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Pharma: Brave new world

Dec 20, 2002

The pharma sector majors continue on their journey to infinity and beyond. The revenue model adopted by these companies is perhaps the boldest in the Indian industry. These companies are following a two-pronged approach. First approach is weaved around looking for an opportunity to tap an existing patent viz. challenge the patent of existing products or wait for the patent to expire and then launch the generic version to tap US market. The second revenue stream is an even bolder one. These companies plan to offer research and development (R&D) services to global majors or carry out work on their own. Considering, the expenditure required for experimentation and the fact that years of research could lead to disappointment makes the bet a very risk one.

The generics front
In August 2001, Dr. Reddy's won the challenge to the patent on fluoxetine (generic of Eli Lilly's block buster product Prozac) and the right to launch the drug. It got a 180-day marketing exclusivity for fluoxetine. Consequently, the generics business, which started with modest sales in 1QFY02, ended the year (fiscal FY02) with 26% of the company's turnover. This was mainly fuelled by fluoxetine 40 mg capsules contributing around 21% to the total turnover of the company i.e. Rs 3,286 m (US$ 67 m). However, since the marketing exclusivity for fluoxetine expired in January '02, two other competitors have entered the market. This has led to a sharp price erosion (almost 80%) for the drug.

In February 2002, Ranbaxy received FDA approval for marketing Cefuroxime Axetil tablets in the US markets after a long legal battle and launched the drug in March 2002. Ceftum (generic Cefuroxime) had already gone off patent in 2000. Due to lack of any other player in the market with necessary approvals, Ranbaxy continues to enjoy ‘technical’ monopoly (in generic version) for marketing this anti-infective in the US markets. Post its launch, the company has already enjoyed about 9 months of exclusivity on the US$ 400 m drug and this exclusivity is likely to continue for some months into the future. Apotex, the nearest generic competitor of Ranbaxy recently received the US FDA approval for its ANDA of Cefuroxime Axetil (only for certain dosages). But Apotex is unlikely to launch its product due to its pending litigation on patent infringement and marketing injunction filed by original patent holder Glaxo.

In the recent past the industry has had its share of disappointments. In November 2001, Dr. Reddy’s lost its challenge to the patent on Omeprazole (an anti-ulcerant product) the largest selling pharma product in the world with US sales in excess of US$ 4 bn. In October 2002, Andrx, the US partner of Cipla, lost the patent infringement case against the original patent holder, AstraZeneca.

The research front
On the research front, Indian pharma majors have been working on molecules and further licensing them to global pharma MNCs. While Ranbaxy became the first company to license a new once–a–day dosage form of ciprofloxacin to Bayer (Novel Drug Discovery System), Dr. Reddy was the first to license a New Chemical Entity (NCE), an anti–diabetes molecule to Novo Nordisk of Denmark.

The disappointments have not been limited to the generics business. In July 2002, clinical trials for Dr. Reddy’s anti-diabetic molecule DRF-2725 licensed to Novo Nordisk were suspended. This came as a major setback for the company. DRF-2725, the dual acting insulin sensitiser termed as ‘Ragaglitazar’ was counted among the major catalysts for the company’s research efforts.

Recent developments
Due to the disappointments in the recent past, pharma stocks have been out of favour. However, this week brought good news. Firstly, Bayer’s Cipro XR 500 mg got approval from the US FDA (foods and drug authority). This was a positive for Ranbaxy as it has worked on the drug delivery system of this product. The drug delivery system has been licensed out to Bayer for a consideration of US$ 65 m. Of this, Ranbaxy has already received US$ 22 m. Once the product is launched in the market (January 2003) the royalty will start to flow in (6%-8% of sales). With sales of Cipro expected to be in the range of US$ 300 m, Ranbaxy could earn as much as US$ 15 m.

In another development, the US courts ruled in favour of Dr. Reddy’s in the Amlodiphine Malate patent. Consequently, the company will be able to launch the product by August next year, when Pfizer's exclusivity term on the product expires. This however, is subject to Dr. Reddy’s winning a citizen's petition that Pfizer has filed with FDA seeking to deny the recent approval. If the company wins this battle, this could translate in significant revenues for Dr. Reddy’s. The original patented drug of Pfizer, Norvasc has sales in excess of US$ 1.7 bn.

          52 week P/E (x) range
Company FY03E EPS
(Rs )
CMP
(Rs)
52 week
high /low (Rs)
Current
P/E (x)
High Low
Dr. Reddy's 61.2 907 1,149 / 676 14.8 18.8 11.0
Cipla 55.5 891 1,029 / 806 16.1 18.5 14.5
Ranbaxy 31.8 567 590 / 412 17.8 18.6 13.0

Currently almost all domestic pharma majors are trading at lower levels compared to their historic valuations. Also a series of successes in generics and R&D business could cause a re-rating of the sector. Therefore, this could be an opportunity to make investments in the sector considering a long-term perspective. However, please be aware of the pitfalls of treading the generics or the R&D strategy.

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