FOSTER CITY, Calif. ( TheStreet) -- Amongst the hubbub over hepatitis C and the upcoming EASL conference, it can seem as though Gilead Sciences' (GILD - Get Report) very existence hinges on whether or not the company can successfully develop a drug to treat the viral liver disease. That's not the case. In fact, the massively profitable HIV business remains the critical driver of Gilead's cash flow over the long-term.
The HIV market has lots of moving parts, so let me give you the conclusion first: Gilead faces a host of challenges over the next decade, but I don't think the company's market dominance will be significantly imperiled over that time. The threats -- new branded competitors, major patent expirations, and increased pricing pressure -- are real and shouldn't be overlooked, yet I think bearish forecasts of Gilead's impending demise in HIV are overwrought.
Having said that, I'm not buying Gilead today because the company's hepatitis C struggles suggest a more insidious concern: Can Gilead continue to innovate?HIV treatment regimens include three drugs: two nucleoside reverse transcriptase inhibitors (NRTI) and either a non-nucleoside reverse transcriptase inhibitor (NNRTI) or a protease inhibitor (PI). For the last decade, Gilead has dominated; 90% of newly diagnosed patients' first-line drug cocktail includes Viread and Emtriva, two Gilead NRTIs. The company also markets Atripla, the first once-daily single-pill regimen -- it's a co-formulation of Viread and Emtriva with Bristol-Myers Squibb's (BMY) Sustiva -- which received FDA approval in 2006. Patients who are not candidates for or cannot tolerate an NNRTI receive a protease inhibitor, or PI, usually alongside a "backbone" of Viread and Emtriva (Gilead has co-formulated the two drugs into a single pill, Truvada). The widespread use of Truvada enables Gilead to capture significant value from the HIV market -- more than 72% of all treated HIV patients take at least one of the company's drugs. Gilead's Patent Problem No biotechnology company is exempt from the patent expiration cycle. Although patents on Atripla and sub-component Emtriva continue until 2021, Sustiva's patent expires in 2013 and the key Viread patent expires in 2018. A few years ago, investors started to worry that generic availability of Atripla's components would have a significant negative impact on the company's long-term earnings. Gilead's HIV "patent cliff" mitigation strategy involved developing a new single pill regimen without Sustiva (the first Atripla component to go generic). Last August, Gilead received FDA approval for Complera, which combines Truvada with Johnson & Johnson's (JNJ) Edurant (which had itself received approval a few months earlier). Essentially, Complera is Gilead's Atripla replacement strategy. With a 2023 patent expiry, Complera extends Gilead's Atripla-like economics -- roughly a two-thirds share of sales -- but still does not provide direct access to the NNRTI or PI market. The second part of management's strategy sought to capture a greater share of total HIV dollars. (Near-term, Gilead's high market share doesn't leave a lot of room for dramatic prescription growth.) To address this opportunity, management explored a new class of drugs, called integrase inhibitors. Gilead's R&D goal was simple: Develop a once-daily, single pill regimen to supplant Atripla, compete with the PIs, and allow the company to control all the drug's economics. The Battle of the Integrase Inhibitors Maintaining long-term market dominance is no easy task since multi-billion dollar revenue opportunities don't go uncontested for long. Competitors Merck (MRK - Get Report) and ViiV Healthcare -- a partnership between GlaxoSmithKline (GSK - Get Report) and Pfizer (PFE) -- are also developing integrase inhibitors, as the companies seek to reinvigorate once-formidable HIV franchises gone fallow. Merck received FDA approval for the first integrase inhibitor, Isentress, in 2007. Despite impressive efficacy, the drug's twice-daily administration has become undesirable to many patients in the era of once-daily Atripla. Although Isentress has had moderate commercial success -- 2011 sales reached nearly $1.4 billion -- it's clear the drug's long-term impact will be modest. (Merck's efforts to develop once-daily Isentress have been unsuccessful thus far.) Meanwhile, Gilead's integrase inhibitor, known chemically as elvitegravir, has encountered some major development hurdles. Most significantly, the company quickly discovered that the drug required "boosting" -- a pharmacokinetic trick often used with PIs to increase blood levels -- with a drug called ritonavir in order to be effective when administered once-daily. To avoid ritonavir's unwanted gastrointestinal side effects (and retain all of the economics), Gilead developed cobicistat, which appears to have an adequate pharmacokinetic boosting effect without ritonavir's side effects. Bullet dodged. Gilead calls the combination of Truvada, elvitegravir and cobicistat the Quad since it contains four drugs rather than the usual three (remember that Truvada is a combination of Viread and Emtriva.) I expect the Quad to receive FDA approval by August 2012 based on data from two pivotal studies demonstrating the Quad to be statistically non-inferior (equivalent in layman's terms) to Atripla and a PI-containing regimen. Gilead skeptics worry because ViiV's dolutegravir -- an integrase inhibitor less than two years behind the Quad -- also appears to be viable as a once-daily pill and likely has a superior resistance profile compared to elvitegravir (meaning the drug can endure more viral mutations without losing efficacy.) A phase III study released last week showed dolutegravir to be statistically non-inferior to Merck's Isentress. Although comparing across trials is always tricky, elvitegravir and dolutegravir look about the same from an efficacy perspective. Since both drugs also have fewer side effects than Sustiva or PIs, I expect elvitegravir and dolutegravir-based regimens to take meaningful market share over the next five years. With Truvada as the NRTI backbone of choice, Gilead will still participate in the economics of any separate pill dolutegravir regimens. Co-formulation Matters As recently as the mid-1990s, HIV patients had to take handfuls of pills multiple times per day. In part due to the side effects of first generation HIV drugs, patient noncompliance was a major problem and a key driver of viral resistance. (If a patient takes an antiviral inconsistently, the virus can more easily mutate and become resistant to drugs.)