The Patent Cliff: A Coda

As a coda to today's post, attention is drawn to the attached article here that appeared on Bloomberg with a by-line date of April 15th ("Drugmakers Posed to Report Biggest Decline Since 2006"). The losses are attribute the fact that "the companies cope with record patent losses in 2011."

And so the challenge to Pharma becomes increasingly immediate and increasingly substantial.

What To Do in the Face of a Patent Cliff: A View from Medium Pharma

Once again, a potential substantial takeover in the pharma business has hit the headlines. And once again, the motivations for the proposed acquisition raise questions about how Big (and Medium) Pharma see the future of their industry. This time the parties are Canada's Valeant Pharmaceuticals International, Inc. and the target of their hostile offer, Cephalon, Inc. a U.S. rival. As reported at the end of March, Valeant made an all-cash offer for all of Valeant's shares, based on a valuation of $5.7 billion. This amounts to nearly a 25% premium over the closing price of Cephalon at the eve of the offering. Funding will be provided by Goldman Sachs. Valeant has also indicated that it intends to replace replace Cephalon's board if the acqusition takes place.

The motivation for the the transaction, as described in a March 30, 2011 report in wsj.com, is as follows (here):

"The offer suggests just how much the anticipated loss of revenue from patent expirations on key products is re-shaping the pharmaceutical industry. As drugs lose patent protection in coming years, drug makers stand to lose hundreds of millions of dollars of revenue and are searching for growth through acquisitions that plug those expected holes and allow companies to cut costs."

My interest is less in the dynamics of the hostile offer itself (I leave that to my M&A colleagues down the hall) and more on the commercial thinking that was reported to lie behind Valeant's offer. The following points are noted: 1. Cephalon faces a patent cliff in 2012, especially for its Provigil-branded narcolepsy product, with the expected concomitant loss in revenue that will follow such loss of patent protection. 2. The two companies share branded generic businesses in Europe and the acquisition will enable Cephalon to achieve cost-cutting in this area. This will help the company make up at least a part of these projected revenue losses.

Lying behind these two considerations are two quite different views of how Pharma should address the challenge of declining revenues in the face of a patent cliff. Cephalon's position seems to be that the company has acquired several promising compounds and it is confident that its development activities with these compounds will bear fruit in the coming years.

By contrast, the CEO of Valeant, J. Michael Pearson (a former McKinsey consultant),is said to view the matter more from the vantage of "financial engineering". In particular, Mr Pearson emphasized that he would focus on acheiving cost-cutting efficiencies, especially in the marketing of Provogil and other drugs when they come off patent protection. Moreover, he would spend less on R&D in favour of entering into partnerships to develop commpounds. In the spirit of financial engineering, Mr. Pearson also noted in a letter that since Cephalon has itself recently made two offers for acquiring companies, this will "... reduce your cash on hand by over $400 million dollars, which makes Cephalon a less attractive acquisition from our standpoint."

These two views reflect the quite different histories of the two companies. Cephalon was established in 1987 and it focuses on drugs in the area of central nervous system disorders, pain and cancer treatment. Its founder, Frank Baldino Jr., passed away in December 2010 after being in charge of the company for more than 20 years. While the company faces an imminent patent cliff next year, it remains fixed, it seems, on a strategy based of continued R&D to develop new products.

Valeant deals in both branded and generic drugs and it has a particularly interesting past. A former CEO, Milan Panic (and also a former prime minister of Yugoslavia) disposed of $1.24 million in stock, only thereafter disclosing that a major drug lacked regulatory approval. The present company itself is the product of the merger of several pharmaecutical companies. If Mr Pearson's announced intention to deemphasize R&D on the part of Cephalon is an indication of the company's general view on the issue, R&D would seem to be taking a back seat to more downstream development and commercialization.

All of this raises the larger question: whence will come the drivers for the next generation of patented drugs? The belief is sometimes expressed that nimble start-ups (like Cephalon) are a prime source for future dynamic R&D. The trend of Big Pharma to seek to acquire companies, rather than to invest these amounts in internal R&D, supports this view, at least in part. On the other hand, Valeant is hardly Big Pharma, and its announced strategy lying behind the proposed acquisition is hardly a vote of confidence for the ability of a one-time start-up such as Cephalon to continue to be a source of fruitful R&D, at least not on its own.

And so the question remains: whence will come the drivers for the next generation of patented drugs?

The Crisis in the Drug Industry: Where Do Patents Fit In?

The headline from the article that appeared in the 6 March issue of the New York Times had the clarion ring of crisis: "Drug Firms Face Billions in Losses in '11 as Patents End" here . The immediate problem is the spectre that patent expirations in 2011 will mean that drug companies will lose exclusivity over more than 10 major medicines with combined sales of nearly $50 billion, thus exposing, it is claimed, the reliance of the industry on blockbuster products.

At a more systemic level, the drug industry faces a whole set of daunting challenges, including "a drought of big drug breakthroughs and research discoveries: pressure from insurers and the government to hold down prices; regulatory vigilance and government investigation and thousands of layoffs in research and development." Finding the solution for any one of these factors is difficult enough; finding the right mix of solutions for these various factors taken together, can only be described as herculean in difficulty.

Taking Pfizer as an example, the industry is talking about "reinventing itself", "fixing our innovative core", and "refocusing on niche products rather than blockbusters, including branded generics". All of this, at least in Pfizer's case, is to be carried out while reducing R&D spending by 30%, so that R&D is directed only "on the most potentially profitable prospects".  The U.S. Government, on its part, through the National Institute of Health, dissatisfied with the pace of current drug development, is talking about the establishment of a billion-dollar centre dedicated to drug development -- this, despite the question why NIH will be able to do a better job of drug development than the companies themselves. In any event, the article then goes on the describe various aspects of the factors, described above, that amount to a potential perfect storm that will challenge the long-term prospects for the industry.

In reading this article from the IP perspective, one thought kept running through my mind. On the one hand, the expiry of more and more patents key to protecting blockbuster drugs is apparently a material proximate cause to the woes facing the industry. On the other hand, the article does not explicitly mention any measures regarding the patent function that might improve the industry's position.

At a certain level, this seems a bit odd. If the patent function is so central, why is there no explicit consideration of that function when considering the steps that the industry can take to reestablish itself. Better R&D--yes; better innovation--yes; but as for better patent strategy, the article is largely silent.

Several thoughts occurred to me:

Linguistic Alignment-- The thinking here is that, when the industry uses terms such as "rediscovery" and "renewed innovation", these notions inherently fold into them proper patent practices. Under this view, patents are an exogenous result of successful execution of these strategic measures. As such, there is no need to consider patents per se separately.

Strategic Potential-- To the contrary, it might simply be that patents are a less exogenous output, but rather an additional source for renewed strategic considerations. One way to think about this is as follows. Much attention has been devoted lately to the fashioning of a new corporate position--Chief Intellectual Property Officer--with high-level C-Suite responsibility to promote and enhance the role of IP (especially, but not exclusively patents) within the company. The CIPO is intended, presumably, to release IP from the silo of the corporate IP department, which more often than not provides patenting services for the company, but without much input at the more strategic level.

And so my question: would such a CIPO (or other form of restructuring of the patent function within corporate strategy) contribute to the efforts of the drug industry to improve its position in the current circumstances? One answer is that this is already taking place, even if these considerations were not discussed in the article. But another possible answer is that patents, as a strategic consideration, need to be reconsidered together with the other factors discussed above.