceutical stocks.
The likelihood of success may be even more difficult to predict than the timing.
Many analysts and investors avidly study the publicly available clinical data, trial
design, and historical precedents to gain a better understanding of the potential
pitfalls; however, there are no crystal balls to predict the outcome of any one event.
Consequently, short-term trading strategies are often fraught with risks. Longerterm investment decisions should ideally be based on a high level of comfort around
the totality of the news flow to be expected over a time horizon of 1218 months.
There are no compelling reasons to shun stocks that are devoid of large individual
catalysts. In fact, stocks with a large number of expected news-flow items that may
not be transformational in and of themselves but have the potential to drive longerterm consensus earnings upgrades and to positively affect sentiment may offer an
attractive riskreward profile.
2013 CFA INSTITUTE
43
However, caution is warranted in the case of upcoming catalysts related to projects that are advertised as free options by the sell side. Although many analysts
may prudently refrain from including the potential upside in their forecasts, it is
often included in the whisper. By the time a sufficient number of investors have
taken positions to benefit from the potential upside, enough of it is priced in to trigger a negative share price reaction in the event of failure, whereas the rally to be
expected in case of success may be limited. A particularity of the pharmaceutical
industry is that news flow without the potential to influence near-term forecasts
may still trigger significant share price reactions. For example, a stock may rally on
the announcement of positive phase III data for a potential blockbuster drug candidate, even though the achievement of peak sales may still be more than five years
away and the drug may not break even until one to two years after the launch.
The relatively modest impact of industry trends on companies operating performance largely precludes trading strategies centered on quarterly earnings releases.
A firms operating margins primarily reflect the growth trajectories or decay curves
of its most profitable assets (i.e., their stage in the product life cycle) and the
timing of major expense items, which is largely discretionary. With the industrys
rising exposure to emerging markets, where business may be more tender driven
and conducted in a large number of different currencies (many successful drugs
are sold in more than 80 countries), even the top line is increasingly difficult to
predict. (Note that US sales of key drugs can usually be forecasted fairly accurately
owing to the wide availability of weekly and monthly prescription data.) An earnings beat or miss is thus not necessarily indicative of a change in company fundamentals; it may simply reflect fluctuations from one quarter to another. Rarely
is there a significant read-across from one companys set of results to those of its
peers reporting later.
Pipeline news flow represents a risk with respect to earnings releases to the extent
that the release contains a pipeline update and may, on balance, be slightly more negative than positive. The reason is that the results of pivotal trials are seldom communicated in the context of earnings releases. Headline results are usually announced
by means of a press release as soon as they become available, whereas the presentation of details must often await a medical congress that may take place many months
later. Medical congress rules typically prevent company management from divulging
any further information ahead of the event. At best, a company may announce positive internal decisions about its pipeline, such as phase III transitions of drug candidates. An important corollary is the possibility that the termination of development
programs or other negative news may be announced in earnings releases.
Although divergent share price performance may be more common and more
pronounced in the pharmaceutical industry than in other industries for the reasons
mentioned, there have been extended periods when stocks have moved as a group,
44
Valuation
Financial
of Pharmaceutical
Statement Analysis
Firms
often linked to industry rotations coupled with a news-flow void. Owing to their
relatively pronounced lack of cyclicality, pharmaceutical stocks are perceived as
defensive in the classical sense (i.e., as offering relatively low beta). (As discussed
previously, pipeline failures and various issues that may arise with respect to a companys current operations have the potential to send individual stocks plummeting.
In the latter part of the last decade, many of the majors suffered a string of setbacks,
prompting some investors to exclaim, This industry is not defensive!)
Because cash flows are relatively stable and predictable during the exclusivity
periods of key products, many companies offer generous dividend payout ratios
and have adopted a progressive dividend policy. Therefore, rotations into the pharmaceutical industry may at times be driven by considerations relating to dividend
yields. Although the rewards for successful stock picking may vary as a function
of the market environment, it appears intuitive that a lack of due diligence with
respect to any pharmaceutical investment invariably entails severe risks to the performance of a portfolio.
2013 CFA INSTITUTE
45
INDUSTRY RESOURCES
REGULATORY AGENCIES
US Food and Drug Administration
10903 New Hampshire Avenue
Silver Spring, MD 20993
(888) 463-6332
www.fda.gov
European Medicines Agency
7 Westferry Circus
Canary Wharf
London E14 4HB United Kingdom
44 (0)20 7418 8400
www.ema.europa.eu/ema
Ministry of Health, Labour and Welfare
1-2-2 Kasumigaseki Chiyoda-ku
Tokyo, 100-8916 Japan
03-5253-1111
www.mhlw.go.jp/english
OTHER RESOURCES
FDA ORANGE BOOK
A useful tool to track drugs approved in the United States, this resource is searchable by brand name, active ingredient, and various other parameters. It also contains such information as the date of approval, the approved dosage forms, and
patents and regulatory exclusivities.
www.accessdata.fda.gov/scripts/cder/ob/default.cfm
US PATENT AND TRADEMARK OFFICE

The federal agency for granting US patents and registering trademarks, the USPTO
provides a searchable database of patents.
www.uspto.gov
46
Industry Resources
FDA ADVISORY COMMITTEES

Announces upcoming panel meetings and provides briefing materials.
www.fda.gov/AdvisoryCommittees/WhatsNew/default.htm
FDA WARNING LETTERS

Communications to drug manufacturers and other stakeholders, which specify deficiencies in production systems that need to be addressed.
www.fda.gov/ICECI/EnforcementActions/WarningLetters/default.htm
FDA PARAGRAPH IV PATENT CERTIFICATIONS

Provides a list of all the drugs that have received a paragraph IV patent challenge
from a generics company.
www.fda.gov/Drugs/DevelopmentApprovalProcess/
HowDrugsareDevelopedandApproved/ApprovalApplications/
AbbreviatedNewDrugApplicationANDAGenerics/ucm047676.htm
EMA FIND MEDICINES

Allows users to view approved as well as submitted medicines; following approval,
a European Public Assessment Report detailing the EMAs views on the drugs risks
and benefits is also made available in this section of the website. A number of
e-mail subscription services are available on agencies websites for those who wish
to receive regulatory news directly.
www.ema.europa.eu/ema/index.jsp?curl=pages/includes/medicines/
medicines_landing_page.jsp&mid=
CLINICAL TRIALS
A widely used resource on completed and ongoing clinical trials. It is searchable by
drug, sponsor, condition, and various other parameters and includes details on each
study, such as the start date and expected completion date, the targeted patient
enrollment, the design (including endpoints), patient inclusion and exclusion criteria, and the geographic location of the study centers.
http://clinicaltrials.gov
PUBMED
A medical search tool that returns abstracts and articles (some of which are free) on
drugs, therapeutic classes, and medical conditions.
www.ncbi.nlm.nih.gov/pubmed
2013 CFA INSTITUTE
47
BLOOMBERG
Users will find a wealth of information, including prescription data and various
analyses, by typing in industry functions (e.g., BI PHRMG for the major pharmaceutical companies).
MAJOR MEDICAL CONFERENCES

Tens of thousands of physicians and other stakeholders convene annually to stay
current on medical developments in their particular field of practice. These events
are often chosen as a venue for the presentation of important new clinical data on
individual drugs. Registration is fee based and is open to the public; abstracts are
typically made available free of charge on the organizations websites.
American Society of Clinical Oncology
www.asco.org
European Society of Medical Oncology
www.esmo.org
San Antonio Breast Cancer Symposium
www.sabcs.org
American Society of Hematology
www.hematology.org
American College of Cardiology
www.cardiosource.org/acc
American Heart Association
www.heart.org/HEARTORG
European Society of Cardiology
www.escardio.org
48
CFA INSTITUTE
INDUSTRY GUIDES
THE
PHARMACEUTICAL
INDUSTRY
ISBN 978-0-938367-81-9
9 780938 367819
90000

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ABOUT THE AUTHOR

2013 CFA INSTITUTE

The Drug Discovery, Development, and Approval Process

Intellectual Property: Patents, Regulatory Exclusivities, and Other Forms of

Financial Statement Analysis

Valuation of Pharmaceutical Firms

2013 CFA INSTITUTE

2012 sales in $bn

Figure 1. Branded Human Prescription Drugs: Key Players

Pharmaceucals (human branded prescripon drugs excluding vaccines)

or production. These ancillary health care activities primarily include consumer

CFA Institute Industry Guides: The Pharmaceutical Industry

CFA Institute Industry Guides: The Pharmaceutical Industry

CFA Institute Industry Guides: The Pharmaceutical Industry

THE DRUG DISCOVERY,

CFA Institute Industry Guides: The Pharmaceutical Industry

example, by academic institutionsis taken into account when choosing a target.

The Drug Discovery, Development, andIndustry

successful completion of phase III is usually a prerequisite for approval. Once a

Target and lead

2013 CFA INSTITUTE

CFA Institute Industry Guides: The Pharmaceutical Industry

The Drug Discovery, Development, andIndustry

Simply put, a study is considered positive if the primary endpoint is met

CFA Institute Industry Guides: The Pharmaceutical Industry

The Drug Discovery, Development, andIndustry

CFA Institute Industry Guides: The Pharmaceutical Industry

The Drug Discovery, Development, andIndustry

2013 CFA INSTITUTE

CFA Institute Industry Guides: The Pharmaceutical Industry

2013 CFA INSTITUTE

CFA Institute Industry Guides: The Pharmaceutical Industry

extent on large pharmaceutical companies to provide funding and clinical expertise

CFA Institute Industry Guides: The Pharmaceutical Industry

FINANCIAL STATEMENT ANALYSIS

CFA Institute Industry Guides: The Pharmaceutical Industry

Financial Statement Analysis

CFA Institute Industry Guides: The Pharmaceutical Industry

Financial Statement Analysis

FORECASTING DRUG SALES AND COMPANY

CFA Institute Industry Guides: The Pharmaceutical Industry

top-down approaches merely serving as a cross-check. Forecasting drug sales

Financial Statement Analysis

simultaneously, regulatory or commercial considerations may result in significant

CFA Institute Industry Guides: The Pharmaceutical Industry

Financial Statement Analysis

CFA Institute Industry Guides: The Pharmaceutical Industry

Disease prevalence (in

Expected peak sales

Success probability (J)

Expected peak sales after

A companion diagnostic test

Based on market share

Financial Statement Analysis

CFA Institute Industry Guides: The Pharmaceutical Industry

CFA Institute Industry Guides: The Pharmaceutical Industry

2013 CFA INSTITUTE

CFA Institute Industry Guides: The Pharmaceutical Industry

Table 4. Suitability of Standard Valuation Methodologies for the Pharmaceutical

CFA Institute Industry Guides: The Pharmaceutical Industry

2013 CFA INSTITUTE

US PATENT AND TRADEMARK OFFICE

Figure 1. Branded Human Prescription Drugs: Key Players

Pharmaceucals (human branded prescripon drugs excluding vaccines)

Table 4. Suitability of Standard Valuation Methodologies for the Pharmaceutical