“Orphan” Drugs: Big Profits in Niche Markets

Developing a new drug is a lengthy and costly process, taking as long as 20 years and potentially costing billions. To recoup their investment quickly, pharmaceutical companies have historically focused on drugs for the most common diseases, such as cardiovascular problems.

But the more drugs there are for a specific indication, the harder it is to get a new drug approved. That’s because in addition to safety and efficacy, the US Food and Drug Administration (FDA) requires a new drug to be more effective than existing competitors.

Focusing on “Orphan” Drugs is the Road Less Traveled

So a recent trend is for pharmaceutical companies to focus on rare diseases for which few, if any, treatments exist. Such diseases are known as “orphans.”

Drugs meant to treat orphan diseases get expedited review by the FDA. And the FDA allows for the use of unapproved drugs by the sickest patients, assuming the drug is relatively safe. But the crucial factor for drug makers is price. Drugs for treating orphan diseases are rarely blockbusters. Still, if a company has enough of them in its pipeline, this can generate solid revenues and even allow for more stringent patent protection. 

Below are two drug makers I like that are taking the orphan-drug approach:

Forest Laboratories (NYSE: FRX)

Like many of its peers, Forest Laboratories has fallen out of favor because of a patent expiration. Forest’s antidepressant Lexapro, which brought in about half the company’s sales last year, now faces competition from a generic version produced by Mylan (NasdaqGS: MYL).

Forest, however, has many promising drugs in its stable. Here’s a roundup: Daliresp is one of only a handful of treatments available for severe chronic obstructive pulmonary disease; the antidepressant Viibryd, which the company owns through its 2011 acquisition of Clinical Data, has seen a spike in sales because of its impressive efficacy and lack of sexual side effects; Namenda, is one of only two drugs available to treat Alzheimer’s.

Forest also has five other drugs in final-stage clinical trials (Phase III), including Linaclotide, developed with Ironwood Pharmaceuticals (NasdaqGS: IRWD), for treating irritable bowel syndrome accompanied by constipation. And another six compounds are in early-stage trials, including a new antibiotic. Although drug companies have avoided developing antibiotics because of the lower profit margins, there’s a pressing need for them, as antibiotic-resistant illnesses are on the rise.

Forest Laboratories has no debt and $2.5 billion in cash on the balance sheet the company can use to finance research or make an acquisition.

Exelixis (NasdaqGS: EXEL)

A more aggressive play on orphan drugs is Exelixis. Although it once had an extensive new product pipeline, Exelixis decided to focus exclusively on a single compound, cabozantinib, after this posted highly encouraging results in early clinical trials.

Initially shown to be a promising treatment for metastatic prostate cancer, trials are now underway to demonstrate the drug’s effectiveness in treating eight different tumor indications. The FDA recently granted priority review for Exelixis’ new drug application (NDA) for treating progressive, inoperable metastatic medullary thyroid cancer (MTC). MTC patients have a poor prognosis relative to other thyroid cancer sufferers, with an 80 percent five-year survival rate and a 75 percent 10-year survival rate. While there are two other drugs currently on the market with MTC indications, clinical trials have shown cabozantinib to be more effective in slowing the progression of the disease and with fewer side effects. The FDA’s decision should be announced in the next few months.

While the market for each of the eight indications is relatively small, in total they have the potential to make cabozantinib a big money maker, if it is approved for each of them.

In the meantime, Exelixis has a modest income stream (some $7.8 million for the second quarter of 2012), due to development agreements with major drug companies. While this might be discouraging for some investors, the company has $295 million in cash and equivalents on its balance sheet, so it’s capable of funding operations for the next two years if necessary.

If Exelixis’ NDA does get a positive response, look for the shares to take off. With a market capitalization of only $800 million, the stock would make a tempting takeover target for a number of its larger competitors.

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