Biotech push may help offset generic competition; some analysts skeptical

To survive in an uncertain future, Eli Lilly and Co. needs drugs that develop faster and cheaper and that perform better.
Biotech drugs, Lilly executives insist, fit that bill.

That’s why Lilly shelled out $6.5 billion to buy the biotech firm ImClone Systems Inc. in November,
six months after it opened its own $1 billion biotech complex in Indianapolis.

Biotech isn’t new at Lilly. The company introduced
its first biotech product in 1982. But since then, Lilly’s focus on biotech has been "discontinuous,"
Lilly executives say. Now, they want to make biotech their top focus.

Biotech isn’t your grandfather’s medicine—or even your father’s, for that matter. Drugs
of their day were typically discovered in plants or concocted by mixing chemicals together.

But biotech drugs are proteins produced by massive
cultures of living cells. Scientists often insert new strands of DNA into the genes of these cells to
get them to produce the protein they want, with the exact features they want it to have.

Biotech proteins are large and complex, so they have to be injected into patients. Traditional
drugs, such as Lilly’s iconic antidepressant Prozac, are simple enough to turn into pills.

"I could probably make [Prozac] in my bathtub
if you gave me enough time," said Dr. Steve Paul, Lilly’s executive vice president of science and
technology. But biotech drugs are literally brewed-like beer—in a series of increasingly larger tanks, up to
tens of thousands of gallons.

"The barrier to entry is higher," Paul added.

But the benefits can be higher, too. Biotech drugs have been able to address diseases chemical
drugs could not. And, because proteins can be engineered to target only one thing in the body, they tend
to have fewer side effects than pills.

Fewer side effects means more biotech drugs that enter human testing actually make it to market. Also, the ability to tailor
biotech drugs means fewer fail before clinical trials. Both save money for Lilly.

Having fewer drugs fail has helped Lilly double its number of experimental drugs in human testing,
from 30 two years ago to 60 now. Two dozen of those are biotech drugs.

It has also helped Lilly reduce its average development costs per drug from $1.2 billion to $1
billion last year. Paul is shooting to average $800 million.

But not everyone is convinced this strategy will work.

Jami Rubin, a drug analyst at Goldman Sachs & Co., said Lilly and its peers have tried to
make their R&D arms more productive for a decade—with little to show for it. Nearly every drugmaker,
including Lilly, does not have enough new drugs to replace its blockbusters.

She suggested the era of the blockbuster may be
over, as research increasingly shifts toward medications tailored to treat relatively small groups of
patients with nearly identical conditions.

By pursuing a new crop of blockbusters, even using "potentially game-changing" biotech drugs, Lilly is placing a
"double down" bet on an old, questionable strategy, Rubin wrote in a Nov. 6 research report,
titled, "When you are in a hole, stop digging."

"If successful with this strategy, Lilly will prove all the naysayers wrong and will boast
one of the most innovative and medically important product portfolios in the industry," Rubin wrote.
"If not successful, Lilly will have destroyed significant value chasing the ‘old’ Pharma model."

Speedy R&D

To understand why Lilly officials see so much
promise in biotech, consider the compound AME 133.

Scientists at Lilly’s San Diego subsidiary, Applied Molecular Evolution, produced hundreds of
thousands of versions of the massive protein by shuffling around DNA in petri dishes full of cells.

Then they picked the one most poisonous against
non-Hodgkin’s lymphoma—especially for the four in five patients whose genes blunt the impact of
Rituxan, the leading lymphoma medicine.

AME 133 sailed through early testing, reaching the second phase of human trials in two years—six fewer than is typical,
according to data from the Tufts Center for the Study of Drug Development.

That means, if the remaining testing proceeds on
schedule—and that’s still a big if—Lilly could save six years of high-wage man hours.

More important, it could wring six extra years
of sales out of the drug before its patent ends. Since Rituxan racked up $2.6 billion in sales last year,
those extra years equal billions of dollars.

Drug patents last 20 years, with some possible extensions. But the clock starts ticking years before they hit the market,
reducing a drug’s average sales life to 14 years.

Other biotech drugs in Lilly’s pipeline include proteins that could reverse the progression of
Alzheimer’s and multiple sclerosis, diseases for which no effective drug exists.

Also, Lilly is working on a biotech drug called
mGlu 2/3, which could replace Lilly’s best-seller, the chemical antipsychotic Zyprexa, without Zyprexa’s
side effects, like weight gain.

Talk about cheaper. Those side effects, along with a stint of illegal promotion of Zyprexa, have cost Lilly $2.7 billion in
legal settlements.

is new and improved," Paul said. "And not just packaging. This is really new and improved."

Tougher regulation

Faster, cheaper, better. It’s
a future that Lilly and all its pharmaceutical peers need to come true.

Drugmakers must develop better drugs for less money because regulators are forcing them to do

The U.S. Food and
Drug Administration has sharply reduced the number of new drugs it approves. It has frowned on "me-too"
drugs that treat a condition in a slightly different way than existing medicines. It has shown less tolerance for drugs with
side effects. And it has required more tests and longer waits before making approval decisions.

Those changes have been a big problem for Lilly
and its peers. They need to develop drugs faster because their old, lucrative blockbusters soon will
have their patents expire—and then have their sales sapped by cheaper, generic copies.

Neither Lilly nor most of its peers have enough new medicines to fill the gap.

Rubin estimates that Lilly’s up-and-coming drugs
will cover only half the $10.5 billion in revenue she estimates the company will lose when the patents
of five of its blockbusters expire between 2011 and 2014.

Pharmaceutical analysts, however, aren’t convinced that biotech drugs by themselves will prove
faster and cheaper to develop. Saving time in early testing, as Lilly has with AME 133, has lately been
offset by the FDA’s demand for more human tests or simply more time in deciding whether to approve a
drug for the market.

biotech gives on one end, the government takes away on the other end," said David Kliff, editor of the Diabetic Investor,
an industry newsletter.

Biotech drugs do get more time on the market than traditional chemical drugs because biotechs are immune from generic copies,
even when their patents expire. But analysts expect Congress to OK generic biotech drugs soon.

Still, analysts expect Congress to require more expensive testing of generic biotech drugs than
is required for traditional chemical drugs, to prove the generic versions are equivalent to the original.
Those higher costs could mean fewer biotech drugs face generic competition.

For all these reasons, said Michael Levesque, a
pharmaceutical analyst at Moody’s Investors Service, "The value proposition of expanding more into
biotech is valid and appealing to pharma."

Tailored treatments

But Kliff, Levesque and other analysts think biotech drugs are promising, not because they can
be developed faster or cheaper, but because they can be tailored to address the burgeoning number of
diseases being identified by advances in genetics.

Whereas doctors used to name and diagnose disease based on observable symptoms, they increasingly
describe diseases based on which genes produce proteins that play a role in the disease.

That shift means the number of distinct diseases
is shooting up and the number of patients with each specific disease is going down.

Cancers are the best example. Doctors now see
breast cancer not as one disease but as many, based on the presence and activity of a woman’s genes.

A particularly aggressive form of breast cancer
occurs when a woman’s genes produce too much of a protein called HER2. No more than 30 percent of breast
cancer patients produce extra amounts of this protein.

In 1998, California-based Genentech Inc. launched Herceptin, which can stop some women’s HER2
genes from making the HER2 protein. Herceptin is now a blockbuster, raking in sales of nearly $1.4 billion
a year.

Genentech also
makes Rituxan, the drug Lilly is trying to top with AME 133.

These changes demand radical action from pharma companies, according to a 2008 report authored
by Deloitte life sciences consultant Terri Cooper. She argued that a decade-long effort to improve R&D
productivity has not paid off for the drug industry.

To stay in business past the next five years, Cooper said, drug companies—both new and old—must
reorganize themselves to serve small patient groups with specific sets of genes. Or, instead, companies
should provide products to treat patients across all stages of one disease, such as diabetes.

That may require massive change—like big
pharma companies breaking themselves into multiple companies. Rubin, the Goldman Sachs analyst, recommended
exactly that strategy for Lilly.

Lilly has no plans for that. But Paul did say Lilly hopes its new emphasis on biotech will help it treat patients across entire
diseases and patients with specific sets of genes. In fact, he hopes Lilly’s strengths in both biotech and traditional chemical
drugs help it to do just that.

"We can leverage our therapeutic area expertise and our biotech capabilities," Paul said, "which I think is
where everyone is headed."

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