Having agreed a major asset swap with GSK and hence simplified its business into three ‘powerhouse’ divisions, Novartis last week held its first ‘Meet the Management’ event for analysts and investors. This involved the top teams of each of the three divisions (and also the early research unit, NIBR) sitting down for extended Q&A sessions with the attendees, to explain how they were going to achieve the objectives set for their part of the business. As the heads of two out of the three divisions have only been in place for the last six weeks, the analysts probably knew more about the businesses than they did, but even so, it was a good opportunity to meet the second tier of divisional management and to try to read the runes on Novartis’s future strategic direction.
The Sandoz part of the proceedings was naturally almost all Q and no A, which was a pity. Sandoz’s refusal to explain very much about what it is doing now makes it particularly difficult for the company to give a convincing answer to the question of what it is going to do differently in the future, but some things are obvious enough without them saying anything at all. For a start, it doesn’t take a Kremlinologist to see that hiring Richard Francis from Biogen Idec to run Sandoz is an indication that biosimilars will be at the top of the company’s list of priority areas, particularly when one of the division’s two mission statements is to retain its leadership in the area. This hiring may be a bit premature of course, since biosimilar sales are currently running at about $400m, or only 4-5% of total turnover. Also, if Sandoz doesn’t launch some new products fairly soon it might find itself temporarily losing the global leader title to Hospira, which has already had infliximab approved in Europe and is just waiting for patent expiry in order to launch it the continent’s major markets. However, it is undeniable that Sandoz has a very strong pipeline in this area and will almost certainly be the first – or one of the first – companies to launch a product down the new biosimilars pathway in the US.
How long this will take is the big unknown. Getting the FDA to the point at which it is ready to actually approve a biosimilar – let alone with interchangeability – is a massive challenge. Sandoz is probably better placed than most companies to do it, but we suspect that it will take much longer than anyone anticipates. Sandoz disclosed at the meeting that it has now answered all the FDA’s outstanding questions on its generic Copaxone and yet there has been no word about whether its file is approvable or not, which demonstrates perfectly the difficulties that it is up against. The FDA hates stepping into new territory and much prefers to work from existing precedent. Even though Copaxone was approved down the NDA rather than the BLA pathway, it is a complex product with a poorly-understood mechanism of action and in the absence of full phase III safety and efficacy trials, the FDA clearly cannot decide how much evidence of similarity is enough to allow it to approve generics. And if it can’t make its mind up on Copaxone, how likely is it to do so on a monoclonal antibody biosimilar? Only with a dossier in front of it will the FDA be forced to come off the fence and say whether the data presented is enough or not and even then, the first filer may end up taking to the courts to secure an approval, just as Sandoz did with Omnitrope, its generic human growth hormone.
So, with rather limited short-term progress expected on the biosimilar front outside Europe, Sandoz’s new MD will have to focus on the other 95% of the business and on his second mission, which is to raise margins. In reality, this has been the aim for Sandoz for years and achieving any sustained improvement is likely to prove far more difficult than leading the world in biosimilars. Sandoz claims to have achieved over $2.5bn of cost savings in the last five years and yet, as one of the analysts pointed out, this has not actually resulted in any improvement in its overall profitability, which has fallen from an EBIT margin of 18.8% in 2008 to one of 16.8% in 2013 (for what Sandoz calls ‘core’ EBIT. The unadjusted EBIT margin went down from 14.3% to 11.2% in the same period). Reinvestment into R&D was the explanation that the management came up with, but another (bigger) one is that generic companies always need to run to stand still due to the continuous pricing pressure that they operate under. Sandoz is not really doing itself any favours by trying to pretend to analysts that its business is fundamentally stable, because it isn’t. If Novartis stopped launching new innovative drugs, its pharma division would hold its margins and continue to grow for some years before there was a noticeable impact. If Sandoz did the same, both sales and margins would head downhill very quickly. Raising margins sustainably therefore requires one of more of: a) better profitability in the base business due to either rising prices or ongoing cuts in COGS, b) a continuous portfolio shift towards products with lower competition and higher margins, and, c) a big pipeline. Because generics companies don’t have a lot of control over the pricing aspect of a), most of them tend to focus on b) and c) and Sandoz duly trotted out a chart showing that the percentage of its sales coming from differentiated products had risen from 32% in 2008 to 45% in 2013. What it wouldn’t – or couldn’t – say was what the difference in margin was between the two product groups or how this had changed over the period. The differentiated part has probably seen an improvement in profitability since 2008, since Sandoz has acquired high-margin businesses such as Ebewe (injectables) Fougera (dermatology) and Falcon (ophthalmology) and has also built up its biosimilars operation, but if that is the case, then it automatically follows that the margin on the rest has gone down rather dramatically. These acquisitions also account for a large proportion of the expansion of the ‘differentiated’ portfolio over the period, with all the remainder due to biosimilars and to enoxaparin (which had peak annual sales of over $1bn and turned over more than $200m even in 2013). This implies that the remaining ‘differentiated’ portfolio has only managed to launch enough new products to cover the decline in the sales of the older ones. Meanwhile, the absolute value of sales in the ‘standard’ portion of the portfolio has not changed at all over the five-year period, despite hundreds of new product launches. Again, this is due to falling prices.
It could be argued that the last five years have been a particularly difficult time and that the next five should be easier. Germany, for instance, has seen more than 70% of the volume of the market move into tenders in the time that Sandoz has owned Hexal. That has taken Sandoz’s German sales down by more than 20% over the last five years, which is a clear indication of the price crunch that it has suffered. Fortunately for Mr Francis, price declines of this scale are no longer possible in any major European market (other than Russia) because prices are so low already. The same is not true in the US however, where plant outages have led to generic prices actually rising for the first time in years, helped by the need of the major wholesalers and pharmacy chains to find partners that can deliver products reliably and not just cheaply. We are not convinced that this situation can sustain. Sandoz showed prescription data from the US to illustrate how it is gaining market share from the other generic majors, particularly Teva, but the most notable line on the chart was the one demonstrating the meteoric rise of the Indian suppliers. News reports of production issues at Ranbaxy and a few others may create the impression that Indian pharma companies are a spent force, but the reality is that there are an awful lot of FDA-approved Indian facilities that are still running well and that have both the volume and the price points that US customers find attractive. Add in Teva, which used to totally dominate the US market and which has just declared a ‘renewed focus’ on generics, and you have all the ingredients for a price war further down the line.
In our view, Sandoz’s current core EBIT margins are actually not too bad for a generics company of its size and diversity. Undoubtedly there are more cost-savings to be had, and the product mix can be further improved as Sandoz rolls out its pipeline of biologic, respiratory and dermatology products, but in the face of steadily falling prices in most parts of the world (including the emerging markets, in which Sandoz makes 28% of its sales), just holding margins at the current level will be an achievement. If Richard Francis wants to make a really meaningful difference to profitability – and he presumably does, otherwise his tenure at Sandoz may be rather short – the quickest (and cheapest) way would be to persuade Novartis to transfer some of its off-patent brands into the generics division. Failing that, he could buy a few from one of the many big pharma companies looking to dispose of their older products. With almost $10bn of sales already, there is nothing in Sandoz’s pipeline that will move the needle on profitability in a meaningful way over the next five years: if more profits are required, they will have to come from outside.