Gilead's deep discounts fuel investor worries about drug pricing

Investors reassessed their growth expectations for the red-hot biotechnology sector on Wednesday after Gilead Sciences Inc warned of steep drug discounts, but a number of fund managers seemed prepared to stick with the stocks. Gilead disclosed late on Tuesday that it would give health insurers and pharmacy benefit managers discounts of 46 percent on its hepatitis C drugs to win market share from rivals such as AbbVie Inc.
Investors and analysts including Bernstein's Geoffrey Porges had expected discounts closer to 25 percent. The surprise fuelled fears of widespread price pressure. On Wednesday, the Nasdaq Biotechnology index slid as much as 3.85 percent intraday, and the broader healthcare index closed 1.4 percent lower. "It was a dose of reality to that sector and its profitability potential going forward," said Michael Cuggino, President and Portfolio Manager of the Permanent Portfolio Family of Funds in San Francisco which manages $5.7 billion including Gilead shares. "Everybody knew this conceptually but it wasn't reflected in the valuation of pharma companies."
Gilead "sent some shivers down some spines," said Scott Eun, Senior Vice President and Portfolio Manager at Standard Life Investments, and will lead investors to rethink the durability of revenue in light of increasing competition. But Eun said Gilead's discount will not change his investment thesis. He said price competition will happen most when competing drugs are comparable.
"A lot of people are interpreting this as a new era where prices will drop drastically," he said. "You can expect there could be more pricing competition but, in my view that's only when efficacy is the same." Eun noted that Gilead's original price tag of $84,000 for the hepatitis C treatment was much higher than investors would have expected. Peter Tuz, President of Chase Investment Counsel in Charlottesville, Virginia, noted that the biotechnology index has been on a tear with a 200 percent gain since 2011.
With biotechnology accounting for more than a third of equity new issuances so far this year, some traders were warning of a tipping point for investment in the sector. But Tuz said drug company margins, often around 30 percent after tax, remain better than average even after discounts. "The fear is that price controls stifle innovation. It hasn't happened yet," he said. "They'll have to sharpen their pencils and recalculate what their outlook is for new drugs and whether they're worth still developing."