Manufacturing & Technology

Lilly battles five-year flu: Analysts: Drugmaker primed for rebound from Prozac defeat

August 29, 2005

It's been a challenging five years for Eli Lilly and Co., which has launched nine new drugs yet seen the price of its stock fall by half, wiping out more than $60 billion in market value.

However, company officials say the drugmaker has rallied from the jarring setback it received Aug. 9, 2000-when a federal appeals court invalidated Prozac's patent protection-and are optimistic better times lie ahead.

They say the company is positioned to increase profit and revenue, thanks to a sharper strategy, a deep lineup of drugs in its development pipeline, and a lack of looming patent expirations.

Many analysts agree.

"I really think we've seen the worst, and going forward we're going to see improvements in profitability, and we think the stock price will follow," said Zach Wagner, who covers the company for St. Louis-based Edward Jones.

Community leaders are hoping he's right. Not only is Lilly the state's largest corporate employer, with 17,000 workers, but company stock sits in thousands of local investment accounts. It's also the main asset held by Lilly Endowment Inc., which has lost billions of dollars in value during the slide.

Heady days

Before the appeals court ruling five years ago, Eli Lilly was enjoying its headiest times. That summer, Lilly shares shot up $14 in a single day, buoyed by positive study results for a promising treatment for the blood disease sepsis.

Then came the Prozac ruling.

The day the court ruled, Lilly's stock price crashed from $108 to $76, wiping out nearly $35 billion in market value in a couple of hours.

Prozac had generated more than 30 percent of the drugmaker's revenue. It was the biggest blockbuster drug ever to lose a patent challenge, Lilly spokesman Ed Sagebiel said.

Lilly officials already had been preparing for life after Prozac. They had developed a so-called "Year X" plan aimed at finding alternative revenue sources. Still, patent protection hadn't been scheduled to expire until 2003, and industry experts and company officials expected Lilly would win that court case.

Stumbling blocks

After the first competitor began selling a generic version the next year, Prozac sales plunged, sapping company profits. Wagner, the Edward Jones analyst, noted that Lilly's gross margin-its profit as a percentage of sales-has fallen every year since 2002.

Another Lilly blockbuster, the antipsychotic Zyprexa, has helped pick up the slack. Last year, it recorded $4 billion in sales, nearly 50 percent more than Prozac posted in its best year.

However, concerns about weight gain and diabetes have pushed it into a sales slump and also created legal problems. This summer, the company agreed to pay $690 million to settle thousands of lawsuits charging product labels did not adequately disclose risks.

Total Zyprexa sales are down 8 percent for the first six months of this year, although Lilly officials say they've made progress slowing market erosion.

The decline has disappointed investors.

"They had been looking to Zyprexa as a key growth driver, and now it looks like it will be flat," Wagner said.

Also casting uncertainty over the stock was manufacturing quality-control problems at some of Lilly's Indianapolis plants.

Lilly announced in 2003 it had fixed the problems. Still, news like that rattles investors, noted Bud Gremel, vice president of the equity department at City Securities Corp. in Indianapolis.

Analysts say about 60 percent of a company's stock price is based on its current stable of drugs and the remainder is based on its pipeline. While Lilly's pipeline has cranked out a stream of drugs, some aren't selling as well as expected.

Take, for example, the sepsis drug, Xigris. The U.S. Food and Drug Administration cleared Xigris for use in only the most severe sepsis cases, which surprised the company and investors.

Xigris debuted in 2001. Analysts once predicted it would reach blockbuster status with $1 billion in annual sales. The drug brought in $202 million last year.

Health concerns also dampened sales of Strattera, Lilly's treatment for attentiondeficit hyperactivity disorder. The FDA required the company to include a boldfaced warning about possible liver damage on the drug's packaging, according to analyst Stephen O'Neil of Louisville-based Hilliard Lyons.

Sales for the drug totaled $124 million in the second quarter, a 31-percent decline from the same quarter a year earlier.

The market feels the pain

Lilly is far from the only drug company with a deflated stock.

Five years ago, Lilly and other companies were flying high partly because of what Indianapolis analyst Ken Skarbeck calls "large drug company euphoria."

Investors anticipated companies would keep churning out blockbusters, fueling rapid growth.

Shares of Merck & Co. traded for $73 that summer. The New Jersey-based company, which is entangled in legal woes surrounding its painkiller Vioxx, recently closed at $27.58. Shares of New Yorkbased Pfizer Inc. also have shed nearly half their value the past five years.

"Any hiccup in future expectations, and those premium prices deflate rather quickly, and that certainly happened in the industry," said Skarbeck, managing partner of Aldebaran Capital LLC.

A host of industry wide challenges also have pressured stocks in the sector. Those include a decrease in managed care reimbursement, increasing generic competition and increasing importation of lower-priced drugs into the United States.

"Those are issues that hang over drug stocks as a group, not just Lilly," Lilly spokesman Phil Belt said.

In spite of the patent loss and industry challenges, Belt said the company has accomplished a lot. He noted that most drug companies that lose a major patent end up merging with another company, but Lilly has avoided that.

Since losing the Prozac case, Lilly has stuck with its "Year X" plan, which calls for heavy spending on research and development, cutting costs without layoffs, and creating partnerships with other companies. Lilly pours about 20 percent of its sales back into R&D, while the industry averages 16 percent.

The company also is tweaking its drug development model. Instead of focusing on finding the next blockbuster, Lilly wants to evolve to what it calls a targeted model.

That means developing therapies tailored to smaller groups of people that are cheaper and have fewer side effects. Or, as Lilly CEO Sidney Taurel told shareholders last spring, delivering "the right dose of the right drug to the right patient at the right time."

Forward-looking statements

Belt believes investors are buying into Lilly's strategy. He notes the company's stock has one of the highest price-to-earnings ratios in the industry, a sign investors think bigger profits are in the offing.

Analysts almost universally agree the company's pipeline is flush with promise. And they notice the R&D spending.

"It doesn't guarantee success, but I think it improves their odds," Wagner said.

Robert Hazlett, an analyst for SunTrust Robinson Humphrey in New York, predicts multibillion-dollar annual sales for Prasugrel, a Lilly coronary drug.

That drug should be launched in 2007, along with Ruboxistaurin, a treatment for diabetes complications that could bring in more than $1 billion a year, according to Hazlett's July 22 report.

Wagner thinks Prasugrel could wind up more effective than Plavix, a Bristol-Myers Squibb Co. clot preventive that notched more than $950 million in sales during the second quarter.

Analysts also are pleased that Zyprexa survived a patent challenge earlier this year. Though the case is on appeal, analysts are confident Lilly will prevail.

Lilly is the only major pharmaceutical company that doesn't face a major patent expiration between now and the end of the decade, according to Belt.

Wagner said that, plus the pipeline, means the company is ready to prosper.

"I think we're going to see a return to higher profitability and higher growth," he said.
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