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http://www.nytimes.com/2002/07/14/business/yourmoney/14DRUG.html

Patent Issues Hurting Big Drug Companies

By CONRAD DE AENLLE

NY investors who fled the collapse of technology stocks have sought refuge in shares of global drug makers, traditionally known for consistent earnings growth in all kinds of economic conditions.

Since last fall, however, the stocks of big pharmaceutical companies have tumbled amid concerns about competition from generic drugs and a slowdown in the number of products in the approval pipeline. The sell-off has left the sector trading roughly in line with the broad market.

The market concerns are genuine, fund managers and analysts say. Although they see some possible bargains, mainly among European companies, they advise investors to tread carefully and to resist the temptation to buy just because prices have fallen sharply.

"There are a few companies that have come down quite a long way and don't look very well," said Emil Doerig, a manager of global pharmaceutical and health care funds for Credit Suisse Asset Management in Zurich. "Investors are of the opinion that drug companies have insufficient new products in the pipeline to compensate for old ones" whose patents are expiring. "Many products have lost patents," he added, "and generic manufacturers are challenging existing patents."

The patent assault, based on an argument that the new drugs are substantially the same as the old ones with expiring patents, has been initiated by makers of less expensive generic drugs. The patent challenges came at a particularly bad time for the industry, said Paul Kavanagh, a partner at Killik & Company, a London broker.

"Until October, big pharmaceutical companies had displayed very good outperformance and had traded up to quite high valuations," Mr. Kavanagh said. "Then, suddenly, investors wanted to buy cyclical stocks. At the same time, something more worrying started to creep into the industry. You started to see court cases by smaller companies trying to get around patents."

In a notable defeat for the big companies, a federal judge in Norfolk, Va., ruled in May that the United States patents on Augmentin, an antibiotic marketed by the large British drug maker GlaxoSmith- Kline, were invalid because they did not contain new inventions. But there is a good chance that Glaxo will win on appeal, Mr. Kavanagh said.

The industry has also been criticized for the types of new products it has developed. A report by Salomon Smith Barney said that a number of these drugs are "me too" products that treat the same ills in much the same way as existing drugs.

The report also noted that the Food and Drug Administration, which regulates the industry in the United States, had been critical of the manufacturing standards of several large American companies, including Schering-Plough, Abbott Laboratories and Eli Lilly. Salomon recommends holding fewer shares of American drug companies than the group's stock-market weight implies and relatively more shares of their European counterparts.

As a result of the regulatory scrutiny and the challenge from generics, industry profitability has been depressed. Mr. Doerig expects this year's earnings to be within 5 percent of last year's results. "Hopefully they will recover" in 2003, he said.

Drug makers are forever searching for the next blockbuster, typically defined as a product that generates at least $1 billion in annual sales. Mr. Doerig said the delay in finding a new F.D.A. director, to replace Dr. Jane E. Henney, who resigned in early 2001, had created a bottleneck in the approval process.

"The F.D.A. has been an organization without a C.E.O.," he said. "It's not really encouraging. There is an impression that nobody is ready to take responsibility for approving new drugs. That is probably the most critical issue" facing the industry.

Mr. Doerig recommends avoiding companies that "have less attractive product profiles" — that is, more drug patents about to expire than others — and investing in companies "with recognized patent protections."

As in other industries, the best companies have strong managements, he said. "Some companies are more successful than others because they have vision," he said, "a focused strategy in which they concentrate on core competence, getting rid of all nonstrategic business."

One of his favorite companies, a success based on both of those criteria, is Novartis of Switzerland. It sold off its agrochemical subsidiary in late 2000 to focus on its pharmaceutical business, and has some strong products up for approval, including treatments for arthritis and irritable-bowel syndrome.

ANALYSTS at Lehman Brothers also like Novartis, citing the success of its existing products over those of rivals. In a report on the company, they said its Lotrel drug for hypertension had been gaining market share over a drug made by Pfizer.

Glaxo, by contrast, is struggling to bring significant new products to market, while the other big British drug maker, AstraZeneca, is straining to defend patents on old ones, Mr. Kavanagh said.

AstraZeneca expected strong revenue from Crestor, its new anticholesterol drug, but has fallen victim to the F.D.A.'s approval logjam. The company is counting on Crestor to help compensate for reduced sales of its ulcer treatment, Losec.

Mr. Kavanagh finds AstraZeneca's stock prohibitively expensive, at roughly 25 times estimated 2003 earnings. Glaxo, at about 16 times earnings, in line with Britain's stock market, offers better value, he said, but he prefers to wait until the price, down about one-fourth from its high of the last year, falls an additional 10 percent or so.

"You're buying a market rating and market yield for a company in what is still a growth industry," he said, "but you have to see very compelling value before you would consider buying these things." 

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