Consolidation in the Generic

Pharmaceutical Industry
An evolving landscape

Dr Peter Norman

Published and Distributed by

Urch Publishing Ltd
PO Box 27554
London SE4 2GZ
UK
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Consolidation in the Generic Pharmaceutical Industry

Executive Summary

The early part of the new millennium has seen a remarkable transformation in the
pharmaceutical markets. The revenue growth generated by major pharmaceutical companies
has slowed dramatically while the generics business has transformed into a high-growth
segment of the pharmaceutical market. This has been accompanied by the emergence of
several major players, with the leading two – Teva and Sandoz – both generating sufficient
revenues from generic pharmaceuticals (in excess of $6bn in 2006) to be described as major
pharmaceutical companies.

In 2006 global sales of generic pharmaceuticals were $77bn, with Europe (27%) and the US
(23%) the most significant territories in producing these revenues. Other significant markets
are Canada, Mexico and Brazil, with India and China steadily emerging in importance. The
Japanese generics market is relatively small and is expected to become increasingly less
significant in global terms as the world generics market grows to $124bn by 2011.

In the US generic drugs sales were $27.4bn in 2006, representing 11% of the total market by
value. Sales of generic drugs grew by 23.6% in 2006 and accounted for 63% of all
prescriptions dispensed. In Canada sales of generic drugs accounted for $3.0bn of revenues,
18.1% of the market by value and 44.5% by volume. In 2006 total European sales of generic
drugs were $27.8bn, split almost equally between Western Europe and Central and Eastern
Europe, with market penetration averaging 27% by volume. But there is considerable
variation across Europe in the market penetration by generics, ranging from 3.5% in Italy to
50.7% in the Czech Republic by value and as high as 70% by volume. Germany and the UK
provided the largest generics markets in 2006, but generic penetration is increasing rapidly in
countries such as France and Switzerland.

Despite its position as the world’s second largest pharmaceutical market, Japan currently has
a low-value generics market. In 2006 sales of generics were only $2.3bn, accounting for 5.2%
of the market by value and 16.8% by volume. Latin America provides a significant
pharmaceutical market with total 2006 sales of $41bn but, like Europe, generic penetration is
variable. It appears to be increasing rapidly in both Brazil and Mexico, the two largest
markets, but the 10–11% market penetration by value compares unfavourably with the 47%
penetration achieved in Chile. Generics account for a significant proportion of drug revenues
in both China and India, while versions of drugs whose patents are not valid in those
countries account for at least as high a proportion of total sales.

There are a number of emerging key issues that impact considerably upon the growth
prospects of generics companies. The recent emergence of authorised generics in the US, as
a means of circumventing certain of the provisions of the Hatch–Waxman Act, is adversely
impacting upon revenues of those generics companies that were anticipating having 180
days’ market exclusivity for being the first to market a new generic product. Concerns over the
anti-competitive nature of this practice may result in its abolition but in the short term the
increasingly widespread adoption of authorised generics will adversely impact upon revenue
growth of the more aggressive generics companies.

The progressive decrease in the number of novel therapeutic entities reaching the market and
the increasing number of those that are recombinant biological agents will both impact upon
the growth prospects of generics companies. The reduced number of new drugs will
ultimately reduce the number of opportunities to launch new generic products although the
impact of this deficiency will not be felt for some 10 years. With many of the more
commercially successful new products also being biological products the financial impact will
be further accentuated.

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Consolidation in the Generic Pharmaceutical Industry

Biological products account for an increasing proportion of the pharmaceutical market, with
20% of the 160 products that generated sales revenues of at least $750m in 2006 being
recombinant products, including 19 blockbuster products generating revenues of $40bn. But
attempts to introduce generic forms (biosimilars) of older biological products, such as
Amgen/Johnson & Johnson’s epoetin alfa, have been hampered both by the complexity of
patents covering the production of the product and by the lack of suitable legislation to enable
the approval of such products. While Europe has now implemented legislation to address this
problem, and recently approved a number of such products, no such legislation has yet been
forthcoming in the US. Such legislation is currently under discussion and may become law by
late 2008.

Although this is just one of a number of entry barriers that hinders the market entry of
(cheaper) biosimilars, the increasing lack of opportunities to develop new generics and the
commercial potential of biosimilars will ensure that a significant number of generics
companies, as well as new specialist companies, will emerge as providers of such products.
But the consumer benefit will be less dramatic than is the case with conventional generics,
because the much higher cost of producing biosimilars will provide much smaller price
differentials from branded products.

In response to some of these problems and in a drive to achieve greater efficiency, many of
the leading generics companies have pursued consolidation via mergers and acquisitions.
This has enabled them to enhance their marketing muscle and to improve their geographic
penetration, many of the companies originally having been focused upon a single country.
This development has been highlighted by the battle between Teva and Sandoz for market
leadership of the sector, with both making several major acquisitions in the period 2000–05,
with Ivax and Hexal, respectively, being their most significant acquisitions.

In response to the emergence of these two major players, several other companies have
pursued the acquisition trail in order to be able to compete more effectively. This has led to
some highly contested takeover battles. A competitive auction between Actavis and Barr for
Croatian-based Pliva saw Barr pay $2.5bn in October 2006. Almost immediately, in what was
seen as a defensive move, Watson and Andrx agreed a merger, with Andrx receiving $1.9bn
from Watson. Merck’s announcement in January 2007 of its decision to sell its Generics
division evoked considerable interest even from some of the smaller Indian generics
companies, with Mylan finally prevailing in May 2007 for €4.9bn.

Hospira acquired Mayne Pharmaceuticals for $2bn in February 2007, thereby reinforcing its
position in the injectables market and highlighting how Hospira is likely to pursue further
targets. Other US-based generics companies appear unlikely to pursue acquisitions but might
be targets for foreign-based companies, with Par potentially the most vulnerable. In Europe,
Ratiopharm, Stada and Actavis are now the most significant European-based companies after
Sandoz, and all appear likely to pursue further strategic acquisitions while appearing less
likely to fall to predators. Within Europe there is considerable scope for further consolidation,
especially in Central and Eastern Europe, with Zentiva, Krka and Gedeon Richter all potential
targets as well as companies that are acquiring smaller companies.

Indian generics companies are potentially the most aggressive and they now appear to have
the ability to secure financial backing to contemplate the acquisition of significantly larger
companies such as Merck Generics. Most of the leading Indian companies have been active
in making acquisitions in other markets to enhance their strategic position, while there is
increasing interest in the advantages that their acquisition by an outsider provides. Mylan
acquired a controlling stake in Matrix Laboratories in 2006 to provide a lower cost
manufacturing source. Significant domestic suppliers in other markets, such as Australia,
Brazil, and South Africa, have also been targets as the more aggressive generics companies
seek to enhance their global presence.

Brazil, Mexico, China, India and South Korea are five countries that could have a significant
impact upon the global development of the generics market. India is the home of many
efficient generics companies and a major source of active pharmaceutical ingredients (APIs)
but currently offers a modest-sized domestic market despite its high population. The

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 Executive Summary

anticipated market growth, the global cost advantages of producing drugs there and the skills
of the local population are all likely to promote attempts to acquire some of the local generics
companies. China offers a larger market and an even lower cost base but currently lags
behind India in technical capabilities for producing pharmaceutical products. While China is
likely to develop as a more significant source of APIs, acquisition of local producers currently
appears unlikely to occur in the short term. Brazil and Mexico offer significantly sized
domestic markets in which demand for generics is expected to increase markedly, thus
providing attractive opportunities for inward investment.

South Korea combines a small domestic market with strong technical capabilities. Despite
this, to date its generics companies have made few efforts to compete internationally. Their
delay in making such moves will hinder future attempts to do so owing to their cost
disadvantages relative to India and China. Brazil offers the greatest potential in South
America. As a highly populated country it offers considerable potential for market
development. Generic penetration is currently low but sales are growing fast and are
dominated by four domestic suppliers. Brazil also offers a good base for further expansion
into the remainder of South America.

In June 2007 the world’s 11 largest generics companies were spread across the world, with
five in Europe and only three in America. Merck, Ratiopharm and Stada are all based in
Germany, Sandoz is headquartered in Austria and Actavis in Iceland. Teva is based in Israel,
with Ranbaxy and Dr Reddy’s the two largest of the Indian companies. Mylan, Barr and
Watson are now the largest three American-based generics companies.

Teva and Sandoz are leading players in nearly all markets, with Actavis, Merck, Ranbaxy and
Dr Reddy’s active in most. Mylan’s proposed acquisition of Merck and Barr’s acquisition of
Pliva have redressed the geographical imbalances in those American companies’ revenues
but Watson continues to remain over-reliant on the US market. Similarly, Ratiopharm and
Stada derive most and almost all their respective revenues from European markets.

Teva is the world’s largest generics company and ranks as one of the world’s top 20
pharmaceutical companies. In 2006 generics produced nearly $7.0bn of Teva’s $8.4bn
revenue. Sandoz, the generics division of Novartis, generated revenues of $6.0bn in 2006
and became the first company to launch a biosimilar product. Watson’s acquisition of Andrx in
2006 produced a company that on a pro forma basis had revenues of about $3bn in 2006, but
reported revenues of $1.98bn. Barr acquired Pliva in mid-2006 and reported revenues of
$1.6bn, while indicating that pro forma revenues were $2.4bn. In 2006 Merck Generics
produced revenues of €1.9bn, significantly higher than the $1.61bn reported by Mylan. Pro
forma revenues for the enlarged Mylan would have been $4.2bn.

Actavis’s growth has been driven by a series of strategic acquisitions, most notably the US
company Alpharma in December 2005. Actavis reported revenues of €1.38bn for 2006. In
2006 Stada reported sales of €1245.1m, while Ratiopharm achieved revenues of €1.7bn.
Ranbaxy and Dr Reddy’s are vying for position as the leading Indian pharmaceutical
company. Ranbaxy’s revenues in 2006 (year ending 31 December) were $1.34bn while Dr
Reddy’s reported revenues for fiscal 2006 (year ending 31 March 2007) of $1.5bn.

Four factors will exert key influences on the evolving competitive landscape over the next 10
years. New market opportunities and the potential offered by biosimilars will provide the key
growth opportunities. But conversely there will eventually be a decline in the number of new
generic opportunities for synthetic therapeutics. Increased competition, both from emerging
markets and from authorised generics, will have a major impact upon both short- and
medium-term competitiveness.

Three strategies stand out for generics companies responding to this evolving landscape.
Consolidation will continue to be a significant option with multiple benefits. Meeting the
challenge of supplying biosimilar products and developing strategies that provide an
alternative to the pursuit of cost leadership, such as the provision of branded generics, will
also be key elements to success.

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