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Healthcare
Dissecting the Outsourced Drug Development
Industry Growth Drivers
Investment Summary
Uncertainty has been a major enemy of CRO stocks (and indeed, the
market in general). The key point of doubt for CRO investors now is
the outlook for long-term Big Pharma R&D investment. We propose
that growth is diminished, but CROs have opportunities to pick up
growth points elsewhere.
Event
In this quarterly preview, we publish an updated version of our CRO
Industry Size Model and discuss the assumptions underlying our
tempered, but still positive, growth outlook.
Key Points
• Biopharma Sales and R&D Growth Significantly Slower. The
BioPharmaceutical industry will face unrelenting challenges in the
coming years, many of which have little to do with the state of
capital markets. First, regulation, in the form of the new
administration's policy initiatives coupled with a stricter FDA, will be
a primary determiner of the pace of revenue growth. A strapped
consumer bearing an increasing share of healthcare costs is a
second challenge for drug makers. Finally, a general lack of R&D
productivity has left a pipeline hole that the industry will only
partially fill before a wave of patent expirations in 2011 - 2013.
• R&D Being Cut; Partnering/Acquisitions on the Rise. Recent
headcount reductions in R&D, coupled with several companies'
decisions to abandon research in non-core therapeutic areas make
abundantly clear the fact that the R&D budget line is no longer a
"sacred cow." We no longer think that R&D can grow meaningfully
faster than sales. Instead, we think that partnering and M&A will
increase as a means to fill pipeline, a trend that seems to be
accelerating with the breakdown in the capital markets.
• Increased Outsourcing. Partially offsetting slower sales and R&D
growth is an assumption that outsourcing penetration will accelerate
as pharma sheds internal capacity. There is broad consensus on
this view, but we add to the discussion a refined analysis of the the
addressable market for CROs, which now excludes $20B for
internal development management, scientific expertise, and
pass-through costs excluded from CRO net revenue. Using a
smaller addressable market, we estimate that the 2008 CRO
penetration stands at ~37% versus our previous 2008 estimate of
~30% using a larger addressable market.
• Taking Market Share. Consolidation of work/share among the
large multi-nationals is another factor that can keep growth in the
black for the public CROs. This should accelerate due to 1) needed
access to treatment naïve populations abroad, 2) sponsors' desires
to have entrenched, efficient relationships with a few preferred
providers, and 3) higher investment by large multinationals in
enhancing and measuring productivity.
• Bottom Line. Our new model shows a '07-'12 CAGR for the CRO
market of 9% versus our previous estimate of 14%. The top
multinationals should post better growth due to market share gains,
offset by FX headwinds at least in 2009. Look for companies with
strong late-stage presence internationally to find pockets of highest
growth: PRXL, ICLR, KNDL.
DRILLING DOWN ON DRIVERS
Pharma sales forecasts falling short (negative)
The BioPharmaceutical industry will face unprecedented challenges in the coming years, many of which have little to do
with the state of the capital markets. First, governmental policy will be a primary determiner of the pace of revenue
growth. We aren’t certain on the timing of policy decisions, but we offer the following general thoughts that play into our
industry revenue forecast.
1. While still short on specifics, proposals for healthcare reform by the newly elected administration clearly target
the high cost of prescription pharmaceuticals. This will benefit generic manufacturers, including potential
makers of biogenerics. Unfortunately for CROs, generic companies account for only about 1% of the R&D pie.
2. The trend at the FDA toward stricter safety standards has continued unabated and has arguably become even
more onerous. The appointment of long-time safety advocate Sidney Wolfe to the FDA’s Drug Safety and Risk
Management Committee likely narrows the eye of the drug approval needle. According to the WSJ, Wolfe has
helped push 16 drugs off the market in his role at Ralph Nader’s Public Citizen advocacy group. More broadly,
a focus on safety is positive for CROs given the need for more complex trials. Not so for their clients. To frame
it in terms of the variables driving growth, a stricter FDA means greater CRO penetration but slower BioPharma
sales and R&D growth.
Second, the recent trend has been, and will likely continue to be, toward consumers bearing a greater portion of
healthcare costs. With Medicare costs rising at an unsustainable rate, with deductibles and copays growing, and with
unemployment increasing at an alarming pace, the consumer will have to pick up the slack in funding healthcare costs.
That means more prescriptions will not get filled, there will be a greater affinity for generics, and consumers will be
forced to simply do without in some circumstances.
The third problem for drug makers is the general lack of R&D productivity in recent years. 2007 was a 17-year low for
new molecular entities. While 2008 saw an uptick to 21 NMEs, the industry is nowhere near its 1996 high of 53. With
the huge patent expiration wave coming in 2011-2013, there is a pipeline hole that will clearly not be filled. We have not
seen, nor are we likely to see in the near future, a disruptive technology that will collapse the cost of developing a new
drug. Investors in large pharma should not interpret the last couple of years of more intensive cost cutting as an
awakening for those in the industry or a panacea for productivity. We believe it optimistic to expect to be able to spend
less and get more (approvals or new revenue) out of it. Cost savings will have to be achieved by better blocking and
tackling, for the most part. Those efficiency gains will be hard won given 1) offsetting regulatory “inflation,” 2) cultural
resistance, and 3) implementation cycles.
These pressures will lead to slower revenue growth and probably also consolidation and increased partnering. We find
the Pfizer/Wyeth deal speculation peculiar in that regard. Both have significant patent cliffs, and cutting their combined
R&D will produce fewer drugs, not more. It may distract investors for awhile, but the new company will be right back in
the same spot soon enough.
With those thoughts in mind, Charts 1 and 2 below detail our projections for industry revenue growth.
293311.pdf
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