Monday, March 22, 2010

Biotechnology Gets a Shot in the Arm

Yesterday's passage of comprehensive health reform no doubt opens a Pandora's box. And while legal challenges may eventually block its full implementation, an outright repeal is unlikely, which means many—if not most—provisions will remain in effect.

One such provision is the creation of a pathway for follow-on biologics ("FOBs", or generic biologics)—new versions of innovator products. For years, the industry has been at an impasse over data exclusivity and patent law.

A pathway now exists, for better or worse. Increased competition will likely make it better for all parties: generic makers, payers, patients, and even innovators.

This morning, Steven Grossman of the HPS Group—and a veteran policy expert on the biopharmaceutical industry—posted an important article on his blog FDA Matters, which we've also published in our newsletter Perspectives. (Read here.)

He writes:

The market was not waiting for the law to pass. Even though a legislatively-created FOB approval process was uncertain, Pfizer, Merck, Novartis, Teva and other major biopharmaceutical companies had already made decisions to be involved. Billions have already been spent or committed by companies before they knew the final FOB ground rules in the US.

More knowledge about the discovery, creation and manufacturing of biologics will be good for innovators, as much as imitators. Some of those biologically-similar products will themselves be innovative. As a result, many will require full approvals rather than being able to take advantage of an abbreviated FOB pathway.

Innovators will benefit from progress on characterizing biologic molecules, new testing methodologies and manufacturing improvements. To take a single example, the FOB market will force new investments in understanding immunogenicity that will benefit the entire industry, as well as patients.

The question now is, What's next?

Expect more dollars invested in biotechnology and specialty pharmacy, the high-value-added supply chain for these products. (Winners could include Medco, CVS, Express-Scripts, and Magellan Health Services.)

Market movement won't occur overnight. It could take five years or more to gather momentum. It's not just product development cycles and legal challenges that affect this, but also specialty pharmacy imbalances as the supply chain retools and expands.

That momentum will be substantial.

Mandated use of electronic health record and ICD-10 implementation will facilitate this momentum by enabling greater specificity in care delivery and establishing more efficient reimbursement.

Because personalized medicine cannot occur without a more competitive marketplace for biopharmaceutical products—and the FDA has been reluctant to approve follow-on products without a pathway—the creation of a pathway is essential to medicine's evolution, and therefore unlikely to be repealed.

Of course, this doesn't mean lawmakers won't alter its details, the 12-year exclusivity period or patent provisions.

Just the basic construction of a pathway should be enough to accelerate powerful market momentum.

Saturday, March 13, 2010

This Time It's Still the Same Problem


Michael Lewis has a problem. Liar's Poker, his expose on 1980s Wall Street, was supposed to appall readers, not enthrall them—or even entice younger generations to aspire to its excesses. He expected his book to be a requiem to a bygone era.

Alas, the money got better, and easier. Bonuses inflated, and so did the lifestyles. Salomon Brothers and its raucous bond floor transformed from a partnership of quirky personalities into a publicly traded, financial services behemoth, where fat cats gambled other people's money at no risk to themselves.

Risk and return completely disconnected. In his new book, The Big Short, Lewis writes: "Success is individual achievement, and failure is a social problem."

He describes a new financial world of big investment banks gorging themselves on Mexican immigrants purchasing $700,000 homes, with $14,000 in earnings. These banks' financial wizardry is so cunning, they believe, that they can manipulate the ratings agencies, and swiftly move two-steps ahead of regulatory bureaucracy. Their customers are so trusting of a AAA rating, that even far-away German pension funds will purchase their billions of dollars in financially engineered products, no questions asked.

Ultimately, the banks' illusions would manifest for what they were—delusions—and they would destroy themselves and, nearly, the system itself.

Several pundits have claimed clairvoyance in predicting the subprime meltdown. The Big Short focuses on those who not only actually forsaw it, but who also staked their reputations, wealth and even their health on their convictions.

And while they proved themselves prescient and gained vast riches as a result, Lewis devotes his pages instead to their moral outrage at the system's corruption. He portrays his protagonists as neither sympathetic nor necessarily the sort of people readers might want to aspire to. They are bright, abrasive, obstinate—and completely obsessed at pursuing their bets against the broken financial system.

Of Greg Lippmann, the Deutsche Bank trader who famously shorted the subprime mortgage market while his colleagues continued packaging ever-more esoteric CDOs, he writes:

Thin and tightly wound, he spoke too quickly for anyone to follow exactly what he was saying. He wore his hair slicked back, in the manner of Gordon Gekko, and the sideburns long, in the fashion of an 1820s Romantic composer or a 1970s porn star.

Even his brief glimpse of John Gutfreund reveals a tortured man: "As he began to describe his career [while on a panel about Wall Street at Columbia Business School], he'd broken down and wept." Gutfreund's biggest and most fateful act, we learn, was his decision to turn Salomon into a public corporation.

Timing the financial system's demise is neither easy nor an overnight accomplishment. Steve Eisman (the acerbic, onetime bank analyst at Oppenheimer, and now hedge fund manager), Charlie Ledley, Michael Burry, and their partners and associates dedicated months of careful analysis to proving and disproving their theories. They also faced the additional challenge of placing their bets with illiquid credit default swaps, not the best vehicle for price discovery, but the only pure vehicle available targeting the faulty subprime loans.

They endured immense skepticism that they were correct, much of it their own, and withstood long periods of market irrationality. In the first half of 2007, for example, the long descent for subprime loans began as default rates escalated, but pricing in CDOs, which packaged the worst of these loans, remained firm. Merrill Lynch and Citigroup, in fact, continued to pump out even more of these toxic products. For Burry, who began building his positions in 2005, this period and the whole of 2006 nearly cost him his fund.

Throughout his book, Lewis juxtaposes two investment styles: on the one side, the short-term anything goes approach by Wall Street traders, and, on the other side, the go-slow careful analysis of his plodding protagonists.

Even Burry's two-year bet would not constitute a classic long-term approach among dedicated value investors. For the hedge fund world in which he existed, it might as well have been decades.

Burry could not escape the expectations of investors demanding continuous monthly gains. Lewis illustrates these investors, extremely wealth individuals, and their demands as irrational as the market itself.

Algorithmic trading, Wall Street's current elixir, has compressed holding periods into milliseconds. So long as quantitative trading produces fantastic wealth, don't expect long-term investing to expand beyond its confines.

Despite their success, Lewis' protagonists had had enough. It was time to move on.

However, it's the Eismans of the world whom the financial system can depend on to keep the big Wall Street firms honest. Time and again, these firms have demonstrated their complete inability to restrain themselves, at least as public corporations. Nor can government, perpetually steps behind and conflicted, provide that restraint.

The problem wasn't that Lehman Brothers had been allowed to fail. The problem was that Lehman Brothers had been allowed to succeed.
The Big Short

Have the big banks really changed? Sure, we won't see them peddle derivative products on subprime loans anytime soon. Nor will we likely see them deploy 30-to-one leverage ratios.

The incentives, though, haven't changed. Even after a financial system seizure, the crisis' worst offenders could still walk away richer by millions. For all the talk of risk, there is no risk, at least not on an individual level. And the system supporting this hasn't changed.

Michael Lewis may have done a better job exposing Wall Street's ugly undersides, and perhaps he will succeed in encouraging future generations of bright-eyed MBAs to reconsider their career choices.

Could this be the bygone era he expected 20 years ago? No way. Not until there's more transparency, more balance, and more Steve Eismans getting their due.