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Shares of generic pharmaceutical stocks have been punished after news surfaced that the US Justice Department could file charges by year-end following a two year antitrust investigation.
By Kris Rosemann
Though difficult to say in light of the poor stock performance of generic pharmaceutical makers of late, we continue to be positive on the long-term secular theme of ongoing growth in the availability of low-priced drugs around the globe, a trend that plays favorably into their hands. Yet another regulatory-related blow, however, was dealt to the pharma space November 3, and surprisingly to those exact firms that work tirelessly to reduce the price of more expensive branded drugs, generic pharma.
Reports surfaced that the US Justice Department could file charges before 2016 is over stemming from a two-year antitrust investigation. The probe is seeking to identify whether executives from more than a dozen companies committed price collusion on roughly two dozen drugs. Companies involved in the investigation include Teva (TEVA), Mylan (MYL), Lannett (LCI), Impax Laboratories (IPXL), Sun Pharmaceutical Industries (SMPQY), and a subsidiary of Endo International (ENDP), among others.
Though the first cases against some of the above listed firms could potentially be brought to court before the end of the year, the exact timing of the situation remains up in the air. People familiar with the situation have likened it to the Justice Department’s probe into potential auto parts cartels, which resulted in $2.8 billion in penalties and brought charges against 46 companies and 65 individuals. 31 of those individuals received prison sentences. Prosecutors have typically had a low rate of success in price collusion cases, however, as the courts have established rather high barriers required to prove that companies have conspired in pricing strategies.
Two of the drugs involved in the pricing investigation are digoxin, a heart failure drug, and doxycycline, a popular antibiotic, both of which are made by multiple companies. Medicaid spent well over twice as much as on doxycycline in the twelve month period ending with June 2014 than it did in the prior twelve months despite a 38% drop in prescriptions; the agency also spent nearly double on digoxin in 2014 compared to 2013 despite a 16% decline in prescriptions. Additionally, a report from the Government Accountability Office in August 2016 revealed that more than 300 of 1,441 established generic drugs had seen their prices at least doubled between 2010 and 2015.
Part of the allure of generic medicines is the idea that they are supposed to be competitive alternatives to more pricey branded drugs and are meant to be a part of the fight in helping patients and insurers lower healthcare costs. However, if the suggested price collusion did take place, the firms involved would be effectively undercutting a driver of the appeal of their products. It’s also worth noting that many like Teva also have branded drugs such as multiple sclerosis drug Capaxone, so the outcome of the probe won’t have pricing implications across their entire drug portfolios, though we note in Teva’s case, Capaxone is fighting off generic rivals itself. In any case, share prices of companies involved have fallen on the news of the potential for charges being filed in 2016.
Frankly, we had been downright puzzled by Teva’s share price performance this year, in particular. But after the news today, we now can posit why shares had been under pressure: someone must have known something about the outcome of this pending investigation (the investigation itself wasn’t news as most had received subpoenas), and they had been selling big before the announcement. We don’t think the prior sell-off was merely de-risking activity. That the market price (and share-price action) can hold important information about the fundamentals of a company is why we pay very close attention to technicals in our work. We didn’t act when we probably should have, and we were blinded by the positive long-term view on generics proliferation coupled with the comfort of holding a rather small weighting in Teva in the Best Ideas Newsletter portfolio.
That said, we’re not going to overreact now, and we plan to continue to ride things out as Teva continues to make up less than 2% of the Best Ideas Newsletter portfolio’s total value. The amount of uncertainty surrounding the investigation is unsettling to a degree, but we’re not ready to make a call on whether the outcome of the charges will materially alter the favorable long-term landscape of generics, particularly with respect to volume growth dynamics and their competitive advantages in low-cost manufacturing. Teva’s shares make up such a minor portion of the market-beating Best Ideas Newsletter portfolio’s value that we’re willing to take on the added risk, even as we keep a keen eye out for any developments that may hit the wires. We’re still not happy with the developments November 3, of course.
Now read, “Update on Teva and the Generics Market (September 2016).”
Pharmaceuticals: AGN, ENDP, GILD, MYL, RDY, TEVA, VRX, VRTX, ZTS
Other related tickers: AKRX, FXH, IYH, VHT, VRX, XLV