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Tuesday, 15 July 2014

Ernst's “Investments in the future” pt 1: Pharmacy

This is the start of a new series of articles on Ernst’s Economy for You. 

Next to my ‘regular’ articles regarding the Dutch and European economies and politics in the broadest sense of the word, I wanted to increasingly focus on handing out possible investment opportunities for companies and private persons.

I want to answer questions like:
  • What will be the winning industries of the future?
  • What will be the winning business and earnings’ models?
  • Which changes should companies make in order to survive?!
  • How can we earn money from these imminent developments? 

The first issue of this series is about pharmacy.

Why pharmacy?

Pharmacy is an industry in which large and extremely wealthy, Western companies, like Pfizer, Novartis, Sanofi, Roche, Merck & Co and a dozen others rule. In the pharmaceutical industry, a few bestseller drugs can pay for the research and development costs of dozens of other, less successful drugs and still reward the shareholders with healthy dividends. 

Due to the circumstance that people need drugs every day, this can be considered a non-cyclical and crisis-resistant industry, in contrary to many other industries. During the last six years, since the crisis started, the stock rates of these companies have all shown steep inclines, turning them into the love interests of many investors.

The sales potential of successful drugs – for instance anti-cholesterol drugs, antacids, anti thrombosis agents or anti-diabetes drugs – is simply overwhelming. 

In many western countries and in countries like Russia, Japan and China, there are four important factors which spur the usage of the aforementioned – and other – drug types:
  • An aging population, as a consequence of both a longer life expectancy and a diminishing birth rate;
  • Improved medicine and surgery, which turned formerly terminal diseases and illnesses into chronical, but yet survivable affections;
  • Computer-aided, desk-bound labour, which forces many people to spend hours and hours on working behind their desks, in a static position. This has undoubtedly a bad influence on people's health
  • A growing global population, which becomes more and more chronically unhealthy (without really being ill), as a  consequence of adopting the western lifestyle, with its overdose of salt, sugar, carbon hydrates and fat in pre-cooked food products.

These factors, as well as the globalization of the pharmacy production, made that a diminishing number of multinational pharma giants services and ‘controls’ a soaring number of potential patients / customers.  

In other words: an ever growing pie needs to be divided among an ever smaller number of eaters: this makes the pharma industry an extremely lucrative one, in theory.

There are, however, a few dark clouds at the horizon:
  • The pharma giants are increasingly trying to grow through mergers and acquisitions, instead of aiming at autonomous growth via the development of own new and innovative drugs;
  • The tunnel-vision of the pharma giants regarding medicine for lifestyle diseases, at the expense of vaccines, drugs against mass-killers and antibiotics is worrisome. 

Paradigm shift: from lifestyle drugs to vaccines and drugs against mass killer diseases?

Most large pharmaceutical companies have shareholders and they are quoted at the international stock exchanges. 

This fact puts pressure on the margins and general profitability of these companies, as well as on their long-term vision and planning: every quarter brings a new confrontation with the ADHD-laden shareholders and the various analysts. 

It is simple: too little profit and too many bleeders and you are out, as a CEO, under pressure of vigilant shareholders and/or private equity companies.

And unfortunately, it is less lucrative to cure somebody from aids, hemorrhagic fever and malaria or from an aggressive inflamation, than to help somebody with chronical diseases, like cardiac diseases, gastric acid problems, diabetes or elevated cholesterol levels.

Why would you create a drug that helps one person to cure within a few days or weeks, while you can also ‘help’ somebody else with expensive prescription drugs, which he must use during the full remainder of his life?! 

This behaviour of the pharma giants was reinforced by the circumstance that deadly diseases (i.e. mass killers), like malaria, aids, aggressive inflamations, dangerous influenzas and hemorrhagic fevers were mainly Third World diseases. 

The Third World was traditionally the place, where people lived with less purchase power, fewer lifestyle diseases and generally a shorter life expectancy than their western counterparts. The general idea was:

[The generally short prescription periods of medicine for one-off usage + lower occurrence of chronical lifestyle diseases +  unwealthy people in the Third World = poor profits for drugs]

I think, however, that this paradigm might shift in the coming years.

The business model of drugs for (former) Third World countries

Three of the four BRIC-countries – Brazil, India and China – as well as other former Third World countries, like Vietnam, Cambodia, Indonesia and some African countries, have (partially) a tropical climate. 

Such a climate, in combination with the often more traditional lifestyle in these countries, offers a strongly elevated risk for malaria and outbreaks of inflammatory diseases and influenzas.

All these countries also have a soaring economic growth in common, as well as soaring wealth and increasing purchase power among their population. 

And the most important factor: India and China alone count for over one third of the world population, while these countries are rapidly developing a relatively wealthy middle class, consisting of hundreds of millions of potential customers for prescription drugs.

It could very well be that these ‘formerly poor’ Third World countries will soon pay top-dollar for improved prescription drugs, against tropical diseases and the other affections mentioned earlier.

While the life-style drugs might remain important cash cows for the Western pharma giants, there could be an immense shift towards the development of ‘third world medicine’, in order to not leap behind the pharmaceutical companies in India and China itself.

This could mean new growth for the Western pharmaceutical industry, albeit in formerly unexpected territory.


There is no denying that the excessive global usage of antibiotics – not only for human recovery, but for intensive cattle breeding and fish farmery as well – is an accident waiting to happen. And this accident will happen rather sooner than later.

The scientific evidence is overwhelming that we are in the middle of an uprising of new generations of ‘superbugs’, which are resistant against almost all kinds of antibiotics and even formerly successful combinations of it.

Fortunately, most incidental outbreaks of these superbugs take place in relatively well-contained environments (like hospitals) and mostly among people, who often already suffered from a low level of resilience. 

The improved hygiene, as well as the natural resilience  coming from the immune system  of healthy people has fortunately stopped massive outbreaks of such superbugs. This is the reason that large accidents, concerning multi-resistant bacteria, hardly occured yet.

Nevertheless, there is a more than average chance that a dangerous, multi-resistant bacteria will cause a massive outbreak of disease in the not so distant future. An outbreak, which – in a worst case scenario – might perhaps be compared with the medieval plague in lethality and possible number of casualties.

Yet, the silence surrounding the development of new, vitally important antibiotics is really deafening. 

The reason for this? The same circumstances which caused the poor interest of the pharma giants in the development of anti-malaria agents and new vaccines against tropical killers. 

Development of new antibiotics did not fit in the current paradigm of the Western pharmaceutical giants, as these will probably not supply the elevated influx of money that other prescription drugs can bring. For this reason, the industry chose until now to fully use up its current portfolio of antibiotics, instead of developing new ones.

In my humble opinion, this dangerous shortsightedness of the pharmaceutical industry – in combination with the blatant ostrich policy of the western governments, to leave the development of new antibiotics to the pharma giants themselves – could lead to a frantic race against the clock, in order to remain the superbugs one step ahead.

The final outcome of this race is anybody’s guess, as new medicine is notoriously hard to develop and takes a very long time to be deployed on the international markets.  

Buying the competition to avoid taxes?

The most significant news from the pharmaceutical industry, recently, has been Pfizer’s plan to take over Swedish/British pharma giant AstraZeneca and subsequently move its headoffice to London, obviously for fiscal reasons:

Many people know by heart that such mega-mergers seldomly yield the economies-of-scale, which were promised in advance and often rather bring the total opposite: billions in lost money on company and ICT restructuring and structurally worse results for both companies than before.

No, the reason is simply that Pfizer doesn’t know what else to do with the money stashed away, as ‘bringing it home’ is impossible in their narrow-minded thought process. Pfizer won't use their money to invent new antibiotics that the world so desperately needs nowadays, or to invent a new drug against malaria which could save millions of lives. These drugs will not be cash cows and therefore they are not worth investing in.

I would urge Pfizer, Novartis and their likes to stop this cash-consuming and utterly improductive moving and spending of their stockpiles of cash money for fiscal reasons, as well as their ‘battles to become the biggest’.

The world needs new and better prescription drugs against mass-killer diseases and especially antibiotics, and it needs those fast, in order to prevent lethal future pandemics from occurring sooner or later!!!

Does real innovation have a chance?

Of course, real innovation has a chance in the future. Without this real innovation in the past, the current pharmaceutical giants would not have existed in the first place.

However, the hyperactive shareholders, as well as the bonus-hungry, short-term focused executive management of these pharma giants, are hardly willing to ‘travel the high road’ at this moment.

This means in practice that, during the next few years, the focus of the Western pharma giants will remain on their bestselling, high yield prescription drugs for western lifestyle diseases. Suffice it to say that this will not lead to mindboggling innovation soon, but only to anti-cholesterol drug no. 22 and anti-diabetes agent no. 15!

Nevertheless, the race for new medicine against mass-killing diseases, like aids and malaria, will be on within a few years: influenced by growing masses of wealthy Chinese and Indian middle class people and by the fast-growing pharmaceutical industries in these countries.

And so will be the hunt for new antibiotics: perhaps at the own initiative of the Western pharma giants or perhaps at gunpoint from anxious governments, which want to avoid cataclysmic outbreaks of infectious diseases in the future. 

Fortunately, I am quite optimistic, as far as mid-term developments are concerned.

How can we earn money on these developments?

As I stated before, the top 5 pharmaceutical companies all showed a steep rise of the stock quotations during the last five years (check out Bloomberg), which means that their stocks are highly (or even over) valued today. This makes these particular companies a less promising investment, when buy-and-hold is your strategy.

My take would therefore be, to only invest in companies that either clearly focus on the development of genuinely new medicine (antibiotics, vaccines or drugs against dangerous influenzas, malaria and aids) or on new innovative techniques for medicine development. 

These focal points will be where the future growth lies, in my humble opinion.

Such companies could be:
  • Small and innovative start-ups in both the West and the Far East, which develop new and innovative techniques for medicine development and / or drugs;
  • Even one or more of the aforementioned top 5 (or 10) Western pharma giants, whenever they show the guts to withstand shareholder pressure and return to genuine innovation, instead of taking over their competitors with tax-money, stashed out of sight of the American Internal Revenue Service.
  • And last, but not least: don’t forget the Chinese and Indian developers of generic prescription drugs, like for instance Zhejiang Huahai Pharmaceutical Company or Ranbaxy Laboratories.

At this moment, most of these companies are still focusing on copying generic Western drugs and some of them yet suffer from serious quality issues. This situation, however, will not last forever.

As the American car industry can already fully confirm, the West should not count on having and maintaining the lead forever in the pharmaceutical industry. Investing in those Far Eastern pharma companies could turn out into an educated gamble, which could end being very much worth your while.

From either side, the pharmaceutical industry will remain a growing industry in years and years to come.

Disclaimer: This analysis is solely written with the purpose of information supply.

I don’t have any financial or business strings attached to this industry. As I am not an investor myself, I don’t have any financial purposes with this advice, except for supplying people with free and interesting information. 

People are free to follow up my advices or not. However, I can’t accept any responsibility for the investment decisions that people make, based upon the advices mentioned in this article.

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