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Pharma: Mitigating R&D risks - Views on News from Equitymaster
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Pharma: Mitigating R&D risks
Dec 1, 2006

The introduction of the product patent law has increased the focus of domestic pharma companies on R&D for new-patented drugs. Though no significant benefits will accrue from new drug discovery research in the short term, from a long-term perspective, if a drug is successful, then the potential upside in terms of revenues and profitability is huge. However, the programmes of domestic companies are still in the nascent stages in comparison to their global counterparts. The risk for domestic companies is also higher, as they have only four to five molecules in the pre-clinical stages, which is considerably lesser than their global peers. Also, R&D is a time consuming process entailing huge investments. Thus, to mitigate the high costs of R&D and risks involved in the same, companies have been adopting various strategies, which we have enumerated below. Analogue research: Most of the Indian companies do not have the expertise in developing a completely new molecule i.e., they do not invest in the target identification exercise. Instead, they have adopted the approach known as ‘analogue research’, wherein molecules are developed from the existing database of validated targets. For example, Dr.Reddy’s anti-diabetic molecule ‘Balaglitazone’ is currently undergoing Phase-II clinical trials. However, it must be noted that the ‘glitazone’ class of compounds were already discovered previously and currently, there are two key marketed glitazones namely ‘Actos’ by Eli Lilly and ‘Takeda’ and ‘Avandia’ by GlaxoSmithKline Plc. Hence, Dr.Reddy’s ‘Balaglitazone’ is a validated target and not a completely new molecule.

Out-licensing: Since clinical trials form a larger chunk (around 43%) of the total R&D investment, domestic pharma companies are increasingly looking to out-license the molecule to a global pharma company after the molecule reaches a certain stage. To cite an example, Glenmark Pharmaceuticals entered into an out-licensing deal worth US$ 190 m with the US-based company Forest Laboratories for the clinical development of Glenmark’s molecule ‘Oglemilast’ (for treatment of COPD/asthma) for the US market. Glenmark will receive milestone payments for the drug depending upon the progress of the molecule. For the Japanese market, the company has out-licensed the molecule to Teijin Pharma. This strategy enables the company to monetise its R&D assets before it is commercially launched.

NCEs out-licensed by Indian pharma
Company Partner Molecule Therapeutic area Status
Dr.Reddy's Novo Nordisk DRF 2725 Diabetes Discontinued
  Novartis DRF 4158 Diabetes Discontinued
Ranbaxy Bayer Cipro XR NDDS Launched
  Schwarz RBx 2258 BPH Discontinued
Glenmark Forest Labs GRC 3886 COPD/Asthma In Phase II trials
  Merck GGaA GRC 8200 Diabetes (Type II) In Phase II trials
Source: Equitymaster research

Co-development and partnership: To mitigate the risk of R&D, companies are looking for partnership agreements with global companies for the joint development of molecules if the initial results are promising. This ensures that the costs associated with the same are shared. Similarly, any revenue upside in the event of a commercial launch will be shared between the partners. To put things into perspective, Dr. Reddy’s recently entered into an agreement with Denmark based Rheoscience A/S for the joint development and commercialisation of ‘Balaglitazone’ (DRF 2593), for the treatment of type-2 diabetes. Under this agreement, while Rheoscience will retain the marketing rights to the European Union (EU) and China, Dr. Reddy’s will retain the marketing rights in the US and rest of the world. If both these partners agree to commercialise the product on their own, then each will pay a certain amount of royalty to the other. Examples of other co-development partnerships are highlighted below:

R&D: Partnering with global companies
Company Partner Molecule Therapeutic area
Dr.Reddy's Rheoscience Balaglitazone Diabetes
Ranbaxy Medicines for Malaria Venture RBx 11160 Malaria
Biocon CIMAB of Cuba BIOMAb EGFR Oncology

Hiving-off R&D into a separate company: This strategy was a novel concept introduced by Dr.Reddy’s after a dismal performance in FY05, wherein R&D expenses had soared to 14% of revenues. Dr. Reddy’s formed India’s first integrated drug development research company – Perlecan Pharma Pvt. Ltd – by roping in Citigroup Venture Capital and ICICI Venture Capital. Accordingly, the company has transferred 4 NCE assets for clinical trials to Perlecan. The clinical development costs will be borne by Perlecan and Dr. Reddy’s will be able to capitalise on any upside in the event of a commercial launch of the 4 assets. Dr. Reddy’s currently holds 14% stake in the company, which the company will gradually hike to 62% depending upon the success of certain research and development milestones. This move is expected to be beneficial to Dr. Reddy’s in the sense that it will mitigate the risks associated with the clinical development of the molecules and will contribute to margin expansion going forward. Also, on the commercial launch of the molecules, Dr.Reddy’s gets a share of the potential revenues generated.

Earlier in CY06, Sun Pharma also announced its intention of hiving off its innovative R&D business into a separate listed company in a bid to unlock value from its R&D assets. R&D expenditure currently constitutes around 12% of the revenues of the company.

To conclude…
We believe that with the ushering of the product patent law in the country, companies investing in R&D will stand to benefit in the long-term despite the risks involved. However, there will be no contribution from the same to revenues in the medium term. Thus, companies such as Cipla, with little focus on R&D might be impacted in the long-term. Considering that Indian companies do not have the resources and the money required to invest in the entire stage of development of the molecules, we remain positive on the partnership strategies followed by these companies, despite the fact that the upside, if any, will have to be shared.

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