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Biopharma CEOs, VCs, and Hedge Fund Managers: Fifty Shades of Greed


Xconomy National — 

I just returned from a family vacation and was going through my accumulated mail. I got a notice that the terms of my auto loan were being adjusted. Instead of paying $300 a month, I was shocked to find out that I would now be paying $16,667 per month. My car company (the lender) explained that it needed to increase my payments because it wanted to fund the development of some new, more fuel-efficient vehicles. My latest bill from my gas company also contained a surprise. Instead of paying about $95, as I did in August, my September bill was now $5,278. The utility explained that it needed the rate increase to pay for additional cleantech research in reducing pollution. If this wasn’t bad enough, I found out that my $120 a month family cell phone plan was being replaced by one costing $6,667 per month, with the extra money needed for company R&D to develop a faster network.

Actually, none of these astronomical price increases happened to me. However, if you are a patient suffering from toxoplasmosis and taking the drug pyrimethamine (Daraprim), you recently saw the price of this medicine climb by the same percentage as the ridiculous numbers I quoted above (it went from $13.50 per pill to $750), a greater than 55 fold increase. This price “adjustment” came soon after Turing Pharmaceuticals acquired the rights to the drug from Impax Laboratories. When news of the huge price hike exploded in the media, Turing CEO Martin Shkreli was anything but contrite, saying, “It’s a great business decision that also benefits all of our stakeholders.” This led to the well deserved public flaying of Shkreli as the very embodiment of greed.

This episode brings up an important question: When do drug price increases cross the line from fair to rapacious? Heeding the biblical injunction, “Let he who is without sin cast the first stone,” most biotech executives stayed on the sidelines and refused to publicly condemn Shkreli and Turing. The bad publicity led biotech’s trade association, the Biotechnology Industry Organization (BIO), to kick Turing out and return its membership dues, stating, “The company and its leadership do not reflect the commitment to innovation and values that are at the core of BIO’s reputation and mission.” I looked up BIO’s membership criteria and found out that membership “is available only to bona fide organizations that promote biotechnology research and support the growth and development of the biotechnology industry; and to organizations with public policy positions and business practices that are generally consistent with BIO’s reputation and its policies and principles in support of innovation, including intellectual property.”

BIO’s tossing of Turing under the proverbial bus made me curious. Are there other biotechs that operate in a similar manner? I wanted to know if companies with similar business models have also been excluded from BIO. After doing a little digging, I’ve been able to make a rough estimate of what criterion BIO might be using to determine when member companies’ drug price increases cross over the threshold into greed. Here’s what I found out:

I identified several companies that, like Turing, buy companies and hike drug prices, but aren’t members of BIO. I don’t know if they ever tried to join the organization. These include Rodelis, which raised the price of its cycloserine pill (used to treat tuberculosis) from $500 per 30 pills to $10,800 (a 21.6 fold increase) after it acquired the drug. This led to an outcry from the Purdue Research Foundation, the non-profit organization that provided it with the medicine, and as a result Rodelis returned the drug. Also a non-member is K-V Pharmaceuticals (now known as Lumara Health), which raised the price of its drug hydroxyprogesterone caproate (Makena, used to prevent premature births) from $20 to $1500 per dose (a 75 fold increase). Protests forced it to drop the price to $690 and institute a patient assistance program. Valeant Pharmaceuticals raised the prices of isoproterenol (Isuprel) five fold and more than doubled the price of nitroprusside (Nitropress) after acquiring them from Marathon Pharmaceuticals (a member of the trade group PhRMA), but Valeant belongs to neither PhRMA nor BIO. While these two drugs have gotten the bulk of the publicity, Valeant has raised the prices on 54 other medicines this year by an astounding average of 65.6 percent (which was the highest in the industry, according to Deutsche Bank).

I did find four BIO members, however, that appear to fit the Turing mold:

Horizon Pharma increased the price of the drug combo naproxen and esomeprazole (Vivomo), a pain medication, six fold the first day it sold the drug after buying rights to it from AstraZeneca.

Retrophin, which jacked up the price of its cystinuria drug tiopronin (Thiola) from $1.50 per pill to $30 (20 fold) after acquiring the medicine from Mission Pharmacal. I should point out that Shkreli was the CEO of Retrophin when Thiola’s price went stratospheric; Retrophin later fired him reportedly for stock irregularities. Biopharma blogger Derek Lowe called this price raise at the time, “The most unconscionable drug price I have yet seen.”

Catalyst Pharmaceuticals is apparently planning on increasing the price of its drug 3,4-diaminopyradine (Firdapse, which is used to treat a rare muscle disorder) to a level that, even though it hasn’t been announced, has already been decried by TheStreet.com’s biotech reporter Adam Feuerstein as “unconscionable.” While the sales price has not yet been announced, it is expected to be in the range of $60,000 to $80,000 per year. At present, patients can actually get the drug for free from Jacobus Pharmaceuticals.

Finally, there’s Raptor Pharmaceuticals and its drug Procysbi. This medicine is actually a “sustained release” version of an existing drug, cysteamine bitartrate (Cystagon), which is marketed by Mylan Pharmaceuticals. Dr. Ranjan Dohil, a pediatric gastroenterologist at the University of California, San Diego hypothesized that coating the pills would lead to the drug being absorbed more efficiently. Raptor licensed this discovery from the university and ran a 43-patient, six-week trial. The results led to FDA approval to sell a coated version of Cystagon as Procysbi. What’s the premium that Raptor decided to charge for this innovation? Cystagon costs about $8,000 per year, whereas Procysbi entered the market at a staggering cost of $250,000 per year (a 31.3 fold increase over the starting drug).

Though it’s a small sample size, it seems that drug pricing increases in the range of about two to thirty fold are perfectly ok with BIO’s policies and principles, but increases in the 50 fold range are clearly not (at least when the info becomes public). It appears that BIO hasn’t been too concerned with the pricing behavior of its members until the Turing overpriced-drug scandal hit the publicity fan. The situation reminds me of that classic scene in the movie Casablanca where corrupt police Captain Renault’s officers raid a bar and he exclaims, “I’m shocked, shocked to find that gambling is going on in here!” just as the croupier hands him a stack of bills, saying “Your winnings, sir.”

After being shredded by both mainstream and social media as the personification of greed, Shkreli promised that he would drop the price of pyrimethamine, although he refused to reveal what that lower price might be. BIO’s actions should point him in the right direction. Drop the drug’s price to a lowly $405 per pill (corresponding to only a 30 fold increase in the drugs price), and perhaps (once the media pressure dissipates and he has settled the numerous legal issues he faces) he can reapply for membership in BIO.

The Bigger Issue

It’s clear that biopharma companies need to charge enough for their medicines to make a solid profit, and that they should be rewarded for taking risk. However, Shkreli’s business strategy was not tantamount to making innovative discoveries. Buying a company with an existing drug merely so you can jack the price up is the antithesis of scientific innovation, although it does actually carry some risk. A paper was recently published suggesting that the high blood pressure medication guanabenz (Wytensin) might turn out to be an effective treatment for toxoplasmosis. If clinical studies are able to confirm the animal data, then this drug might cut deeply into pyrimethamine sales, leaving a schadenfreude-tinged smile on the faces of Shkreli’s numerous critics. What will his shareholders have to say if that happens?

So how should risk taking get rewarded? How should innovation get recompensed? Should these two factors be incentivized in the same way and to the same degree? Is it possible to separate them and set up a remuneration system that a majority of stakeholders on both sides of the cost equation could agree to? This would be a fascinating topic to build a drug pricing conference around.

Biopharma companies make a wide spectrum of profits on their drugs. Some earn a little, others a great deal. People who want to hold back soaring drug costs are not looking to block innovation, just ensure that consumers can afford to get the drugs they need. The drug companies often point out that people’s insurance carriers mostly pick up the cost of expensive drugs. For the most part, this is true. However, folks who don’t have health insurance, or who are stuck with significant co-pays for their medicines, will still be hit with greatly inflated medical bills. And for those of us who are fortunate enough to have insurance, what do you think happens to your rates when your insurer has to spend a lot more money buying you the pricey drug? You don’t have to be a healthcare expert to answer that question.

Many companies don’t raise their drug prices all at once, but overcharge the public by instituting large yearly price increases. According to Deutsche Bank, Big Pharma companies raised the average prices on their drugs by 13 percent in 2014 (by comparison, the U.S rate of inflation was only 0.8 percent). And what is the justification for this? The practice is slower and not as obvious as the egregious price hikes cited above, but it can have the same effect on patients. It’s just another way of saying “pay me later” instead of “pay me now.”

Any Other R&D-Free Ways to Make Money in Biotech?

BIO is clearly okay with its members coming up with and promulgating new (non-R&D based) strategies for making big money in the biotechnology arena. However, it is definitely not a fan of a different moneymaking strategy employed by hedge fund manager Kyle Bass, who leads Hayman Capital Management. Bass created an organization (the Coalition for Affordable Drugs) that identifies companies that have (what he considers to be) low quality patents on their drugs. He then challenges these patents in court via a process known as inter partes review.  These reviews are an administrative legal process that was expanded as part of the 2011 Leahy-Smith American Invents Act. The Act has made it easier to challenge and invalidate drug patents, and some of these challenges have already been successful. Torrent Pharmaceuticals won a patent challenge against Novartis’s multiple sclerosis drug fingolimod (Gilenya), and Noven got two other patents covering Novartis’s rivastigime (Exelon) transdermal patch system tossed.

Bass claims that part of the reason he instituted his hedge fund strategy is to help reduce drug prices. BIO, however, maintains Bass is an exploitative individual, or as James C. Greenwood, the CEO of BIO put it, “There’s nothing in this man’s history to suggest he has any interest in lowering health-care costs.” After Big Biotech Celgene lost a court ruling to dismiss one of Bass’ challenge to one of its patents, BIO responded by saying, “This cursory and erroneous ruling reinforces the immediate need for Congress and the PTO leadership to take clear and decisive action to prevent any further misuse and abuse of the Inter Partes Review process by hedge funds, extortionists and other questionable entities seeking to undermine it for their own financial benefit.”

Am I the only one detecting a whiff of hypocrisy here? BIO is generally supporting the efforts of biotech companies who invented nothing (they bought drugs and jacked up their prices) while at the same time opposing the efforts of a hedge fund manager who has also invented nothing (he shorts stocks and profits when their prices fall). In the case of Kyle Bass’s hedge fund, the fight is being waged in an actual court of law. In the case of the profiteering biotech companies, the battle is being fought in the court of public opinion. And speaking of the public, it’s clear that many people have not bought into Big Pharma’s efforts to tie a “value proposition” to many uber-expensive new drug prices that are often completely untethered from reality.

Interestingly, even some venture capitalists are decrying these “buy and raise prices” strategies. Well known venture capitalist and blogger, Atlas Venture partner Bruce Booth, tweeted that raising prices through the roof, “with no R&D risk-taking, is just not right.” This again leads me to ask: Where is the line is being drawn? Why has there been no outrage directed against the individuals and organizations that funded Shkreli’s strategy? The prospectus for investing in Turing reportedly outlined the exact strategy that Shkreli followed, including a provision that the drug be sold through a tightly controlled distribution system to prevent generic drug makers from acquiring samples of it. Did he somehow dupe his investors, or did he execute on a plan that was precisely what they funded him to do?

Even if your exposure to venture investing is no more sophisticated than viewing the occasional episode of Shark Tank, you know that a primary criterion used by Mr. Wonderful and the gang is to de-risk your investments as much as possible. One would think that the Turing/Valeant/Hayman Capital strategies would be a godsend to such investors. Why waste money chasing elusive, expensive innovations when there are already existing markets with known numbers of willing customers to exploit? The big problem, of course, would be if all biopharma companies acted this way. This would eventually lead to there being no new drugs to buy at any price.

The potential threat of political action to curtail drug costs has hammered down the share prices of most drug companies, including Valeant. Few think, however, that there is any real risk that Congress would actually take some significant action to regulate drug pricing. Well-funded industry lobbyists and anti-regulation Republicans will see to that. This issue, however, is not going to go away. It may simply move to the back burner until the next drug pricing scandal erupts. It’s important to understand that some people who can’t afford their drugs will die as a result of this malfeasance. An outraged public cries out for action, and (nearly all) politicians respond by sitting on their hands. We shouldn’t be standing for it. Nobody is questioning the rights of companies to make a fair return on their investments, but it’s time to curtail the actions of greedy organizations that profit off of outrageous drug prices and questionable business models.

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