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The Anatomy of an Industry

"The stakes for the pharmaceutical companies are enormous," says Bartfai. "Twenty-six billion dollars was spent on developing drugs last year, and nine new chemical entity (NCE) drugs were approved." (The FDA defines an NCE as a drug with no previously approved active chemical moiety).

This stakes are reflected in the typical price-to-earnings (P/E) ratios for companies involved in drug design.

The P/E is the ratio of the market value of a single share of stock divided by the total earnings for that share. So a P/E of 10 means that every $10 of stock returns a dollar of profit. According to Charles Schwab Company, the historic average P/E ratio for all the fortune 500 companies is around 16 and, of course, varies with the economy.

Blue chips stocks, the shares of those industries like car manufacturers or utilities companies tend to have smaller P/E ratios—under 10. The low number reflects the fact that these industries are time-tested and established as long-term, secure earners.

The P/E of growth industries, like those in the health sector, tend to be larger. The market average for major pharmaceutical companies is around 20. Biotech companies tend to be even higher. The 2001 P/E average for the largest biotechnology companies listed on the New York Stock exchange was nearly 40, according to Forbes magazine. Small publicly traded biotech companies can be higher still.

The high P/E ratio of pharmaceutical companies and biotechs means that the earnings per share is low with respect to the cost of the stock, but, more importantly, that investors have high expectations for the companies to show significant growth and yield large profits in the future.

Another characteristic of the pharmaceutical industry is a lack of customer brand loyalty. There are no "Upjohn people" or "Roche people" the way there are "Pepsi" or "Coke people." Unlike other industries, where products may be selected on the basis of manufacturer, pharmaceutical companies rely wholly on the effects of the drugs they produce and market.

"If you succeed, nobody asks [whether you] you have made this kind of drug before," says Bartfai. "If you make a truly original drug that has a health benefit, people will eventually buy it."

The drug doesn't even have to be the first one on the market to fight a particular indication. The thing that counts is that it is significantly better than any other drug out there.

As an example, Bartfai points to Astra, which entered the billion-dollar-a-year heartburn market with the drug Losec (also called prilosec), which blocks a proton ATPase responsible for pumping acid into the stomach. Astra was at the time a tiny company entering a huge pond. But Losec was more effective than its competitors, Zantac and Tagamet, both well known labels, and is one of the reasons why Astra (now merged to form AstraZeneca) has emerged as the largest pharmaceutical company in the world.

"Nobody even knew how to spell [Astra]," says Bartfai, who was a consultant for the company at the time "But we made a significantly better drug, [which] so far has had $36 billion in sales."

The health benefit doesn't even have to be as tangible as reducing acid reflux and stopping somebody's heart burn.

"You can sell something which does not cure a disease if you have a good enough argument that it can prevent a disease," says Bartfai. "High cholesterol is not a disease, but six billion dollars is spent each year on cholesterol-lowering drugs."


NEXT WEEK: Part 2—Drug Development is the Single Most Regulated Human Activity



The Lectures:

DEVELOPMENT OF DRUG DISCOVERY PARADIGMS IN BIG PHARMA OVER THE LAST 100 YEARS, on Thursday, April 25. This overview will cover drug discovery paradigms, physiology-based drug development, 1880–1980; high-throughput screening-based drug development, molecular/cellular drug discovery, 1980–2000; and "reverse pharmacology," based on genomics and proteomics, 1999–present.

TARGET-BASED DRUG DISCOVERY, on Thursday, May 2. Topics to be discussed include validated drug targets: what they are and for whom, a determination of their value, and comparison of targets for the same clinical indication.

SELECTION OF CLINICAL CANDIDATES: MULTIPLE PRESSURES, on Thursday, May 9. The presentation will focus on the key milestones of preclinical drug development—timing, expenditures, backup strategies, outside validations, and orphan drugs—as these factors play out in big Pharma decision making.

All lectures will be held from 5 to 6:30 PM in the Valerie Timken Amphitheater of Green Hospital.


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