The Optics of Health Care Reform

Going over a cliff is one thing. Seeing over it should be much easier.

But, at least for now, Wall Street isn’t ready to take in the view. How else to explain the drumbeat of headlines about the negative impact of health care reform on pharma during the 2011 year-end conference call season?

“No one is really looking beyond the cliff today,” Sanofi Aventis CEO Chris Viehbacher declared during his company’s year-end earnings call at the start of February. “I haven't sensed anybody in the investment community really trying to figure out who's going to win in 2014 and '15. That's just not there.”

Viehbacher made those comments in explaining why he intends to wait until mid-year to offer a longer term outlook, until the company is more completely over its own patent cliff. In Sanofi’s case, that means a full-year of Lovenox generics, resolution of the uncertain status of generic Taxotere, and the end of the line for Plavix. (For more on the company’s overall performance, read "The Pink Sheet" DAILY story, here.)

“I would suspect as we get through a bigger chunk of the patent cliff, and we get closer and closer to 2012 and 2013, I think we're going to have more of a receptive audience to that, and that's why I think we want to do it then. I just think we'd be shouting in the wind a little bit if we tried to do it today.”

It’s not that the patent cliff is unexpected or dramatically worse than predicted. “Two years ago I stood up in front of a lot of you and said 20%-25% of the sales of this company are going to disappear between now and 2013 because of generic competition,” Viehbacher noted.

Rather, there is an overall negative sentiment, he believes.

“This is an industry that tends to focus on the negative. People start worrying about patent expires the day after you launch a new product. If you're any good in R&D, they're not going to give you any value for it in your portfolio. And if you're not any good at it they're not going to like you either.”

That negativity may be overstated, but there is no denying that investors have taken a decidedly glass-half-empty approach when it comes to the impact of health care reform on biopharma companies.

To be fair, the up-front costs of the law are significant—and a real crimp on the profitability of an already challenged sector. (See “Taking Lumps From Health Care Reform,” The RPM Report, June 2010.)

The health care reform implementation also includes a number of elements that further accentuate the negative. It isn’t just the size of the impact from bigger rebates, the new “market share” fee and the Medicare Part D donut hole discount. It's what they do to the P&L statement.

The health care reform impact, essentially, hits the trifecta for what analysts don’t want to see in a quarterly report:

(1) Lower gross margins. The increased Medicaid rebate and the donut hole discount represent an off-the-top reduction in revenues, with no associated reduction in costs. The same number of units are sold, just at lower prices. That makes for reduced gross margins across the board.

(2) Higher SG&A expenses. The market share fee (which begins in 2011) is accounted for as a sales cost and recorded on the expense line. At a time when manufacturers across the board are trying to show their seriousness about cost-cutting, the fee offsets some of those savings. While that is no different in profit terms from an off-the-top-line revenue adjustment, it further clouds the picture for companies trying to show that they are delivering on past promises to downsize.

(3) Higher taxes. The market share fee is (by law) not tax deductible. That means most pharma companies will report an effective tax rate that is at least a percentage point higher than it was in 2010. Again, that doesn’t change the magnitude of the hit, but it makes yet another closely watched variable look worse instead of better. Viehbacher observed wryly that another industry headwind—European price cuts—at least include an associated reduction in tax liabilities. (On the other hand, with corporate tax reform on the table in Washington, this isn't such a bad time for companies to report higher effective tax rates.)

Lower gross margins. Higher expenses. A higher effective tax rate. You can see why Wall Street isn’t loving health care reform right now.

Still, the impact of reform pales in comparison to the impact of the patent cliff. And, unlike a cliff, there is an upside to reform. All those discounts, rebates and fees helped buy an innovator friendly intellectual property system for biologics and biosimilars, improvements in insurance coverage (especially for high drug cost seniors who fall into Medicare’s “donut hole”), and, eventually, a much larger insured population to buy pharmaceuticals.

It is just that that all that happens on the other side of the cliff.

When investors are ready to look that far forward they may be in for a surprise. At least for some companies, what looked like a cliff may turn out to be a valley, with real growth prospects on the other side of the patent expiry period.

image from flickr user andrea trassati used under a creative commons license

2010 Exit/Financing DOTY Nominee: Castlight

It's time for the IN VIVO Blog's Third Annual Deal of the Year! competition. This year we're presenting awards in three categories to highlight the most interesting and creative deal making solutions of the year. The categories are: M&A Deal of the Year, Alliance Deal of the Year, and Exit/Financing Deal of the Year. We'll supply the nominations (four or five in each category throughout December) and you, the voting public, will decide the winners (by voting early and often, commencing once we've announced all the nominees). Strap yourselves in, it's The Race for the Roger™.

Castlight's $60 million June Series C wasn't the biggest venture round of 2010. (That honor belongs to Archimedes, which pulled in a stunning $100 million from new and existing investors in March). In fact according to Elsevier's magic eight ball (also known as Strategic Transactions), Castlight's financing -- certainly a large sum -- wasn't even enough to merit a top five ranking, inched out by the raises of European companies Immatics and AiCuris, and on the U.S. side by Relypsa, Cerenis, and Pearl Therapeutics. Why, then, does it merit your vote for IN VIVO's DOTY in the Exit/Financing class?

Call it a vote for the new world order.

You probably know that earlier this year Congress passed a small piece of legislation called the Patient Protection and Affordable Care Act. We at IVB thought about nominating health care reform for DOTY, but after a couple of years of running this competition, we knew better. HCR is too big, too vast, too encompassing a topic to capture the voting public's imagination. You, dear reader, want something more tangible that you can point to and say yes, here's a deal that embodies a larger trend at work.

And if ever a financing represents the new business and market opportunities now in play because of health care reform, surely it's the Castlight deal. Castlight, founded in 2008 as Ventana Health Services, aims to solve one of the thornier wickets of health care delivery: the issue of pricing transparency for medical services.

Downloadable smart phone apps such as TheFind can tell you whether Amazon or WalMart or Best Buy has the best price on the fancy new GPS system you want to buy your girl friend with the poor sense of direction. But it can't tell you where to get the best price on a colonoscopy or a dental cleaning or an MRI. And with the advent of high deductible health care plans and an ever larger percentage of costs being passed on to the consumer (er, patient), that's valuable information to have.

Castlight aims to illuminate this murky arena, creating an algorithm that allows users to search a database of providers to determine out-of-pocket costs for various procedures. Its business model is simple: the company aims to sign contracts on a monthly per-employee fee with businesses that self-insure or are encouraging their own employees to make smarter--i.e. more cost-conscious--health care choices. But it's easy to imagine the model could evolve over time to an open access system where pricing is based on a per-use fee and anyone can sign up to use it. To date, Castlight already has one customer: the grocery store giant, Safeway, which employs about 200,000 workers.

Castlight has plenty of competition too. Small start-ups such as Change: Healthcare, along with insurers such as Aetna, or even information service providers like Thomsen-Reuters, are getting into this game. Though Castlight is small compared to some of those established players, it boasts an impressive roster of founders and backers, which include not just traditional venture backers such as Maverick Capital, Oak Investment Parnters, and Venrock, but also the Wellcome Trust and the Cleveland Clinic.

It certainly helps that one of Castlight's founders, CEO Giovanni Colella, is no neophyte in the health care services arena. He sold his previous firm, Relay Health, which enables doctors to communicate with patients via secure web-based technology, to McKesson in 2006. An added bonus is surely the involvement of investor Alan Garber, a professor of medicine at Stanford who also happens to run that university's Center for Health Policy.

Analysts have long said the only way to rein in skyrocketing health care costs is to make patients understand what they are paying for and why. But for most of us health care is heavily subsidized by our employer. With some one else footing most of the bill, there ain't a huge incentive to ask the neurologist treating your headaches if an expensive MRI is must-have data that will change his or her treatment plan for you. If it's not, knowing the costs of the MRI versus a 10-pill prescription for generic sumatriptan become valuable data points that help guide decision making--especially if you have to pay a portion of the tab.

It's perhaps surprising that with the passage of health care reform, VCs aren't talking up the opportunities in actually delivery of care with greater enthusiasm. Conventional wisdom is such technology plays are risky--unlike drugs or devices, these tools can be commoditized and don't have the same intellectual property protections that limit the playing field.

But the IP protection enjoyed by drugs and devices is a red herring. Health care reform means comparative effectiveness will be the rule not the exception and that means biopharma and medtech companies face increasing competition not less as payers, physicians, and patients evaluate the costs and benefits of various therapeutic options. Already companies have pivoted, talking about differentiation and unmet need as being important drivers of innovation.

By that definition, doesn't the information Castlight provides represent innovation with a capital "I"?

And that's why Castlight deserves your vote for the exit/financing deal of the year. It's a vote for innovation -- maybe a different kind of innovation than you are used to --but innovation nonetheless.

Heceta Head Lighthouse courtesy of flickrer dezz, courtesy of a creative commons license.

French Doctors' Deal Provokes Fuss, so It Must Be Working...

Funny what happens at Halloween. Yours truly was looking up the latest on the French doctors' pay-for-performance scheme, the CAPI (Contrat d'Amelioration des Pratiques Individuelles) and she comes across the Centre for Advanced Paranormal Investigation. Rather spookily Halloweenic.

In the real, mostly pumpkin-free world of biopharma, CAPI represents France's first step towards Anglo-Saxon capitalism: rewarding docs with good old cash when they hit their performance targets--targets aimed at lowering drug costs, boosting generics and improving outcomes. The scheme was introduced last year as part of a host of changes aimed at cutting the mega-deficit. (Read about other more recent measures here.)

As one has come to expect of our French neighbours, there was outrage when CAPI came along. Outrage from physicians' councils ("...contrary to ethical guidelines!"), and from the drug industry association ("...this will be a brake on innovation!").

A year on, however, the scheme is undoubtedly working. (In tough times, money speaks louder than principles.) After a strong start in mid-2009, it had pulled in almost 15,000 doctors by September 2010, according to Le Quotidien du Medecin.

And most of those are apparently doing what the scheme--which is voluntary, by the way--wants them to do: prescribe more generics, do more screenings and vaccinations. Two thirds of CAPI doctors have met their one-year objectives and received, on average, €3,101--or their "thirteenth month"'s salary, as the assurance maladie describes it.

But there's always a reason to complain, it seems. This time, the anger's with the one third of CAPI-affiliated docs (about 1700) that didn't get their money. It's a scam, say some. Others claim the measures on which docs are assessed are inappropriate and unreliable. And besides, they ask, how can the same body that sets the objectives for the scheme be the one to measure whether those objectives have been met?

We'll spare you most of the details (you can read about some of them, in French, here). One complaint that seems fair, though, is that the authorities, in setting the scheme's objectives (in terms of numbers of diabetics remaining compliant, number of mammograms carried out, for example) didn't control for the prevalence of these particular diseases in particular areas. So for some doctors it might be much easier to clock up the figures than for others.

But all this misses the more important point that CAPI is working. It's making doctors prescribe more generics (generic prescription targets are set at 90% for antibiotics, at least 80% for PPIs and 70% for statins) and it's making them more aware of long-term outcomes. So assuming that happy doctors with a bonus continue to outweigh unhappy ones without (and encourage the unhappy ones to try harder rather than to have a tantrum and pack it all in), CAPI--the non-paranormal version--may yet prove an important component of France's ongoing attempts to rein in the deficit. Spooky.

image from flickr user ...antonio... used under a creative commons license.

Novartis Gilenya Launch: The Importance of Health Care Reform

Since literally the day the Pharmaceutical Research & Manufacturers of America reached an agreement to contribute $80 billion-ish to health care reform, we have been calling the "dollars for donuts" deal a real coup for industry. We haven't let anything deter us. Not published estimates that the true cost is well north of $80 billion over 10 years, nor a series of big charges announced during quarterly earnings reports after the reform law was enacted.

We are ready to start feeling vindicated.

Exhibit A: Novartis' new oral MS therapy Gilenya, which, Bloomberg reports, is being launched with one of the most ambitious patient copay support programs yet attempted in the industry. In our view, the strategy Novartis is pursuing perfectly illustrates the advantages of the PhRMA deal.

How so? Because it shows off perfectly the two key advantages of the reform deal: pharmaceutical companies maintain control of their launch prices while simultaneously consumers are sheltered from attempts to impose price sensitivity on them.

Those twin advantages, in our view, more than make up for the deeper rebates, new Medicare discounts, and market share fee imposed on industry as part of the deal.

According to the article, Gilenya will be priced at $48,000 per year (or about $4,000 per month). That is a hefty premium to the injectable beta interferons widely used for MS, more in line with the pricing of Biogen Idec's Tysabri, which is limited to patients sick enough to risk PML associated with the therapy.

Gilenya may cost more than Avonex, but it won't feel that way to patients: Novartis will be covering copays for all Gilenya users (except in states where that is not permitted), up to $800 per month.

Suppose every commercial managed care plan decides to slap an $800 (20%) copay on the brand? That will reduce Novartis' net price to something more in line with Avonex--while avoiding any meaningful cost-sharing on behalf of the patient that might provide an incentive to chose the older therapy.

That's pretty nifty, but what does it have to do with health care reform?

Well, at the risk of stating the obvious, Novartis can set its own price for Gilenya because there are no federal price setting mechanisms in the US. That easily could have been part of the reform law; after all, a breakthrough drug pricing board was one key element of the Clinton health care reform proposal two decades ago. So Novartis doesn't need to tie its price to existing therapies, benchmark to overseas prices, negotiate on QALYs or anything else.

True, the health care reform law ratchets up the one price control that already exists in the US (Medicaid rebates). But if manufacturers control launch prices, they can build in the deeper mandatory discounts to that program. And Medicaid remains completely free of consumer price sensitivity, since there are only de minimis copays for drugs.

In addition, health care reform limits the ability of plans to respond to Novartis' attempt to protect patients from high copays. One response by payors might be to set an extremely high copay to absorb the company's $800 per month and still create price sensitivity among consumers. Not gonna happen. Thanks to health care reform, there are limits on cost-sharing that health plans can impose.

Last but not least, there is the validation of Novartis' copay support plan for the centerpiece of the PhRMA deal, a 50% discount on brands in the Medicare Part D "donut hole." Copay support programs are prohibited in Medicare and other federal programs (except via bona fide, third-party charities). So Novartis' program isn't available under Part D.

Instead, the company will be required by law to offer a 50% discount for beneficiaries exposed to the donut hole.

Low-income Medicare beneficiaries already have essentially no copay under Part D, and the discount doesn't apply to them. But those who do face the Part D cost sharing will be exposed to much less out of pocket spending, thanks to the discount program and the already generous catastrophic coverage of Part D.

At $4,000 per month, Gilenya patients will blow through the donut hole quickly, but the discount program will save them about $1,800 while they do. The net patient cost will be on the order of $5,000 for a year's therapy--not cheap, but not unbearable for a highly effective oral MS drug.

And, given that Novartis is offering commercial patients $9,600 per year in copay support, it is hard to argue that the 50% donut hole discount is a hardship to the company. In fact, we are willing to bet that Novartis' only regret about that aspect of the deal is that the company can't give a 100% discount in the donut hole.

Of course, as health care reform phases in, the taxpayers will start to kick in additional coverage in the donut hole.

We said it before and we will say it again: there is a lot for Big Pharma to love in health care reform.

Synagis' Special Status Under Health Care Reform

It is every marketer's dream to have a product that is in a class by itself.

AstraZeneca/MedImmune's respiratory syncytial therapy Synagis (pavilizumab) can claim that distinction in an entirely new way as the Centers for Medicare & Medicaid Services implements new rebate provisions for the Medicaid prescription drug program under the Affordable Care Act: Synagis is the only drug that will benefit from a new, lower mandatory rebate on drugs that are "approved by the Food & Drug Administration exclusively for pediatric indications."

Recall that the health care reform law raised the minimum Medicaid rebate percentage from 15.1% to 23.1% for most brand name drugs. But the law sets a lower rebate amount (17.1%) for two classes of drugs : clotting factors and pediatric-only drugs. (For a complete analysis of the Medicaid rebate changes, see here.)

If that isn't complicated enough, the new rebate amounts were effective retroactively to Jan. 1 (the law was signed at the end of March), but CMS didn't provide any guidance on which products were covered until now.

For clotting factors, the list of covered products was pretty simple, since the new rebate provision specifically cites products that already receive a separate furnishing payment from Medicaid. So that list of affected drugs is no surprise. (Manufacturers who benefit include Bayer, Aventis Behring, CSL Behring, Novo Nordisk, Baxter, Talecris, Grifols and Pfizer/Wyeth).

But it was by no means clear what products were covered by the "pediatric-only" exemption. Now we know: Synagis. (The official "list" is here.)

It turns out that Synagis is the only product approved by FDA all of whose indications are explicitly limited to pediatric use (from birth to age 16). That, at least, is what CMS determined. (The agency does invite anyone who is "aware of other drugs that meet the pediatric definition specified" by CMS to email mdroperations@cms.hhs.gov .)

We note with amusement that CMS' explanation of how it came up with the "list" runs a full page. For that matter, the section of the law that CMS is interpreting [Sec. 1927(c)(1)(B)(iii)(II)(bb) for all you Medicaid rebate wonks] is longer than the list of covered drugs. Wouldn't it have been easier just to say "the minimum rebate on Synagis is 17.1%?"

Okay, that's not how legislation works. And we suspect AstraZeneca is just as happy that the provision flew beneath the radar screen a bit; there is enough controversy about the pharmaceutical industry's "deal" on health care reform--a deal, we might add, negotiated by the Pharmaceutical Research & Manufacturers of America when it was chaired by David Brennan, CEO of AstraZeneca.

But a bit of perspective here. We assume AZ is pleased that the minimum rebate on Synagis is lower than for most brands, but it is not like AZ will reap some kind of windfall as a result.

First, the new minimum rebate is still two percentage points higher than the old 15.1% minimum rebate. According to MedImmune's 2006 10K filing (the last filed by the firm before it was acquired by AZ), every percentage point increase in Medicaid rebate liability translates into roughly an $11 million hit to sales for the brand.

Then there is the separate provision of the health care reform law extending Medicaid rebates to managed care plans. While that affects a relatively small segment of the overall Medicaid prescription drug market, the impact per unit sold is large (in this case, no rebate to 17.1% minimum).

Last but not least, there is a provision in the new rebate rules that attempts to recoup rebates on new formulations of products. The idea is that, if a sponsor changes a formulation and sets a new price point, it should still pay the same amount in rebates (or more) as it did under the old formulation.

We think that provision affects Synagis as well, since (as MedImmune disclosed in the 2006 10K filing), "during the fourth quarter of 2005, we successfully transitioned to the liquid formulation of Synagis in the US from the lyophilized formulation, which has resulted in a reduction in allowances for government rebates and an increase in net realized price during 2006."

That provision, however, is even less clearly defined in statute than the pediatric-only rebate--and CMS hasn't issued guidance on interpreting it yet. (We've written about the line-extension rebate in The RPM Report, here.)

So, net-net, AZ is paying much higher rebates on Synagis than it would have without health care reform. But, thanks to its special treatment under the law, they aren't quite as high as they might have been.

Is the PhRMA Search Over?

The buzz in Washington is that the Pharmaceutical Research & Manufacturers of America is preparing to make an announcement about its new CEO. It is just that no one seems to know WHO the pick is.

We published our own suggestions shortly after Billy Tauzin announced his intention to step down (here and here). But frankly, we thought PhRMA would wait until after election day to finalize its choice, both because it obviously makes a huge difference who is calling the shots on Capitol Hill, but also because the pool of available candidates could change dramatically too.

If the rumors of an imminent announcement are correct, obviously that thinking was wrong. And so is our thinking that PhRMA could NEVER keep the pick secret for this long. (We hear there have been very clear warnings issued about the consequences for anyone who talks out of school on the search, but still...This is Washington, DC!)

If PhRMA is ready to make the pick, it will surely be someone with management experience (rather than a "big name" political figure). We would also assume it will be someone who won't have trouble working with Republicans, since PhRMA can probably count on reasonably good access to the White House at the CEO level given the heavy lifting industry did in support of health care reform.

So who is it? Someone out there knows--and you can comment anonymously below!

Musical Chairs on CER: Industry Picks in Tune, But Who Will Represent Government?

There is plenty of interest in industry in the question of who, exactly, will be overseeing the launch of a new federal comparative effectiveness research effort in the US.

Under the health care reform law, that effort will be overseen by a public/private partnership called the Patient-Centered Outcomes Research Institute.

With the June 30 nomination deadline past, it turns out that the pharmaceutical industry's two biggest trade associations--the Biotechnology Industry Organization and the Pharmaceutical Research & Manufacturers of America--are on more-or-less the same page when it comes to who should serve.

As we report in "The Pink Sheet" DAILY, bio and PhRMA each nominated the same four candidates, with bio's slate including two additional choices to serve on the board of governors of PCORI.

Of course, they won't all get seats: by law, PCORI will have three industry reps, and they are supposed to represent the pharmaceutical, biotech and device sectors. So figure on two of the six PhRMA/bio nominees actually getting seats.

The choice, incidentally, is to be made by the Comptroller General of the US, otherwise known as the head of the Government Accountability Office. That is currently Gene Dodaro, who has been acting CG since David Walker stepped down in March 2008. Congress is supposed to send a bipartisan list of nominees to the President for selection of a successor--but Congress couldn't agree on a list and now it isn't clear when or if Obama will pick a permanent head. That should make everyone in bio and PhRMA proud that they were able to agree on a relatively short list of nominees.

Settling on the industry reps will be fun, but there is an even more interesting choice to be made in rounding out the board of governors.

PCORI's 19 member board has only four slots reserved for government officials, and two of those are filled by statute (National Institutes of Health Director Francis Collins and Agency for Healthcare Research & Quality Administrator Carolyn Clancy). That leaves only two open slots for the board--and way more than two interested government agencies.

Remember: the Federal Coordinating Council for Comparative Effectiveness Resarch that was formed a year ago had 15 representatives, all from government. The FCC was dissolved upon enactment of the health care reform law. That means that when the music stops, 11 members of that team will not have seats on the PCORI board.

Who gets the two vacant seats for government agencies? Easy. The Food & Drug Administration and the Centers for Medicare & Medicaid Services, right?

Not so fast. We are hearing that the Department of Veteran's Affairs is sure to take one of the slots. That may not be intuitively obvious to us regulatory-centric types, but it is perfectly logical: VA operates a massive, fully integrated health care system and claims to have pioneered the field of CER.

So that leaves one slot open, and 10 people still standing. Should be an interesting choice....