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Pharma: The next stop is... - Views on News from Equitymaster
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  • Apr 10, 2006

    Pharma: The next stop is...

    While pharma stocks have been garnering investor interest over the past few weeks, one of the factors that have sparked the rally has been the increased activity on the acquisitions front. And these acquisitions have not taken place in US, but the second largest market in the world, Europe. So what is it that has attracted domestic pharma majors such as Ranbaxy, Dr. Reddy's, Wockhardt and even smaller players like Matrix Labs and Torrent Pharma to this region? Let us take a fundamental view.

    Generic fundamentals to remain strong: In Europe, the ageing population (as a percentage of regional population) is expected to rise from the current 20% to around 26% by 2025. As is the case in the US, this is likely to put a strain on the healthcare budgets of European governments paving the way for faster entry of generics in the region. Apart from this, drugs worth US$ 14 bn in innovator sales are scheduled to go off patent in Europe between CY06 and CY11 highlighting the potential for generic pharma companies (Source: Ranbaxy presentation).

    Low profit, low risk:Unlike the US, where pricing is generally unregulated, in the European market, they are restricted by price controls (for branded drugs as well as generics). As a result, profit margins tend to be lower in Europe than in the US. That said, risks also tend to be lower. This is because in Europe, generic players do not face legislation corresponding to the 180-day exclusivity period (the 180-day period is unique only to the US markets). Also, compensation for alleged patent infringement is typically lower than in the US. In that sense, profits from European operations tend to be relatively stable.

    Differing penetration levels: In countries, where the prices of branded drugs are high, generic drug prices also tend to be high as is the case in Germany and UK. By contrast, in low-price countries, like France, Spain and Italy, generic drugs command a minor share of the total market. However, generics are expected to catch up in these countries due to government cost-containment measures.

    Generic penetration levels
    Country Penetration* Price difference**
    UK 55.0% 80.0%
    Netherlands 35.0% 50.0%
    Germany 45.0% 30.0%
    France 5% to 15% 30.0%
    Italy 5% to 15% 25.0%
    Spain 5% to 15% 25.0%
    * Average penetration after 4 years
    ** Avg. difference between brand & generic price after 4 years
    Source: IMS Health

    Favourable pricing trends: Although in volume terms, the US is the world's largest market, its value is relatively lower than either the UK or the German market. This is due to narrower price difference between generics and branded drugs in Europe, compared with the US. Also, due to the absence of any 180-day exclusivity period in Europe, prices for generic drugs throughout their life-cycles tend to remain more stable. To put things in perspective, in the US, generally during the 180-day exclusivity period, a generic company prices its products approximately 30% below the price of the branded drug. Once this period gets over and more players make an entry, prices erode by as much as 90%. This kind of volatility is not witnessed in the European markets, though prices do decline with increasing competition.

    Longer approval timeframe: Though generics are making strides in the European region, caveats exist in the form of longer approval timeframes. For instance, in the US, generic drugs are launched after they have approved by the US FDA. In Europe, generic companies follow the 'mutual recognition' procedure. This option allows for market approval granted by one member country to be extended to one or more countries, selected by the applicant. Therefore, this approval process has been more complicated and more time-consuming than in the US. Regulatory approval typically takes at least 24 months in Europe and an average 20 months in the US (Source: Fitch).

    Indian pharma: Capitalising on Europe…

    Going the European way
    (% of sales) CY03 CY04 CY05
    Ranbaxy 8.6% 15.8% 16.7%
    Dr.Reddy's* 7.2% 12.7% 12.5%
    Wockhardt 31.2% 42.0% 41.2%
    * March ending company

    Domestic pharma companies Ranbaxy, Dr. Reddy's and Wockhardt have identified Europe as their second priority market after the increasingly competitive US market and have stepped up activity in this region. For example, in CY05, domestic pharma major Ranbaxy forayed into Spain (by acquiring the generic portfolio of the Spanish company Efarmes) and Italy (set up its subsidiary and also acquired GSK Plc's generic division, Allen SpA). The company also recently acquired the Romanian company Terapia. Dr. Reddy's, by acquiring Betapharm, has gained a strong foothold in Germany, which is the largest generic market in Europe. Wockhardt, in fact, established a global footprint by acquiring companies in UK and Germany and at present, this region is the largest contributor to its revenues. Though the US continues to be a lucrative market, a competitive pricing environment has compelled these companies to turn their attention to the faster growing European regions. Eventually, a widespread geographical reach and an early presence in markets to capture significant market share will contribute to the revenue stream of pharma companies in the long term.



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