A few days ago, I introduced EGIS as one of my new positions (part 1, part 2).
At that point in time I did not spend so much time on the generic drug business in general. However I think its makes a lot of sense to look at this a little bit more closely as it seems to be quite interesting. As this collection is mostly a reminder to myself, I will start with a summary and then have the details afterwards:
The generic drug secor seems to be in a secular tailwind which might explain the nice margins for the sector as a whole. I personally do not believe fully in the “common knowledge” that company size is key, as the large players look less profitable. Finally, the market in Russia, EGIS biggest single market, seems to be a great opportunity although the risks are clearly there as well.
General business model generics:
The general business model for generic drug companies is in theory quite simple: You have to copy expired patented drugs as quickly as possible and then try to sell them either as
a) the cheapest alternative
b) as a “generic brand”
So in order to be succesful, one has either to be a trusted brand (see all the Ratiopharm adverts in Germany) or the cheapest one. As we all now, advertising has significant effects of scale, so for a small player to become a trusted brand is quite difficult. Low cost in contrast is in theory easier to achieve as a smaller player. As generic companies have to produce a lot of different products, I would assume that it is possible to become cost efficient in some drugs if one concentrates on those which have maybe a similar prodcution process.
Clearly, distribution plays a role as well. A generic drug company has to get into pharmacies. Usually, large pharmaceutical wholesalers (Celesio etc.) try to control that part of the supply chain. A big Generic company may have advantages here as well.
Interestingly, at least some of the big players do not have better margins than EGIS. Teva for instance has on average around 13% NI margin and 11% ROCE vs. EGIS 11.9% net margin and 12% ROCE for the last 15 years. So at least in hard numbers the size advantage does not look so significant. Maybe big players like Teva are not so interested in small markets like Serbia, Bulgaria and Romania ? Also some of the big US players (Actavis) are a lot less profitable than the smaller players.
Additionally, I think many people greatly mistake size and competitive advantage. Size can be a competitive advantage in some cases, but often, “diseconomics” of scale dominate, especially in companies which are the results of frequent mergers. This leaves a lot of room for smaller, more agile players to gain ground.
A further difference in business models is the fact, that some generic companies actually produce the so-called Active pharmaceutical Ingredients (API) themselves like for instance EGIS. other, like Stada buy them and only “mix” the drugs. Maybe this is the reason why Stada scores so badly both in margins and ROCE against EGIS ?
“Pay for delay”
An even more interesting business model has developed for some generic companies in the last years, the so-called “pay for delay” market. Here, R&D pharamaceuticals pay directly to Generics companies to delay their start of production and distribution. This almost seems to good to be true: You get paid for doing nothing. As often, things which are too good to be true will go away quickly. In this case, both in the US and Europe courts have already indicated that they consider this practice as illegal to a large extent.
The generic drug business has a strong secular tailwind. Medical costs skyrocket in most countries. One of the “quick fixes” for Governments is to make life easier for generics and harder for patented drugs in order to drive down costs for drugs.
Clearly, in many countries also Generic drug makers suffer, such as in EGIS home market Hungary. However, I think they can adapt better than “research companies” who need to invest a lot more into the development of new drugs.
All in all, it is better to invest into a sector with secular tailwinds than in a distressed sector.
Special Case Russia
Russia is currently the biggest single market for EGIS and the main driver for growth. The major driver here seems to be a Government led program established in 2009 to increase the supply of medication to Russian people significantly until 2020. Part of that program is also to increase the percentage of domestically manufactured drugs. So it might make some sense for EGIS to find a local partner or m&A target. Nevertheless, this will of course be risky. Stada for instance tried to take over Russia’s Pharmstandard, but ultimately failed to do so.
This seems to be a big “buzz word” in generics at the moment. Biotech drugs cannot be as easily copied as “normal” drugs. Generics companies will have to invest a lot more money and effort into producing socalled “biosimilar” drugs. EGIS has already ligned up a deal with a Korean Biotech company, but as far as I understand it is only a distribution deal. Clearly an area to watch.
Krka (ISIN SI0031102120)- Slovenian Generics company
Krka is another Eastern European generic company based in Slovenia. It is nominally more expensive than EGIS, but it is more profitable as well. It might even be a “special situatioN” as the Slovenian Government which currently control the company, might be forced to sell their stake.
More to come on Krka….
Interesting Interview with the EGIS CFO 2 years ago:
Click to access Finance-EE-02-2011-PharmaInterview.pdf
When the business cycle goes down, public budgets go into the red and governments need to cut spending. This significantly affects the health sector as a major area of public spending. Thus, through the reimbursement system, a macro-economic crisis hits the pharmaceutical business usually with a delay of approximately two years.
Finally a big link dump from where I have compiled my “knowledge” above:
Click to access newport-deals.pdf
Click to access EFPIA%20Figures%202012%20Final.pdf
Click to access Zasimova%20final%20netti.pdf
Click to access 0895_0895.pdf