A Multibillion-Dollar Market Filled With Unknowns

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The Food and Drug Administration released guidance last week for drugmakers to get started applying to make biosimilars, the generic versions of biologic drugs.

That's the good news for drugmakers looking to enter the market that's expected to be around $4 billion by 2015 and increase from there. Unlike small-molecule drugs, biologics have been largely untouched by generic competition because there hasn't been a pathway to gain approval. This guidance has been a long time coming; the FDA was given the power to approve biosimilars by the health-care reform bill, passed nearly two years ago.

One size fits some
Unfortunately, the guidance isn't as simple as "Do A, B, and C, and we'll approve your drug." Because biologics are so diverse and their amount of characterization is vastly different, different biosimilars are going to require different levels of scrutiny. Some might be able to get away with just small clinical trials while others will likely require trials that rival the ones used to gain approval of the branded product.

The basic gist of the guidance: Ask and we'll tell you what you need to do for your drug. Even then, science isn't always predictable and experiments and clinical trials that the FDA asks for could spur new questions.

Presumably, the requirements will remain fairly constant for multiple generics being developed for the same branded product. Coming in as a second generic will probably result in a cheaper development pathway since the company will be able to learn from the pioneer. But late arrivers will have to deal with more competition. As Momenta Pharmaceuticals (NAS: MNTA) and Novartis (NYS: NVS) showed with their generic version of Sanofi's (NYS: SNY) Lovenox, having no competition other than the branded product can result in sales in excess of $1 billion annually for a generic.

Pharmacist as gatekeeper
Small-molecule generics haven't had to market their drugs because pharmacists have the power to substitute generics, when available, when they get a prescription for a branded product. Doctors have the ability to stop the substitution, but generally don't. Health insurers love it because it saves them a ton and patients prefer the smaller copay available for most generics.

At this point, drugmakers look like they're going to have to market their biosimilars because the drugs will be classified as a separate molecule. Drugmakers will be able to recoup those costs by charging closer to the branded drug price -- say 55% to 75% -- compared to 10% seen with small-molecule drugs where there's lots of generic competition.

There will be an option to ask that the biosimilars be interchangeable with the branded drug, but that will require additional clinical trials. It'll be interesting to see how the math works out there. Presumably, the added volume will make up for the added cost, but if a second drugmaker tries the same thing, the pricing pressure might push the economics out of favor.

Managing the risk
With all the unknowns over how expensive the development of biosimilars could be and how long it might take, many drugmakers are teaming up to share the risk. Amgen (NAS: AMGN) and Watson Pharmaceuticalshooked up as did Momenta Pharmaceuticals andBaxter (NYS: BAX) .

In the Amgen-Watson deal, Amgen is taking the lead with Watson contributing up to $400 million in co-development costs. Amgen will pay Watson royalties and milestones on the biosimilars that are developed.

For the Momenta-Baxter deal, the generic-drug maker, Momenta, is taking the lead. Baxter will pay Momenta $33 million up front and contribute more as milestones are achieved.

In addition to sharing the risk, branded drugmakers teaming up with their generic counterparts makes sense because they can both bring something to the table in this rather complex mix of the two industries.

Valuing the opportunity
Figuring out how much the biosimilar market is worth to the myriad drugmakers looking to make a buck in biosimilars isn't going to be easy. Even with the added guidance from the FDA, there are still a ton of unknowns, especially over timing of revenue.

Fortunately, the unknown risk is muted by other drugs -- branded or traditional generics -- that most drugmakers gearing up for biosimilars are also developing. At this point, it's probably best to value the drugmakers based on their other assets and figure that any biosimilars down the line are an added bonus.

Biosimilars represent an important tool for reining in U.S. health-care costs and are a key part of the Affordable Care Act. But these generic manufacturers aren't the only companies favored by the government. Download The Motley Fool's special free report, "Too Small to Fail: 2 Small Caps the Government Won't Let Go Broke," and discover two potential multibagger stocks that have the weight of the government behind them.

At the time this article was published Fool contributor Brian Orelli holds no position in any company mentioned. Click here to see his holdings and a short bio. The Motley Fool owns shares of Momenta Pharmaceuticals. Motley Fool newsletter services have recommended buying shares of Momenta Pharmaceuticals and Novartis. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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