Pharmaceutical industry

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Pharmaceutical industry

2015 Global ranking – strategy decisive

The annual company reporting season is always an exciting period. It is an ideal time to update our industry statistics and drug database and always throws up some interesting observations. In our opinion success and failure in 2015 was determined by strategic decisions made by management teams 15-20 years ago. ► 2015 Global market: The global market for prescription drugs is estimated to

have grown about 4.1% in 2015, but in dollar terms it was down 3.2% to an estimated $786bn due to strength of the USD against most other currencies.

► Global top 15: After many years of consolidation, market share of the top 15

companies has fallen to 53.7% compared to peak levels around 61.4% a decade ago. This highlights the emergence of new players into the market. Novartis remains the #1 ranked company in the world due to its diversified portfolio.

► US top 15: In the US, the top 15 companies are more dominant, with 68.6%

market share. However, this is also a reduction from the 76.5% level in 2005. Gilead Sciences retained and extended its #1 ranking in the US with 7.0% market share. Roche is the leading European company in the US, ranked #4 with 6.0%.

► Strategy all important: Looking at the various changes in ranking over the last

decade suggests that strategic decisions made 10-15 years ago have had a big impact on company’s fortunes. A comparison has been made between the big three in the UK. Shareholders in GSK have suffered badly because management did not use its considerable cash resources wisely and have not invested enough or acquired new technologies. In contrast, Shire had added significantly to shareholder value with its buy-and build strategy, although its latest move might mean that it will struggle from here.

► Antibodies – Drivers of growth: Companies that invested in antibody-derived

drugs have generally performed well. There are now 60 antibody drugs approved globally, covering a big spread of diseases, which sold just over $80bn in 2015. This represented 10.2% of the world market. Since launch these drugs have had cumulative ex-factory sales of a staggering $560bn and have represented a quarter of industry growth since their introduction.

Pharmaceutical sector performance

Source: Reuters Eikon

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March 2016

Analysts Martin Hall 020 7148 1433 mh@hardmanandco.com Gregoire Pave 020 7148 1434 gp@hardmanandco.com

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Global pharmaceutical industry

2015 ranking

Although the focus of Hardman & Co is generally on companies with micro- to mid- sized market capitalisations, it is important to understand how those companies are faring within the industry in which they operate. Given that all the major pharmaceutical companies have reported 2015 results during the last month, we thought this would be an opportune time to update the global ranking and see how various companies’ strategies over the last decade have played out. As always, it has thrown up some very interesting findings!

Moreover, when we write research reports on our contracted companies, it is important to outline the commercial market opportunity that the often disruptive technology of the small company is targeting. While it usually constitutes only a very small part of the overall report, the data within those 1-2 pages are often dynamite. Pharmaceutical sales are defined as anything that requires a prescription (Rx) and excludes OTC/consumer products. However, it does include generic drugs. Market shares have been calculated from initial estimates that the global prescription drug market was valued at $786bn in 2015. All our data, going back as far as 1988, have been complied consistently and are based on ex-factory sales reported by companies and converted to US$ using average exchange rates. Therefore, it is very robust.

Global highlights

2015 was a very tough year for the pharmaceutical industry worldwide. Although we estimate that the industry saw modest 4% underlying growth, this was eroded in dollar terms by the strength of the USD against most other currencies. Notwithstanding that, no less than eight of the top 10 drug companies in the world reported lower sales in 2015, many being hit by the loss of patents on major drugs.

► Novartis remains the top ranked pharmaceutical company worldwide for the

third year running with 5.66% market share. Whereas most of the industry has focused its activities on patented (branded) drugs, the strategy of Novartis has been to retain and develop a strong presence in generics and biosimilars which has helped to maintain its #1 position.

► Gilead Sciences was the only company to make major gains to become the sixth

largest company in the world with 4.09% market share, rising from #9 in 2014 and #15 in 2013. This move has been driven entirely by the success of its hepatitis C franchise and, even though competition has arrived, many of the new drugs still need to be used in combination with Gilead’s drugs.

► Teva has also been a steady riser over the years. Initially, this was on the back

of multiple acquisitions and consolidation of generics businesses. However, with its strong cashflow, the company also invested in branded pharmaceuticals, particularly in the field of multiple sclerosis, which has borne fruit and now represents 47% of product sales.

► Novo-Nordisk entered the top 15 companies in the world in 2015 for the first

time. Unlike many of its competitors it has achieved this largely through organic growth and by focusing on a single therapeutic franchise – treatment of diabetes. Its success has clearly been helped by the worldwide spread of obesity and associated increase in diabetes.

The annual company reporting period is always exciting and throws up some interesting statistics

Modest growth in the global pharmaceutical market in 2015 was offset on USD translation…

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Pharmaceutical industry – Global ranking 2000-2015

# 2000 Share 2005 Share 2010 Share 2015 Share

1. GlaxoSmithKline 6.85% Pfizer 8.33% Pfizer 7.43% Novartis 5.66%

2. Pfizer 6.82% GlaxoSmithKline 6.55% Novartis 5.60% Pfizer 5.55%

3. Merck & Co 5.36% Sanofi-Aventis 6.54% Merck & Co 5.43% Roche 4.94% 4. AstraZeneca 4.66% Novartis 4.81% Sanofi-Aventis 5.09% Sanofi-Aventis 4.38% 5. Aventis 4.48% AstraZeneca 4.49% GlaxoSmithKline 4.93% Merck & Co 4.43% 6. Bristol-Myers Squibb 4.01% Merck & Co 4.47% Roche 4.85% Gilead Sciences 4.09% 7. Johnson & Johnson 3.61% Johnson & Johnson 3.30% AstraZeneca 4.43% Johnson & Johnson 4.00% 8. Novartis 3.50% Roche 4.22% Johnson & Johnson 3.06% GlaxoSmithKline 3.46% 9. Pharmacia 3.27% Bristol-Myers Squibb 2.94% Lilly 2.87% AstraZeneca 3.01%

10 Lilly 3.08% Abbott Labs 2.88% Abbott Labs 2.71% Abbvie 2.91%

11. Roche 2.86% Lilly 2.77% Bristol-Myers Squibb 2.66% Amgen 2.66%

12. Wyeth 2.76% Wyeth 2.53% Amgen 2.00% Teva 2.28%

13. Schering-Plough 2.52% Amgen 2.32% Takeda 1.97% Lilly 2.13%

14. Takeda 2.37% Takeda 2.02% Teva 1.93% Bristol-Myers Squibb 2.11%

15. Abbott Labs 1.76% Boeh. Ingelheim 1.74% Bayer 1.86% Novo-Nordisk 2.04%

Source: Hardman & Co Life Sciences Research

The pharmaceutical industry is, ultimately, a cyclical industry based around patent protection. On average it takes approximately 10 years from first discovery to launch, leaving a further 10 years until patent expiry for the company to obtain a return on its investment. Generally, once the patent has expired, often after an element of life-cycle management, sales collapse over the following two years, rendering the drug effectively worthless. Therefore, it is the responsibility of management to ensure a steady flow of drugs through the company’s research pipeline both organically and inorganically. However, this is easier said than done.

This was exemplified in 2015 with 80% of the top 10 ranked companies reporting sales declines. In most cases this was due to the loss of patent on a major drug and, even though new products have been launched, the commercial traction is insufficient to offset the generic competition.

Strategy has been key

The table above shows the changes in the top 15 ranked drug companies every five years over a 15 year period. While some movements are the direct result of the introduction of successful new drugs, many have been the consequence of loss of patent protection and a defensive strategy of consolidation, removing costs in order to protect operating margins.

Strategy has been all important. Management of the major players 10-15 years ago often took the easy option of acquiring companies with established products, with the sole intention of creating ‘fat’ and then reducing excess costs. Instead, they perhaps should have taken the riskier option of acquiring new technologies with the aim of improving the product pipeline. Ironically, they probably thought that the risker strategy also put their jobs at risk, which many ended up losing anyway!

Gilead Sciences

Undoubtedly, the greatest success has been Gilead, a company that has focused its research and development in the field of anti-viral drugs. In 2000, the company had sales of just US$150m and it was ranked #49 worldwide. In just 10 years, Gilead had risen to #21 globally with sales of US$7bn. In 2015, Gilead rose to #6 worldwide with sales of US$32bn. The success of the company is even more apparent in the US (see table, page 5) where the company consolidated its position as the leading drug Eight of top 10 companies reported

sales declines last year

History suggests that

managements should make more external investments in new technologies

Transformational performance largely on the back of a single drug

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Pharmaceutical industry – 2015 global ranking

--Global Rank -- Sales --- Market share ---

2005 2015 Company CAGR 2005 2015 ∆ 4 1 Novartis 6.0% 4.81% 5.66% +0.85% 1 2 Pfizer 0.1% 8.33% 5.55% -2.78% 8 3 Roche 5.9% 4.22% 4.94% +0.72% 3 4 Sanofi-Aventis 0.2% 6.54% 4.38% -2.16% 6 5 Merck & Co 4.1% 4.47% 4.43% -0.05% 34 6 Gilead Sciences 33.3% 0.35% 4.09% +3.74%

7 7 Johnson & Johnson 3.5% 4.30% 4.00% -0.30%

2 8 GlaxoSmithKline -2.2% 6.55% 3.46% -3.08% 5 9 AstraZeneca 0.1% 4.49% 3.01% -1.48% 10 10 Abbvie 4.4% 2.88% 2.91% +0.03% 13 11 Amgen 5.7% 2.32% 2.66% +0.35% 24 12 Teva 14.3% 0.91% 2.28% +1.37% 11 13 Lilly 1.6% 2.77% 2.13% -0.63% 9 14 Bristol-Myers Squibb 0.8% 2.94% 2.11% -0.83% 20 15 Novo Nordisk 11.0% 1.08% 2.04% +0.96% Global Rx market 3.9%

Source: Company reports; Hardman & Co Life Sciences Research

GlaxoSmithKline

How the mighty has fallen! It seems incredible that GlaxoSmithKline was the #1 ranked drug company in the world in 2000 with sales of US$22bn giving it 6.8% market share. Since then its position has steadily eroded and, whilst sales have risen to USD27bn (CAGR 1.2%), this is well below the 5.9% compound growth rate for the global industry. In 2015, GSK dropped to #8 in the world with just 3.46% market share, compared to #2 and 6.55% market share a decade ago.

The company’s strategy has been to believe in its own R&D pipeline, assuming that the new drugs in development would be sufficient to offset the loss of patents on maturing products. Although management and the business development team at GSK has undoubtedly looked at hundreds of new technologies over this period, it has rarely taken the plunge to bring such technologies/products into the company. As such, the company has suffered from the “Not Invented Here” syndrome which has been to the detriment of its standing with the industry and in its stock market valuation.

This is superbly illustrated by the statistics in the following table. At the end of December 2005, GSK commanded a stock market valuation of £85.5bn. Despite investing and writing off -£36.9bn in R&D over a decade, its market capitalisation has fallen to £65.9bn. Much of this underperformance has to be due to decisions regarding R&D and business development made 10-20 years ago.

Changes in market capitalisation 2005-2015

--- 2005 --- --- 2015 --- Mkt cap R&D Rank Mkt cap Rank Mkt cap ∆ 2005-15 GlaxoSmithKline #2 £85.5bn #8 £65.9bn -£19.6bn -£36.9bn AstraZeneca #5 £44.7bn #9 £58.4bn +£13.7bn -£30.5bn

Shire #41 £3.7bn #28 £27.8bn +£24.2bn -£4.8bn

Shire + Baxalta *#19 *£45.7bn +£42.1bn

*Assumes conclusion of merger with Baxalta Based on share prices taken at close of business on 31st December

Source: Hardman & Co Life Sciences Research

GSK has fallen from #1 to #8 in a decade…

…reflected by a £20bn fall in its market capitalisation…

…after having invested ca.£37bn (50% of the market cap!) in R&D

GSK has failed to buy into and embrace new technologies

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Shire Pharmaceuticals

In contrast, over the same period of time, Shire has continued on its strategy of buy- and-build, adding specialist therapeutic areas and technologies through licensing deals and acquisitions that complemented and added to those that it already possessed. In 2005, Shire was ranked a lowly #41 in world pharmaceuticals and had a stock market value of £3.7bn – 1/23rd (4.3%) the size of GSK. On a stand-alone basis, over the last decade Shire’s buy-and-build strategy has added £24bn of value with only $3bn/£2bn coming from share issues to fund its M&A activity.

On the assumption that its recently announced deal with Baxalta concludes, the combined entity would enter the top 20 drug companies worldwide and have a market capitalisation of around £46.0bn – making it about ⅔ the size of GSK. Ironically, this might prove to be its peak because, given its size, future growth from here might prove much more challenging.

AstraZeneca

AZN sits between the two. On one hand, the merger of Astra with Zeneca was partly defensive, allowing the removal of costs; on the other hand, AZN has bought into new technologies that it did not have in-house and that were likely to change the future landscape for drugs. In May 2006, it bought Cambridge Antibody Technologies to provide a position in the emerging field of therapeutic antibodies and followed this in June 2007 with the acquisition of MedImmune, which took the company into biologics and vaccines. It has supplemented these bigger deals with some in-licensing of products. The importance of its move into antibody technology can be found on page 6. Consequently, AZN’s stock market performance has been positive.

Focus on the US market

The last decade is ideal in highlighting the different strategies employed by company management teams. The following table and chart shows the ranking of the top 12 companies by US Rx drug sales in 2015 compared to 2005. It also highlights the change in market share over this period of time. It is easy to observe the positive moves made by Gilead (hepatitis drugs), Teva (generics/M&A) and Roche (antibody-derived cancer drugs). In contrast, the defensive M&A moves to create ‘fat’ and then reduce costs by Pfizer (-4.8% share), GlaxoSmithKline (-4.6%) and Merck& Co (-1.3% share) are notable.

Pharmaceutical industry – 2015 US ranking

----US Rank ---- Sales --- Market share ---

2005 2015 Company CAGR 2005 2015 ∆

27 1 Gilead Sciences 35.7% 0.48% 7.01% +6.53%

1 2 Pfizer -1.9% 11.03% 6.20% -4.83%

3 3 Johnson & Johnson 2.4% 6.99% 6.05% -0.94%

10 4 Roche 7.6% 4.25% 6.04% +1.79% 7 5 Amgen 5.3% 4.78% 5.45% +0.67% 4 6 Merck & Co 1.7% 6.64% 5.36% -1.28% 9 7 Novartis 5.0% 4.53% 5.03% +0.50% 8 8 AbbVie 3.3% 4.72% 4.46% -0.26% 5 9 Sanofi-Aventis 0.6% 5.74% 4.16% -1.58% 17 10 Teva 14.8% 1.37% 3.71% +2.34% 2 11 GlaxoSmithKline -4.6% 8.01% 3.43% -4.58% 6 12 AstraZeneca -0.9% 5.03% 3.13% -1.90% 20 13 Allergan 18.7% 0.80% 3.01% +2.21% 12 14 Lilly 1.1% 3.72% 2.82% -0.90% 11 15 Bristol-Myers Squibb 0.1% 3.93% 2.70% -1.23% US Rx market 3.9%

Source: Company reports; Hardman & Co Life Sciences Research

On the other hand, Shire’s buy-and- build approach has been very rewarding

AZN looks poised to benefit from its investments in antibodies and vaccines

Big difference in outcomes from offensive (new technology) moves...

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US ranking 2005-2015 – Rx market share winners & losers

Source: Hardman & Co Life Sciences Research

Given the declines in market share, it would be a natural assumption to think that, in the absence of new drugs coming through the pipeline, the major players have eased back on their R&D investment. In reality, the opposite is true. In 2005, the top 15 players spent $48.2bn (16.8% of Rx sales) on R&D; by 2015, this had risen to $81.8bn (20.8% of Rx sales). A focus on R&D investment will be the subject of a future research note. 0.0% 2.0% 4.0% 6.0% 8.0% 10.0% 12.0% GI LD PFE JNJ RO G AM GN MRK NO VN AB BV SAN TE VA GSK AZN AGN LLY BMY US m ar ke t s ha re (% ) 2005 2015

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The rise of antibody-derived therapeutics

In 2015, drugs derived from monoclonal antibodies have grown to represent 10.2% of the entire global market for prescription drugs. The first – ReoPro (abciximab) was launched in 1995 and there are now 60 regulatory approved monoclonal antibody drugs on the market with sales totalling just over $80bn in 2015. The table below shows the ranking of the top 10 drugs by ex-factory sales, with Humira (adalimumab) being the top selling drug in the world last year. The table also shows that drugs derived from antibodies have generated cumulative sales since launch approaching a staggering $560bn! These figures are expected to rise in coming years given that the FDA approved eight antibody derived drugs in 2015 and has a similar number under review in 2016. Therefore, the therapeutic opportunity is enormous.

Drugs based on monoclonal antibodies cover a big spread of diseases and have revolutionised the treatment of autoimmune disease such as arthritis (rheumatoid and psoriatic) and cancer. While arthritis drugs are the biggest sellers, 35 (58%) of the 60 approved drugs are for the treatment of different forms of cancer. However, it is thought that the currently approved, and waiting for approval, drugs represent the success of the first generation of antibody-based products and that a new generation of engineered antibodies based on a variety of biotech platforms is required to produce new therapeutics with enhanced mechanisms of action and/or improved pharmaco-kinetics and safety profiles:

► Bi-specific and Tri-specific antibodies ► Antibody-drug conjugates

► Alternative technologies

► Antibody and non-antibody scaffolds

From the following table it is clear that certain companies stand out, having embraced this new technology 20 years ago. Roche was one of the first to buy-in to biotechnology through its innovative deal with Genentech. Novartis and Johnson & Johnson have also been active in bringing in new technologies. The rewards of these investments are demonstrable. Over the next few years, given recent approvals and anticipated approvals, we would expect to see Bristol-Myers Squibb and AstraZeneca featuring more in this list. The question for companies and investors alike is, therefore, what is next the next technology that companies should be focusing on?

Top 10 antibody drugs – 2015

Rank Drug Generic name Company 2014

($m) 2015 ($m) Growth (%) Cumulative ($m)

1 Humira adalimumab AbbVie 12,543 14,012 +12% 78,609

2 Rituxan/MabThera rituximab Roche 7,541 7,333 -3% 73,539

3 Avastin bevacizumab Roche 7,013 6,948 -1% 57,205

4 Herceptin trastizumab Roche 6,858 6,796 -1% 59,756

5 Remicade infliximab Johnson & Johnson 6,868 6,561 -4% 59,532

6 Gleevec/Glivec imatinib Novartis 4,746 4,658 -2% 46,612

7 Soliris eculizumab Alexion Pharma 2,234 2,590 +16% 9,546

8 Stelara ustekinumab Johnson & Johnson 2,072 2,474 +19% 8,206

9 Lucentis ranibizumab Novartis 2,441 2,060 -16% 15,395

10 Orencia abatacept Bristol-Myers Squibb 1,652 1,885 +14% 9,170

Totals 76,635 80,513 +5% 558,382

Source: Company reports; Hardman & Co Life Sciences Research

There are 60 approved drugs derived from antibodies…

...including the biggest selling drug in the world with annual sales of $14bn…

….and cumulative antibody drug sales now approaching $560bn!

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