Generic drug consolidation and the pending implementation of Medicare Part D in January, with its cost pressures likely to benefit unbranded drugs, appear to be swaying investor confidence in favor of generic drug makers.

Merger speculation fueled generic company growth in the third quarter, most notably for Alpharma, which surged 71.9%, posting the single best performance on the F-D-C Index of pharmaceutical companies (see chart: " ¹ Quarterly 'F-D-C' Index of NYSE Stocks ").

Alpharma released a statement Aug. 22 reiterating that it is continuing to evaluate strategic alternatives, an announcement that sparked a 20% jump in its stock.

The company has made consistent reference to exploring strategic alternatives dating back to October 2003. In April, the firm said it was evaluating various options to "maximize shareholder value while ensuring Alpharma's independence," noting that CEO Ingrid Walk would retire after a successor was named.

However, merger speculation has continued, with Indian drug maker Ranbaxy reported to be among the firm's suitors.

Alpharma also benefited from positive second quarter financials, which included a doubling of operating income, record free cash flow and significant debt reduction. The stock opened nearly 22% higher on Aug. 2, the day after the earnings release.

The firm's U.S. generic business is undergoing a turnaround stemming from an initiative undertaken in 2003 to counter "significantly" lower generic drug prices through cost improvements, the company reported during its Q2 earnings call.

The drug maker reduced inventory, cut its headcount by 500 and implemented purchasing changes that resulted in tens of millions of dollars in savings to offset price reductions.

Alpharma is not releasing earnings predictions for the year, but the firm said it expects to be profitable in the second half.

Investors also may be heartened by the company's progress in resolving manufacturing issues at several of its plants.

Since 2001, Alpharma has received multiple '483 reports from FDA detailing good manufacturing practice deviations at its Baltimore, Md., Elizabeth, N.J., Skoyen, Norway and Copenhagen, Denmark facilities.

Prior to an inspection in September 2004, FDA placed a hold on all ANDA approvals for products produced at the Elizabeth plant. The hold was lifted after the inspection, and four ANDAs - including gabapentin capsules and tablets (Pfizer's epilepsy agent Neurontin ) - were launched in the fourth quarter.

Lingering issues at the Elizabeth plant are expected to be wrapped up by June 2007, and a follow-up inspection at the Baltimore facility is anticipated this year to review the firm's corrective action plan, Alpharma said in its second quarter 10-Q filing.

News that Alpharma may be seeking a buyer added to speculation that generic drug makers will use consolidation as a means of combating increasing pressures on issues such as pricing, authorized generics and drug safety.

Generic manufacturers also are likely to face growing competition from Indian firms striving to enter the U.S. market.

At the Generic Pharmaceutical Association's first annual policy conference Sept. 19 in Washington, D.C., ABN-AMRO Banking Director Tommy Erdei said a number of Indian firms like Lupin, Aurobindo and Sun Pharma aim to enter the U.S. market as direct competitors, shifting away from their current role as suppliers (² Also see "Generic Industry Faces Consolidation As Indian Firms Look To Enter U.S." - Pink Sheet, 26 September, 2005., p. 11).

Some generic drug marketers have already moved to consolidate. Teva announced in July that it will acquire Ivax for $7.4 bil., creating the largest generic player in the industry, based on combined 2004 sales of $6.1 bil.

Teva and Ivax said they plan to use the merger to offer the lowest possible price on generic drugs when needed (³ Also see "Teva/Ivax Merger Will Create Significant Pricing Flexibility In Generics" - Pink Sheet, 1 August, 2005., p. 19).

The two drug makers expect the merger will result in synergies of $150 mil. within the first two years. The deal is expected to close at the end of 2005 or early 2006, at which time Teva will offer at least 300 products in the U.S. market.

Ivax' stock rose 22.6% in the third quarter.

The Teva/Ivax combination follows another generic merger earlier this year, when Novartis, which was up 7.5% in Q3, added Eon and Hexal to its Sandoz division (⁴ Also see "Novartis Seeks To Be Generics “Powerhouse” With Eon, Hexal Acquisitions" - Pink Sheet, 28 February, 2005., p. 21).

Mylan and King also had planned to merge earlier this year, but negotiations broke down when King announced it would have to restate financials back to 2002 (⁵ Also see "King Says It Can Grow On Its Own Following Collapse Of Mylan Merger Plans" - Pink Sheet, 7 March, 2005., p. 37).

Nonetheless, King rebounded in the quarter, jumping 47.6% and exceeding the value it reached during the merger negotiations with Mylan. Following the break up, King voiced its intentions to go it alone.

The company's strong quarter was spurred by solid second quarter financials released Aug. 9, when King said sales and earnings were driven by sharp increases in branded drugs including Altace (ramipril), Skelaxin (metaxalone) and Sonata (zaleplon).

Within the generic ranks, two other players turned in a strong performance in the third quarter, with Watson up 23.8% and Barr up 12.7%.

Despite FDA's inability to reach a decision on Barr's emergency contraceptive Plan B switch application in August, the firm benefited Sept. 8 from an announcement that the company had resolved a patent dispute with Organon over the oral contraceptive Mircett e (desogestrel/ethinyl estradiol).

Barr said it would pay $155 mil. to purchase the NDA for Mircette, a move that will ensure continued marketing of a generic version, Kariva .

Merger speculation aside, generic drug companies also stand to benefit from the looming implementation of Medicare Part D in January, as an influx of seniors becomes eligible for prescription drug coverage.

According to IMS Health's Cambridge Pharma, total prescription drug revenues are expected to grow 1%-2% per year through 2008 as a result of the pending drug coverage (⁶ [A#00670400014], p. 21).

However, it is anticipated that generic drug makers are more likely to see an impact on their top lines over brand companies.

Part D drug plans are adopting utilization management features aimed at cutting costs by driving generic use, and most will adopt co-pay structures that encourage beneficiaries to choose generics over branded drugs.

As the strained health care system looks for ways to realize additional savings, generics also will likely benefit from Medicaid reform initiatives.

GPhA President Kathleen Jaeger stated at the association's policy conference that Medicaid reform initiatives aimed at increasing generic substitution could generate savings greater than the $10 bil. the government is seeking over the next five years (⁷ Also see "GPhA Medicaid Reform Goals Include Substitution Incentives, WAMP Pricing" - Pink Sheet, 26 September, 2005., p. 9).

The upside for generics is "continued cost pressure on the health care systems," IMS VP-Global Healthcare Strategy VP Graham Lewis said during the meeting.

Despite optimism on some fronts, however, the generic drug industry also is facing hurdles. Those include declining growth from primary care-driven markets, more authorized generics and a backlash over drug safety issues.

"The growth rates for the hypertension market, the statin market, the common or garden anti-infective market or so on has declined astronomically," Lewis stated. "It's the specialty rate that is now growing, and that raises all kinds of issues in terms of skills required and capabilities required among generic companies."

For example, by 2009 the oncology market is anticipated to be a $55 bil. market, "completely dwarfing" the statin market, the IMS exec added.

On the other hand, several blockbuster drugs are going off patent next year, including Pfizer's Zoloft (sertraline), Merck's Zocor (simvastatin) and Bristol-Myers Squibb's Pravachol (pravastatin), which will provide several new avenues for generic competition.

Whereas most generic drug company stocks performed favorably in the third quarter, branded firms struggled in comparison, leading to a modest 1% gain on the "F-D-C" Index of pharmaceutical companies.

Pfizer (-9.5%), Lilly (-3.9%) and Bristol-Myers Squibb (-3.7%) all declined in value.

Merck continued its descent after a Texas state court jury found the company liable Aug. 19 in the first Vioxx case to reach trial (⁸ Also see "Merck Reconsiders Legal Strategy: Will Settlements Ease Vioxx Pain?" - Pink Sheet, 29 August, 2005., p. 3). The issue fell 11.7% in the quarter.

Among the companies included in the "F-D-C" Index of diversified companies, which rose 1.3% in the quarter, Abbott experienced the largest set back, falling 13.5%.

Some investors may be wavering on Abbott after FDA's Oncologic Drugs Advisory Committee recommended against approving the firm's investigational prostate cancer therapy, Xinlay (astrasentan), Sept. 13.

Abbott, however, said it will use a back-up Phase III study to support Xinlay approval if the agency follows the committee's recommendations for further review (⁹ Also see "Abbott Looks To Xinlay Back-Up Study After Negative Advisory Cmte. Review" - Pink Sheet, 19 September, 2005. p. 5).

The "F-D-C" Index of wholesalers experienced the strongest sector growth, up 9.1% in the third quarter. AmerisourceBergen jumped 11.8%, Cardinal 10.2% and McKesson 5.9% as the distributors continued to rebound from a transition year in 2004.

The increases suggest investors are more confident in the wholesale distributors' new payment structure; the big three pharmaceutical wholesalers completed a transition to a fee-for-service distribution model from a buy-and-hold model earlier this year, which they had predicted would better estimate sell side margins and reduce earnings volatility in the segment.

The wholesalers were the only sector on the "F-D-C" Index to beat the mainstay indices: the Dow Jones Industrial Average and S&P 500 were up 2.9% and 3.1%, respectively.

Generics Infringe On Branded Stock Growth As Investors Eye Mergers, Part D

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