Drug Profits: Inoculated from Congress

While the iShares NASDAQ Biotechnology Index (NSDQ: IBB) has gained more than 50 percent over the trailing year and nearly doubled over the past two, it's not immune from the occasional sell-off. Since last Friday, the index is down by more than 8 percent following Congressional concern about high drug costs.

Those concerns are unwarranted, which opens the way for investment opportunity.

Gilead Sciences (NSDQ: GILD) recently launched Sovaldi, a new hepatitis C treatment, and plans to sell a 12-week course of treatment for $84,000. The House Energy and Commerce committee sent a letter to the company questioning the cost, worrying that high price tag could put the treatment out of reach for uninsured patients.

The Committee also brought up the point that hepatitis C is a disease that's extremely prevalent among low-income and minority patients, many of whom are on state Medicaid programs and other forms of government health care assistance. Considering that many of those programs operate on tight budgets, the concern is that such high drug costs could stretch them even further. For instance, it's estimated that the cost of Sovaldi alone could cost California's Medicaid program almost $30 billion per year.

The committee has asked Gilead for a briefing on the issue by April 3.

Gilead isn't the only company with a pricey drug. In last week’s Money & Medicine, I wrote about Alexion Pharmaceuticals (NSDQ: ALXN) and its drug Soliris, the world's single most expensive drug costing nearly $410,000 per year. Sanofi's (NYSE: SNY) drug Myozyme costs $300,000 per year while the price of ViroPharma's (NSDQ: VPHM) Cinryze runs at about $350,000.

So, what happens next? The odds are, not much.

The current law specifically prohibits Medicare and Medicaid from negotiating drug prices and the programs are forced to cover virtually any drug that the Food and Drug Administ! ration has approved.

The only leverage the programs have in setting prices is that Congress has said they can refuse to pay any more than what "the market" pays for a drug, though that's a poorly defined term. Medicare and Medicaid, like private insurers, can also use formularies, or lists of preferred drugs for specific conditions for patient reimbursement purposes, but they don't play a role in setting prices.

The simple fact is that government-administered health care programs have never really had any teeth in terms of drug pricing, a fact that was left unchanged by the Affordable Care Act (ACA) to get the pharmaceutical companies to go along with it.

While drug prices will eventually have to be addressed vis-à-vis those programs to contain costs and ensure the long-term solvency of the programs, after the huge battle over the ACA that issue isn't likely to come any time soon. Republicans aren't inclined to interfere in the free market mechanism and Democrats will be gun shy on the issue for some time to come.

About all Congress can do to address the issue is to crow about it on the public stage and hope to shame drug companies into lowering their prices. But this “bully pulpit” has its limitations.

The market itself will also help to flatten the price curve to at least some degree. Pharmacy benefit managers (PBM) such as Express Scripts (NSDQ: ESRX), the nation's largest, have processed about 1.5 billion prescriptions last year, giving them significant leverage in negotiating pharmaceutical reimbursement rates. While pricing spats occasionally emerge among the PBMs, manufacturers and pharmacies, the PBMs usually prevail.

The other significant force is the sheer size of the hepatitis C market. With about 4 million chronic cases in the US and an estimated 180 million around the world, drug makers have a huge incentive to continue developing new, and hopefully more effective, treatments for the disease. That competition will inevitab! ly help p! ush down prices.

The only real exception to that rule is treatments for rare and orphaned diseases such as those offered by Alexion Pharmaceuticals and ViroPharma. Those markets are so small they receive special exemptions from price controls and are subject to virtually no price negotiation since there are few, if any, other treatment options available. But those cases are so rare that they don't pose a significant risk to America’s insurance schemes, public or private.

So while the news of Congressional interest in drug pricing has clearly spooked some biotechnology investors, the simple fact is that this isn't the issue that will unhinge the sector's swing upward. That makes Gilead Sciences a particularly good bet now.