Roche Has $47 Fair Value But Patent Protection Abroad A Concern

Roche Holdings (PINK:RHHBY) is the latest victim of India’s efforts to lower the costs of highly expensive patented drugs as the country’s Intellectual Property Appellate Board (IPAB) has nixed Roche’s Indian patent for Hepatitis C drug Pegasys. ^[1] While the move may not significantly hurt the company at the moment, it certainly fuels concern among pharmaceutical giants who have been eying the rapidly growing emerging markets to offset the weakness in European and U.S. markets.

We maintain our price estimate for Roche Holdings at $47, which is in-line with the current market price.

See Full Analysis for Roche Holdings Here

India, with a population of 1.2 billion, has a huge patient base suffering from life-threatening diseases. However, the country’s per capita income is considerably lower compared to developed and other emerging countries. Further, most of the people in India pay directly from their pockets as opposed to insurance proceeds in developed countries, and so the market remains quite price-sensitive. While the government subsidizes medical costs for the poor, the country still doesn’t have deep pockets to afford drugs that cost as high as $5,000 in therapies at times. So, the Indian government has been mulling ways to control the prices of life-saving but highly expensive patented drugs in a bid to make them affordable for the patients. A new policy to cap the prices of life-saving drugs may come as early as next month.

Taking away patent rights of certain life-saving drugs and allowing domestic companies to manufacture significantly lower-priced generic drugs is also part of the strategy. The cancellation of Roche’s patent on Pegasys shows the country’s aggressiveness in this regard. Earlier this year, the Indian government granted a license to domestic drug manufacturer Natco Pharmaceutical to make and sell German company Bayer’s patented cancer drug at nearly 1/30th of the price (from approximately $5,000 to $150 per month) in return for a 6% royalty on sales to the latter. ^[2]

Pegasys generates about CHF 1.5 billion in revenue and close to 45% of that is from international markets including emerging markets like China and India. Therefore, revenues losses from the judgement would not be significant. By moving the trend-line in the chart below, you can see how a decline in revenues impacts the company’s stock price.

We are however worried about similar moves in the future that could hurt pharmaceutical giants who are trying to recover R&D costs by heavily charging for their patented products (sometimes at exorbitant prices). However, before jumping to conclusions, one should consider the potential of the market which remains untapped due to affordability. For example, there are about 12 million Hepatitis C patients in India, significantly higher than the U.S. and Europe. ^[3] But, not many of them are able to afford Pegasys, which costs more than $6000 for a six-month treatment.

While additional revenues from new patients may not entirely make up for revenue losses from low prices by selling products at affordable prices, the company can build goodwill over a period of time and be well-positioned to tap growth in primary and generics market. The average income level in India is catching up with the rest of the world. In addition, the country’s spending on healthcare (as % of GDP) is considerably low than most of its peers and is likely to go up in the future. Further, insurance coverage is also increasing. All of these factors point to a rapidly growing market that pharmaceutical companies cannot afford to ignore.

However, lower prices will certainly result in lower margins even as volumes jump. But, on an absolute basis, profits may continue to grow and add to shareholders’ value.

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1. India revokes Roche patent in new blow for Big Pharma, Reuters, Nov 2 2012 [↩]
2. Natco Pharma bags licence to sell Bayer’s cancer drug Nexavar, EconomicTimes, Mar 13 [↩]
3. Hepatitis C Statistics, WHO [↩]