Last week, the illustrious Wall Street rating agency Moody’s reported on two interesting outlook downgrades, China as a country and pharmaceuticals as a global industrial sector. Now I won’t hold Moody’s alleged role in rating many of the subprime quality mortgage-backed collateralized debt obligations (CDOs) that helped take down the global economy in 2008 against them. They are under review by the U.S. Justice Department for that little imbroglio, but from my vantage point, I do find these two downgrades ironic, if not a bit rich.
Moody’s downgrade of China from Stable to Negative was based on their interpretation of weaker fiscal metrics, high liabilities from provincial/local government and state-owned enterprises, and a 24 percent erosion of foreign reserves over the past 18 months. Moody’s was further influenced by China’s efforts to simultaneously maintain economic growth, implement economic reforms, and calm a bungee jump type market volatility, while hitting a +6.5 percent increase in their annual GDP target.
Fair enough! Goldman Sachs’s CIO, Sharmin Mossavar-Rahmani chronicled similar sentiment in their whitepaper, Walled In: China’s Great Dilemma, released just before Davo’s World Economic Forum in January to calm everyone’s nerves.
U.S.-based Moody did have the sobriety to acknowledge that the Chinese economy was very large and that while experiencing slower GDP growth, it is markedly higher than peer nations. With these macroeconomic ironies, along with China’s high domestic savings and still substantial foreign exchange reserve, Moody rated China Aa3, with an overall Negative outlook.
However, in almost a comical sharp contrast, Moody’s downgrade of the global pharmaceutical industry from Positive to Stable, based on a decline in projected EBITDA of 3-4% over the next 12-18 months instead of 4-5%, suggests to me that the circus elephant in the corner of the parlor room, complete with a large spray of black roses around his neck, was completely overlooked.
Yes, Moody did state that one principal concern for the downgrade was the continuing debate around high drug prices in the United States, with many manufacturers taking more modest price increases than in the past.
Anyone in the United States with a pulse and healthcare premiums to pay, who are even semi-comatose to the political tsunami facing the healthcare industry in general and the pharmaceutical industry specifically might suggest Moody’s characterization is, at minimum, a bit of an understatement.
In their report, Moody acknowledges that in addition to the lowered pricing flexibility facing the United States, long an anachronistic concept in the European Union and even Japan, adoption rates for some products have been slower than expected.
What I find worthy of a mental image, demanding an introduction by Rod Sterling, complete with extended cigarette is Moody’s Potemkin village-like proclamation: Patent expirations for blockbuster drugs will remain modest through late 2017! In order to maintain any degree of credulity a disclaimer—read this statement in a fading echo voice, as if you just stepped off a cliff—should have been noted in the report.
All I can say, even with a precursory examination of the principal patent expirations for the top 25 drugs (2014 rank), Moody’s moderate sentiments relative to patent expiration is a gross understatement.
We all understand defensive legal strategies and the process, formulation, color, presentation, probably even season-of-the-year, patent claims that companies create as the primary patent for their blockbuster product ticks away. However, acceptance of US ANDAs and 351K Biosimilar applications by the FDA are a pretty good acknowledgment of the precarious nature of an innovator’s original patent monopoly and, in effect, the coming end of an era.
And while it took a decade longer, requiring a boisterous inclusion of enabling legislation and financing as part of the historic Affordable Care Act (ACA), for the FDA to develop and formalize an approval pathway for biological drugs versus the European Union, dozens of biosimilars are currently in development for most of the major innovator biological drugs that represent a majority of gross pharmaceutical sales.
And while there has been tremendous dissonance created around the issue of interchangeability, even the U.S. Senate has expressed disdain for such tactics, which I predict will be a very short diversion.
Following last months’ FDA Advisory Panel’s 21-3 recommendation to extrapolate all indications for the biosimilar application as an alternative to Johnson & Johnson’s $6.5B blockbuster Remicade®, it is becoming evident that clinicians involved in assessing the data mandated in FDA’s 351K Biosimilar Drug Approval Pathway are quickly gaining confidence in the comparative efficacy and safety profiles between biosimilars and the innovator drugs they will compete against.
A quick look at U.S. sales of biologicals, either off patent or soon to be off patent in the next 24 months, and considering their profit contribution to global corporate balance sheets, makes for quite an uncertain outlook for much of the sector.
I do agree in the general direction that Moody advised for both China and the global pharmaceutical industry. However, one thing that is uniquely different is the corrective actions each is taking relative to the shared interest of reforming the healthcare system.
In the United States, an environment of public condemnation of high drug costs, the actions of some to raise drug prices appear tone deaf. This comes at a time when much of the industry is consolidating future focus on very discrete markets with finite patient populations, which will ensure high therapy costs, illustrating the law of diminishing returns when viewed from a public health policy perspective.
Projected growth for much of the global pharmaceutical sector is disproportionately dependent upon excess profitability attributable to the United State’s current unrestricted pricing environment. U.S. pharmaceutical pricing flexibility is rapidly becoming the poster child for a fiscally unsustainable healthcare system. When one examines the components of U.S. health expenditure, drug costs represent a very discrete and politically less impactful line item target, ideal for fiscal redress in 2017, a watershed reckoning period based on the delayed execution of the 2010 ACA.
Between CMS bidding, PBM formulary restrictions, and at a time when numerous biosimilars will be approved or well into the FDA 351K pipeline for approval, I cannot fault Moody’s outlook because they qualify it with a 12 to 18-month expiration date. However, beyond that period, a caveat emptor is certainly warranted.
In contrast to an over reliance by the pharmaceutical sector on regulatory subterfuge and litigious wars designed to preserve the status quo in the high margin U.S. market, China has just undertaken the most significant reforms governing pharmaceuticals in a decade.
As a critical part of their strategic plan to reform their overall healthcare system and lower costs, improve quality and extend more services to all citizens, China has recognized the need to reform how drugs are developed, manufactured, approved, and commercialized. The new director of the Chinese FDA (CFDA) rapidly shepherded a series of reforms in 2015 that will dramatically change the domestic pharmaceutical industry. These policy changes will require multinational pharmaceutical companies to extensively modify or accelerate their China strategies over the coming months if they want to “play” in China.
While many adjectives have been used to describe the Chinese economy, static is not one. As exemplified by the commitment to drastically change their pharmaceutical sector, China might not ideally communicate their reform actions, but they represent real and substantive reforms.
Meanwhile, the global pharmaceutical industry’s actions to address the changing dynamics of their principal revenue stream, the U.S. market, are insufficient to ensure long-term viability of current operational composition. Efforts are also “too little, too late” to force significant realignment, at least in strategic priorities, if not global pharma’s overall business model.
For me, Moody’s prognostications, at a minimum, are incomplete. Which is why I offer the perspective that the time for China and the global pharmaceutical market to fully unite has arrived.
As America’s great sage Yogi Berra would say, “The future ain’t what it used to be.”