Expiringpatents are usually bad news for major pharmaceutical
companies, especially if the patents are for popular "blockbuster"
medications generating $1 billion or more of annual revenue. When
those patents expire, thepatent holders can usually expect revenue
from their blockbusters to erode as rivals bring similar versions
Now, I'm not saying you should avoid the stocks of big drug
Pfizer Inc. (
Johnson & Johnson (
and others simply to avoid near-term bumps in financial performance
that may come with patent expirations. These companies have been
around for ages, and they're always working on new blockbuster
drugs to replace those going off-patent. So I'm not too worried
about their long-term profitability orinvestment merit.
Still, you can protect yourself against periodic performance
blips resulting from patent expirations by investing in companies
that know best how tocapitalize on this vulnerability. In fact,
there's one firm I especially like because it has made a habit of
turning brand name patent expirations into big profits.
I'm referring to Parsippany, New Jersey-based
Watson Pharmaceuticals Inc. (
You probably haven't heard of Watson, but the firm has three
decades of experience bringing generic drugs to market in a timely
fashion. Among the latest are generic versions of Pfizer's
$5.3-billion high-cholesterol medication Lipitor and Johnson &
Johnson's $1.4-billion attentiondeficit and hyperactivity disorder
(ADHD) treatment Concerta. Watson introduced generic Lipitor Nov.
30, 2011, the day the patent on the branded version expired.
Generic Concerta became available May 2, 2011, also the exact date
the original brand went off-patent.
Sales have long been fantastic, rising 18.6% annually during the
past decade from $1.2 billion in 2002 to the $6.6 billion they're
on track to achieve in 2012.Earnings have soared by 13.9% a year
during this time, starting at $1.63 a share and on pace to hit $6 a
share in 2012. As a result, the stock has rewarded shareholders
with market-beating performance, delivering an annualized rate of
return of 11.4% for the past decade, compared with 6.6% for the
And I feel confidentshares of Watson still have plenty of room
Because generic drugs are generally much cheaper for patients
and health care systems overall, demand for generics should remain
very strong in coming years. As the world's third-largest
manufacturer of these drugs, Watson is well-positioned to help meet
A key move to put the company in that position was the
recentacquisition of Switzerland-based generic drug maker Actavis
for $5.7 billion. Before this, many investors were concerned about
revenue headwinds because of Watson's limited international
exposure and a slowing pace of patent expirations domestically. But
the deal transformed Watson -- which plans to begin operating
exclusively under the Actavis name in 2013 -- into a global
This is because Actavis was already a formidable player in the
global generics market, with $2.5 billion in annual sales, more
than 1,000 products on the market, several hundred new products in
the pipeline and operations in 40 countries. Some of its
better-known products include generic versions of the ADHD
medication Ritalin and the sleeping pill Ambien. With this
acquisition, Watson became the world's third-largest generic drug
manufacturer, up from No. 5 before.
Based on a December 2011 announcement of apartnership with the
well-known biotech firm
Amgen Inc. (Nasdaq: AMGN)
, it appears Watson will also be entering what many investors
consider the drug industry's next frontier -- "biosimilars," which
are near-equivalent versions of existing medications. Although the
two companies haven't yet revealed which medications they intend to
imitate, analysts speculate the $9-billion arthritis drug Humira
Abbott Labs (
and the $3-billion cancer medication Rituxan made by Genentech Inc.
are among the potential candidates.
Risks to Consider:
Like the big drug makers, Watson faces heavy competition --
particularly from low-cost generic drug producers in India and
Action to Take -->
Because of Watson's long history of success and recent growth
initiatives, I think it's arguably the best play on the highly
profitable generic drugs space, as well as on potentially lucrative
biosimilars. Indeed, analysts predict revenue will continue to
expand quickly, rising 13% a year to about $11 billion in 2017.
Earnings are projected to climb to $9.50 per share during that
time. If you multiply the stock's historicalprice-to-earnings ratio
of 14 by 2017's projectedEPS , then you get an estimated stock
price of $133 (14 x $9.50). This implies the potential for a 56%
gain from the current price of about $85 a share.