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Equity Perspectives

Fueled by valuable genetic information and greater cooperation from regulators, R&D in pharmaceuticals and biotechnology has rebounded strongly, with new drugs reaching the market faster than ever, all of which has driven sector outperformance.

Fueled by valuable genetic information and greater cooperation between industry and regulators, research and development (R&D) in pharmaceuticals and biotechnology has rebounded strongly, with new drugs reaching the market faster than ever, all of which has driven sector outperformance in the last year. Lord Abbett research analysts Lavina Talukdar (pharmaceuticals and biotechnology) and Matt DeCicco (small cap therapeutics and services) explain the dynamics behind this major growth story.

After listening to a wide range of scientific presentations at the American Society of Clinical Oncologists annual conference (ASCO) in Chicago last year, Lord Abbett Research Analyst Lavina Talukdar sensed some strong investment themes. This was the largest gathering of cancer experts in one location, and a number of pharmaceutical and biotechnology companies in her investment universe were pursuing more innovative strategies, applying valuable knowledge from genomic research, and using targeted therapies that appeared to offer considerable upside potential.

What impressed Talukdar at ASCO-2012, though, was the overwhelmingly positive new data from the large cap pharma companies in attendance. "The new data weren't just mere improvements on already established treatments for various cancers," she reported to Lord Abbett colleagues afterward. "Instead, many of the data sets presented were groundbreaking and paradigm shifting. This used to be the case for the biotech companies just five years earlier."

Talukdar argued that this was the time to own large cap pharma names—after a decade or more of relative underperformance—given the combination of low multiples, high dividend yields, the anniversary of major patent losses, and the emergence of a more productive pipeline.

One company in particular reported very encouraging progress against melanoma (considered one of the most difficult forms of skin cancer to treat) as well as lung and renal cancers—not with some new chemotherapy but with a groundbreaking approach that induced the patient's own immune system to fight the cancer. And on the strength of early test results, the company was going to move straight into a Phase 3 clinical trial, which is typically the final stage before regulators allow a drug to be marketed.

As the implications of such news sunk in, investors would, months later, drive up the price of that company's shares, anticipating approval of at least one immunotherapy regimen in early 2014. But looking further ahead, Talukdar felt that the leaders in this technology had the potential to generate significant growth in an otherwise slow economy.

Building and Promoting the Investment Thesis
Talukdar's interest in biology and other natural sciences started early on and eventually led her to combine premedical coursework with business and finance studies in college. But with the advent of managed care in the mid- and late 80s, a prominent orthopedic surgeon changed her mind about going to medical school. Her ongoing fascination with various sciences, on the other hand, remained strong and continues to inform her coverage of the companies in her sectors.

In early 2013, Talukdar was invited to an in-house brainstorming conference with fellow Lord Abbett investment professionals to discuss differences between her view of the pharmaceutical and biotechnology sectors and what the overall market appeared to be thinking.

Her first "variant perception" (as the moderator put it) was that R&D productivity in both pharmaceuticals and biotech, which had been written off over the last five to 10 years, was now accelerating to what some experts considered the most encouraging pace in more than a decade. (See Chart 1.)


 
Chart 1. Pharmaceutical Research and Development Continues at a Healthy Pace
Global pharma R&D spending

Source: JP Morgan research. Data labeled "A" is actual as of December 31 of years listed. "E" refers to JPMorgan research estimates. LC Growth refers to last-calendar-year growth.

 

Like her colleague, Lord Abbett Research Analyst Matthew DeCicco, Talukdar was impressed with the growing number of drug approvals per R&D dollar (see Chart 2) and the growing number of drug approvals in recent years (see Chart 3). While there was always a chance that Food and Drug Administration (FDA) policy might change during the next presidential administration, both analysts believe the number of drug approvals would continue to rise.


 
Chart 2. Drug Companies Are Getting More Bang for Their R&D Buck
New molecule entity (NME) per $1 billion in R&D spent

Source: ISI Research. Data as of December 31, 2012.

 

 
Chart 3: In Recent Years, the FDA Has Approved More Drugs in Less Time*
FDA new molecular entity (NME) approvals

Source: Citi Research. Data as of December 31, 2012.
* In terms of months.

 

"The industry has gotten a lot smarter about the way it develops new drugs," DeCicco said. "In addition to more intelligently designed clinical trials, they’re focusing on drugs targeted to smaller patient groups with similar disease characteristics, which gives them a greater probability of success."

One catalyst for this trend was the flood of valuable information since the human genome1 was sequenced in 2003; another was the increasing level of cooperation in medical research transformed by advanced diagnostic, testing, and imaging technologies, all of which have helped the pharmaceutical and biotech sectors reach a critical inflection point, where new breakthrough drugs can reach the market faster than ever.

Strange as it may sound, this faster time to market reflects the growing importance of biology in drug development. Before the sequencing of the human genome, R&D processes may have been more driven by chemical analysis, which is to say, a pharmaceutical company would typically devise a chemical compound and then test its effectiveness in the human body.

Now that the human genome has been sequenced, however, scientists have gained a better understanding of the human body's vast array of microscopic pathways and switches. That, in turn, has led to what are commonly called "biologics," which include a wide range of products, such as vaccines, gene therapy, tissues, and recombinant therapeutic proteins. Biologics can be composed of sugars, proteins, or nucleic acids, or complex combinations of these substances, or may be living entities such as cells and tissues, according to the FDA.

"In the past 10 years, new technologies have provided tremendous insight into the genetic and molecular basis of disease," Talukdar said. "And all that has set the stage for a massive increase in personalized medicine not just in the war on cancer but also against a variety of serious diseases."

What is personalized medicine?2 "At heart, what this is all about is harnessing our exploding knowledge of the human genome and applying it to the treatment of severe disease for individuals based on genetic analysis," said J. Leonard Lichtenfeld, deputy chief medical officer for the national office of the American Cancer Society. "[The] focus today is on cancer, but other diseases such as degenerative brain diseases also will be impacted by our knowledge of the human genome."

"The number of personalized medicines, treatments, and diagnostics available has been growing steadily in recent years," DeCicco added. "And it's fair to say the pace of scientific discoveries is likely to drive a lot more innovation later in this decade."

Morphin' Orphans
For years, the pharmaceutical industry has had trouble recouping the costs of researching and developing drugs targeted to major illnesses. Although some drugs were once considered promising after early clinical trials, they failed to show enough convincing data in late-stage trials to earn regulatory approval.

For makers of drugs targeted to rare diseases (also known as "orphan drugs"), the regulatory frustration has been even more acute, even though a law designed to encourage development of such drugs has been in place since 1983.

All that began to change for the better after Timothy Coté settled in as director of the FDA's Office of Orphan Products Development in 2007, with direct responsibility for promoting the development of products that demonstrate promise for the diagnosis or treatment of rare diseases or conditions.

"We have an opacity problem at the FDA," Coté acknowledged later.3 "It's a big black box. Nobody knows what they're thinking inside. And we're smashing that black box. We're making it transparent, and we're showing people that what we're doing is reasonable, that we don't bite, and [that] we are just as interested in getting new drugs for people with rare diseases as the sponsors are."

Since then, the FDA has become even more receptive to getting drugs approved and on the market if they can be designated as breakthroughs. "In order to gain that status," Talukdar said, "the company has to create very early clinical trials showing a drug has the potential to change the course of a certain disease and would really have a meaningful impact on patients, even in Phase 1 of testing."

In a sense, the FDA is sharing risk with the pharmaceutical and biotech companies in order to get critically needed drugs in the hands of patients.

Why would the FDA, a regulator long concerned with potential side effects, work toward greater cooperation with industry?

"There could be two reasons," Talukdar said. "One is political, which may seem plausible because people want more drugs on the market, but that is rarely a main motivator. I really think it's because the FDA itself is also using the same tools that biotech and pharma companies use to elucidate the biological pathway of a disease and, therefore, demonstrate the efficacy and safety of a proposed drug in a shorter time frame."

Whatever the explanation, investors are encouraged by the prospect of more drugs coming to market faster than in previous decades. Even if those drugs are not so-called blockbuster compounds with vast patient populations, targeted therapies have the potential to generate significant new revenue streams. All of which helps to explain why both large cap pharmaceutical companies and more innovative small caps have both outperformed larger indexes in the last year. (See Chart 4.) While some of the large cap pharmaceutical companies Talukdar covers have eclipsed the larger market in the last two years, several small cap companies in DeCicco's universe have seen their stock values double or triple in the same time period.


 
Chart 4. Biotechnology Stocks Have Outperformed the Overall Market by a Substantial Margin
Monthly returns (%) of NASDAQ Biotechnology Index4 (NBI) versus S&P 500 Index,5 August 31, 2011–July 31, 2013

Source: Morningstar.
Past performance is no guarantee of future results.
For illustrative purposes only and does not reflect the performance of any Lord Abbett mutual fund or any particular investment.
Indexes are unmanaged, do not reflect the deduction of fees or expenses, and are not available for direct investment.

 

Assuming the confluence of disruptive technology and precision medicine becomes more widely appreciated, both Talukdar and DeCicco believe the multiples of stocks in their respective universes will expand. "I think we're just scratching the surface with some of this innovation because the strongest players are accelerating development all the time," DeCicco said.

Immunotherapy Opens New Front in War on Cancer
One factor driving pharma and stock prices this year has been significant progress in figuring out not just why a disease is taking hold but also what the body's response is. In the case of cancer, much depends on the ability of T-cells (a form of white blood cell) to fight the disease. If those T-cells are not strong enough to combat cancer cells or are somehow being shut off by the cancer cell itself or some immunological deficiency, the chance of that disease spreading will typically increase, and diseased cells growing at a very rapid rate may invade other cells that are normal.

One company Talukdar follows has been particularly knowledgeable about the myriad ways cancer can respond, adapt, and eventually become less sensitive to chemotherapy. In the case of melanoma—to cite just one of several promising examples—company scientists came up with a drug that prevents cancer cells from turning off the T-cells so critical to the body's immune system. And Talukdar found that this has helped extend the life expectancy of melanoma patients anywhere from two to three months to as many as two to three years.

Meanwhile, a second drug developed by this company has also shown very strong results in blocking the "keyhole" that cancer cells use to disable the body's defenses against cancer. That can allow the body's immune system to continue fighting cancer, especially if taken in conjunction with other targeted agents such as chemotherapy, Talukdar added.

While Talukdar considers the company mentioned above a front-runner in the latest generation of targeted cancer drugs (a factor that helped its stock price gain more than 34% for the year ended September 12, 2013, a highly unusual jump for a pharma company its size), several other global players she has recommended for portfolio managers' consideration also have promising medicines in the pipeline.

"With these types of disruptive technologies taking hold now, I envision such combinations in the future will complement the way we think about cancer," Talukdar said. (See "Cancer by the Numbers.") "We should see more significant breakthroughs, if not full outright cures, with cancer possibly becoming more of a chronic disease as opposed to a death sentence."

Developing Another Genetic Weapon
Another disruptive force in the war on serious diseases is the maturation of so-called RNA6 technologies that combine the fields of biochemistry, chemistry, molecular biology, cell biology, physics, nanotechnology, and bioinformatics. Simply put, RNA conveys genetic information from DNA7 and plays a critical role in the formation of proteins that regulate myriad bodily functions.

"Proteins are like the serfs in a feudal system," Talukdar explained. "They’re the ones that do all the work, that make sure your food is digested properly, make sure your eyesight is functioning well enough, make sure each cell is getting its healthy dose of every vitamin, and break down the fats, and so on and so on."

Against that backdrop, another company in Talukdar's universe recently received FDA approval for a drug that binds to RNA instead of proteins, which have been the focus of the pharmaceutical industry for more than 100 years. That and other innovations in the pipeline have helped the company's stock price jump almost 200% for the year through August 15, 2013, and since RNA technologies are still in their relative infancy, Talukdar believes the stock has the potential to advance even further.

One reason for such optimism is the high degree of flexibility the company can apply to creating, manufacturing, and targeting drugs to a wide variety of diseases. Another reason is its faster and more cost-efficient approach to drug discovery and early development stages than traditional small molecule drugs. As Talukdar put it, "The advances this company has made in process chemistry have far-reaching implications for patients in need."

—Reported by Steve Govoni


Cancer by the Numbers

Reports of rising survivorship and promising clinical trials may be encouraging, but the many forms of cancer remain a major public health challenge for patients, their families, and healthcare providers.

According to the American Cancer Society (ACS), nearly eight million people worldwide die each year from cancer, and for all the progress on the pharmaceutical front, the number of deaths is projected to pass 13 million by 2030.

In 2010 alone, there were 13.2 million new cases of cancer, costing $290 billion worldwide, and the number of new cancer cases is projected to rise to 22.2 million in 2030, costing $458 billion, the ACS says.

When it comes to treating the pain of that disease, ACS says 90% of the morphine used globally is administered in Australia, New Zealand, Canada, the United States, and some European countries alone, leaving just 10% for the rest of the world. As a result, some researchers have found that 99% of cancer patients in developing countries are dying with untreated pain.

According to research from the University of Chicago, reducing cancer death rates by 10% would be worth roughly $4.4 trillion in economic value to current and future generations.


1 A genome comprises the complete DNA (deoxyribonucleic acid) in an organism, including its genes. Genes carry information for making all the proteins required by all organisms. These proteins determine, among other things, how the organism looks, how well its body metabolizes food or fights infection, and sometimes even how it behaves. (Source: Oak Ridge National Laboratory.)
2 According to the President's Council on Advisors on Science and Technology, personalized medicine refers to the tailoring of medical treatment to the individual characteristics of each patient. It also refers to the classifying of individuals into subpopulations that differ in their susceptibility to a particular disease or their response to a specific treatment. Preventive or therapeutic interventions can then be concentrated on those who will benefit, sparing expense and side effects for those who will not.
3 Lorna Benson, "FDA Works to Speed Up 'Orphan Drug' Process," MPR News, Minnesota Public Radio, August 6, 2010.
4 The NASDAQ Biotechnology Index is a modified market-capitalization-weighted index designed to measure the performance of all NASDAQ stocks in the biotechnology sector. The index was developed with a base value of 200 as of November 1, 1993.
5 The S&P 500® Index is widely regarded as the standard for measuring large cap U.S. stock market performance and includes a representative sample of leading companies in leading industries. The index is unmanaged, does not reflect the deduction of fees or expenses, and is not available for direct investment.
6 RNA, or ribonucleic acid, is a molecule similar to DNA (deoxyribonucleic acid). Unlike DNA, RNA is single-stranded. An RNA strand has a backbone made of alternating sugar (ribose) and phosphate groups. Attached to each sugar is one of four bases: adenine (A), uracil (U), cytosine (C), or guanine (G). Different types of RNA exist in the cell: messenger RNA (mRNA), ribosomal RNA (rRNA), and transfer RNA (tRNA). More recently, some small RNAs have been found to be involved in regulating gene expression. (Source: National Human Genome Research Institute.)
7 DNA, or deoxyribonucleic acid, is the chemical name for the molecule that carries genetic instructions in all living things. The DNA molecule consists of two strands that wind around one another to form a shape known as a double helix. Each strand has a backbone made of alternating sugar (deoxyribose) and phosphate groups. Attached to each sugar is one of four bases: adenine (A), cytosine (C), guanine (G), and thymine (T). The two strands are held together by bonds between the bases; adenine bonds with thymine, and cytosine bonds with guanine. The sequence of the bases along the backbones serves as instructions for assembling protein and RNA molecules. (Source: National Human Genome Research Institute.)

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