The FDA recently drafted guidelines for the review (and ultimately the approval) of so-called biosimilars or biogenerics—cheaper, copycat versions of branded biotech drugs. The long-awaited move may well change the dynamics of the drug industry as we know it. And investors can cash in on the opportunities.

Some Background

Unlike standard pharmaceuticals, biotech drugs have not had to face competition from less costly generic versions until recently. Indeed, since the birth of the biotech industry in the 1980s, the FDA has lacked the authority to review and approve cheaper replicas of branded biotech drugs (otherwise known as biosimilars or biogenerics). That’s largely because of the differences involved in duplicating biotech drugs, versus their traditional chemical-based counterparts. However, with the guidelines issued by the FDA in February, the biopharmaceutical landscape is about to change drastically. The drafted procedures outlined by the agency pretty much set in motion the provision included in the healthcare reform bill, which was signed into law in March 2010, to establish an abbreviated regulatory approval pathway for low-cost generic biotech meds.

Not surprisingly, the concept of creating a copycat version of a biological drug has caused much discord for more than two decades. While supporters of biosimilars have pointed to the sizable cost savings for consumers, greater patient access, and improved competition, opponents have long argued that biotech drugs are much more difficult to replicate than conventional chemical drugs, as their structural properties can be compromised in the development process.

Biotech firms use biotechnology to manufacture drugs, which involves the manipulation of microorganisms (such as bacteria) or biological substances (like enzymes) to perform a specific process. They essentially use those microorganisms or highly complex proteins from genetically-modified living cells as components in medications to treat various diseases and conditions, from cancer to rheumatoid arthritis to multiple sclerosis. Since no two living cells are exactly the same, it is virtually impossible to develop an identical facsimile of the original biologically engineered medicine. By contrast, conventional pharmaceutical companies rely on a chemical-based synthetic process to develop small-molecule drugs, making them a lot easier to copy.

Regulatory Requirements

The regulatory process for biogenerics, which is more rigorous than for generics of standard chemical medications, requires that such drugs meet a set of criteria in order to be approved either as biosimilars or as interchangeable products. To get the OK as a biosimilar, the generic must be shown to be very similar to the underlying biological product, in terms of safety and efficacy, with slight differences allowed for inactive components. For a biogeneric to be considered interchangeable, it must not only meet that criterion above, but its composition must also be shown to be nearly the same, or interchangeable, with the original biologic product, and produce the same clinical result with any given patient. That would enable health practitioners to easily switch patients from the original biotech drug to a generic, without much risk.

Importantly, makers of biogenerics will be expected to submit extensive chemical and biological testing data to the FDA. In certain cases involving an interchangeable product, the regulator can even require animal and human studies to be done.

Patent Protection

The FDA’s new framework puts to rest the question of how much time a biologic drug can enjoy market exclusivity without facing any generic competition—a major bone of contention between proponents of generic equivalents and industry naysayers. Whereas biotech companies have held that patents on original biological products should be valid for about 14 years, to properly give a company the chance to recover development costs, while also providing an incentive to innovate, proponents of biogenerics have argued that a shorter market exclusivity term, such as seven years, would not only help lower prescription drug costs but also increase access to patients. Under the current guidelines, the exclusivity period is for 12 years, as reflected in the nation’s healthcare reform law. (For standard pharmaceuticals, it is only about five years.)

What To Look For

No doubt, the FDA’s new authority will open up the floodgates for biogenerics in the United States. While nonbranded equivalents of biotech drugs have been available for quite some time in Europe, where an approval process has existed for years and replicas are sold at a 20%-30% discount to the original meds, the recently outlined FDA procedures should now make it easier for drugmakers to launch such products in the
United States. And given the high demand for cheaper drugs, the sales potential in the domestic market seems particularly vast.

According to industry data, the U.S. market for biosimilars is estimated to be between $11 billion and $25 billion by 2020. That would represent 4%-10% of the worldwide biotech drug sector. Biogenerics are also expected to save the government a bundle in healthcare spending in the next ten years—roughly $25 billion.

Among the drug manufacturers to benefit from the FDA’s wider-reaching authority are industry stalwarts Merck & Co. (MRK - Free Merck Stock Report) and Pfizer (PFE - Free Pfizer Stock Report), both of which have plans in the works to develop generics of biotech treatments. Likewise, Israel-based generic drug giant Teva Pharmaceutical (TEVA) is well positioned to make its mark in the biogeneric space through its biosimilars unit. Ditto for Swiss pharmaceutical heavyweight Novartis (NVS), which is likely to expand its footprint in the generic biotech area via its Sandoz division. Biotechnology drug companies, including the sector’s top player Amgen (AMGN) and Biogen Idec (BIIB), will probably look to get a piece of the action, too. From an investment standpoint, there is much to be gained here. Indeed, keeping an eye out for drugmakers making strides on the biosimilars front should enable investors to reap rather generous rewards.

At the time of this article’s writing, the author did not have positions in any of the companies mentioned.