Eli Lilly's Pipeline Springs a Leak, but Don't Worry

NEW YORK (TheStreet) -- Never one to shy away from a contrarian position, back in October I rushed to the defense of Eli Lilly (LLY) following some harsh words and several downgrades from the Street. Investors had many concerns.

Chief among them were worries about Lilly's pipeline of drugs in development and production. Although I wasn't necessarily Lilly's biggest fan at the time, I didn't agree with the idea the stock, which then traded at around $49 per share, would see the 20% downside suggested by Jefferies analyst Jeffrey Holford, who cut his price target to $40.

Holford cited pipeline fears, which have been a known issue with Lilly for some time. But I believed this was already priced into the stock. Lilly had retraced 15% in the couple of months before Holford's note.

Fast-forward two months later: The Food and Drug Administration (FDA) announced it approved generic versions of Cymbalta, Lilly's blockbuster anti-depressant drug that accounts for more than 25% of Lilly's revenue. Even more interesting: Unlike most generic approvals, FDA announced that it had, in fact, granted not one, but six approvals to, among others, Teva Pharmaceuticals (TEVA).

But here's the thing -- the market didn't flinch. Everyone knew the so-called "patent cliff" was coming. Lilly is still trading at around $49 per share, as of the Monday close -- the same price from back in October when I told you not to worry. It seems that I was right the Street had already priced in the competition from generics.

Having said that, Lilly is still not out of the woods yet. These new generic rivals must still compete on price.  I believe it is safe to say their prices will be much cheaper than Lilly's. Even so, it will take several quarters before Lilly will feel the impact on its consolidated results.

Here's another thing that no one is talking about: the fact that the FDA issued six approvals may actually play into Lilly's favor. Not only must these generics compete with Lilly's branded drug, but they must also compete with each other on price. The production of these new generics will be based on the profits these companies are able to produce.

With that in mind, if the drug makers are unable to justify the production costs with solid margins or  meaningful profits, they won't waste any time developing the drug. It just doesn't make good business sense. While Lilly's pipeline continues to obsess the bears, this assumes the generic competition will execute flawlessly if and when they are given the green light by the FDA. That's a misguided way to look at it.

In Lilly's case -- and specifically Cymbalta, which posted $1.1 billion in third-quarter worldwide sales -- investors shouldn't expect an immediate drop in revenue. Given that there are now six potentially new cheaper alternatives that will enter the market, expectations should be adjusted accordingly.

To the extent that Lilly can maintain between $350 million to $500 million in Cymbalta revenue, I believe this should be considered a monumental victory, given the floodgates that have just been opened. Let's not forget, these sort of issues are commonplace in the land of Big Pharma.

Shares of Merck (MRK), for instance, are up more than 22% year to date. This is even after the company lost the patent to Singulair, Merck's top-selling asthma drug. Pfizer (PFE) has jumped, too. Although some believe Pfizer hasn't been the same since it lost cholesterol treatment drug Lipitor, the stock is still up 25% on the year and is close to its 52-week high.

My point is there is much more to a company than meets the eye. While losing patents to generic alternatives is known to adversely impact upon the bottom line, it's not as paralyzing as it sounds. Nor is it the death knell of any operation.

The fact remains that a good management team understands that the same resources used to create one blockbuster drug can also be deployed to find the next one. This is Lilly's challenge today.

At the time of publication, the author held no position in any of the stocks mentioned.

This article was written by an independent contributor, separate from TheStreet's regular news coverage.

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