Generics Fans Bide Time

That's because a number of big brand-name drugs lose patent protection next year.
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The latest round of quarterly financial reports is nearly over, and you can almost hear the collective cry from generic-drug makers: "Wait until next year."

Next year is when the new Medicare drug program takes effect, giving generic pharmaceutical companies more hope for a bigger piece of a potentially bigger market.

A host of big brand-name drugs go off patent, meaning 2006 -- and 2007 -- will be much better than 2005, when relatively few patents expire.

And next year is when generic-drug companies hope their highly fragmented industry can exhibit a bit more predictability -- perhaps through consolidation -- in an environment characterized by vicious price competition and tougher demands by managed care organizations.

"We believe a perfect storm is materializing for the U.S. generic industry, leading to the potential for strong near-term growth," says Richard Watson, of William Blair & Co., in a recent research report. Watson warns, however, that while some companies will benefit from good management and smart strategies, others will fail to execute.

Potential upcoming benefits are tied to potential risks, says Standard & Poor's. The ratings firm issued a report last month declaring that the industry's overall credit outlook is negative even though the industry is expanding. More competition and new entrants could mean downgrades of generic companies.

Merging Ideas

S&P's report came out a week before

Teva Pharmaceutical Industries

(TEVA) - Get Report

said it would pay $7.4 billion to buy

Ivax

(IVX)

. S&P promptly placed its ratings for Teva on CreditWatch

with negative implications, meaning the agency is deciding if it will change its rating. Teva's BBB rating is one step above the lowest investment-grade rating.

If Teva, considered the strongest of the pure generic companies, can have its credit placed under question, imagine what will happen to weaker players. S&P says the industry is "entering a more challenging period," adding that it "expects pressure" on companies' credit ratings.

Generics remains a hard business to gauge for analysts and investors. During their most recent quarters, more generic companies missed Wall Street's earnings estimates than matched or beat the predictions. Those calculations exclude several companies with market capitalizations below $200 million and two drugmakers that were recently delisted from

Nasdaq

and now trade as 'pink sheet' companies.

The latter are

Able Laboratories

(ABRXQ)

, which has filed for bankruptcy protection, and

Impax Laboratories

(IPXL)

, which hasn't filed its 2004 10-K statement and subsequent 10-Q reports with the

Securities and Exchange Commission

.

Many investors who bet on the generic-drug industry at the beginning of this year have been disappointed. Through Aug. 9, more generic-company stocks are down than up, regardless of their size.

The better performers tend to be the largest companies, reinforcing the belief on Wall Street that mergers and acquisitions will be good for the industry and for investors. Meanwhile, many companies with market capitalizations below $1.5 billion, along with smaller companies, have been hammered. Among the losers, many have lost 20% to 45% this year.

"Most companies that have stumbled over the last year or two have stumbled due to execution," says Watson. "Consolidation is not the answer to problems."

(TheStreet.com will look at the prospects for wheeling and dealing in an upcoming article.)

More Products, More Prospects

Depending on who's counting, generic drugs account for 54% to 56% of U.S. prescriptions. By the end of the decade, generics could represent two-thirds of total prescriptions thanks to greater utilization encouraged by government and private health-care payers.

Generic companies are ready to feast once patents expire on several big-name drugs in 2006 and 2007.

Next year's targets include the cholesterol drugs Zocor from

Merck

(MRK) - Get Report

and Pravachol from

Bristol-Myers Squibb

(BMY) - Get Report

; the antidepressant Zoloft and the antibiotic Zithromax from

Pfizer

(PFE) - Get Report

; and the heartburn drug, Protonix, from

Wyeth

(WYE)

, according to a recent report by WR Hambrecht & Co.

The following year, Pfizer's blood pressure drug Norvasc will be subject to generic competition, and

Johnson & Johnson

(JNJ) - Get Report

will lose protection for its antipsychotic Risperdal.

If Pfizer loses a patent challenge to its cholesterol drug Lipitor or

Sanofi-Aventis

(SNY) - Get Report

and Bristol-Myers Squibb lose a challenge to the anticoagulant Plavix, generic-drug companies would be awash in extra opportunities.

Watson predicts U.S. generic-drug sales will grow this year to $42.7 billion from $41 billion last year. Sales should jump to $48.2 billion next year and to $53.1 billion in 2007. His figures exclude the effect of successful patent challenges to Lipitor, Plavix and other drugs.

This sounds like good news for cost-conscious consumers, but what about investors? Even though an improved environment appears on the horizon, investors know they must be selective. There's a powerhouse like Teva, but there's also Able.

Within just a few months this year, Able halted all manufacturing, recalled all products and filed for bankruptcy.

More Government

The big question about the new Medicare drug plan centers on how much extra revenue the government will provide for the generic-drug industry.

"We forecast a tailwind for generics, with sales increasing 3% to 5% through 2010," says a recent report from SG Cowen & Co. "Managed care organizations and pharmacy benefit managers view the Medicare drug benefit as an attractive opportunity, and the response has been tremendous."

Although some analysts predict brand-name drugmakers won't see much, if any, gain from the new Medicare program, "generics revenue should increase significantly," says Andrew Forman, of WR Hambrecht, in a recent research report. Forman says Medicare could be worth a 2% revenue increase in 2006 on top of the 2% gain thanks to patent expirations.

Favorable trends in government and the private sector, he adds, could result in a tripling of generic-drug sales to $68 billion in 2010 from $21 billion in 2000.

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