VRX: The Balance of Power Between Valeant and Formulary Managers – An Empiric Framing

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Richard Evans / Scott Hinds / Ryan Baum / Hardy Evans


203.901.1631 /.1632 / .1627

revans@ / shinds@ / rbaum / hevans@ssrllc.com


January 5, 2016

VRX: The Balance of Power Between Valeant and Formulary Managers – An Empiric Framing

  • 24% of VRX’s US brand Rx net sales are from products/doses that have AB-rated[1] alternatives. Any formulary manager (e.g. PBM, HMO) could easily choose not to cover any of these VRX products or doses, immediately reducing their payments to VRX by a corresponding percentage
  • 49% of VRX’s US brand Rx net sales are from products that do not have direct AB-rated substitutes, but do have close therapeutic alternatives – specifically, alternatives that are close enough substitutes to the VRX products that it becomes feasible for formulary managers to deny coverage of the VRX product, instead requiring beneficiaries to use the alternative
  • Taken together formulary managers have the option of reducing their payments to VRX by as much as 73% by requiring beneficiaries to use available alternatives. By no means are we suggesting that all or even a majority of formulary managers will impose such broad restrictions; rather, our point is that formulary managers’ ability to impose such highly impactful restrictions gives them the advantage in the VRX v. formulary manager balance of power
  • Because VRX recently has become one of the largest drivers of market-wide US Rx net price inflation, formulary managers have little choice but to push back. We fully expect formulary managers to apply their negotiating leverage to VRX in such a manner that VRX cannot increase its net pricing any more rapidly than +/- 6% for the foreseeable future; and, we see very realistic scenarios in which VRX’s rate of US net pricing gains is well below this upper limit
  • VRX’s agreement with WBA has no effect on the prices paid by formulary managers, nor does the agreement place any practical limits on formulary managers’ options for putting price pressure on VRX

Where we’re BULLISH: Biopharma companies with undervalued pipelines (e.g. AMGN, BMY, GILD, SHPG, VRTX); Biopharma companies with pending major product approvals (e.g. ABBV, ACAD, ADMA, ALIOF, BIIB, CHMA, CLVS, CPRX, CTIC, GILD, ICPT, JAZZ, LLY, LPCN, MRK, NVO, OCUL, PTCT, SRPT, TEVA, ZSPH); SNY on undervalued basal insulin franchise and sales potential for Praluent (alirocumab), in addition to its undervalued pipeline; CFN, BCR, CNMD and TFX on rising hospital patient volumes; XRAY and PDCO on rising dental patient volumes and rising average dollar values of dental products and services consumed per visit; CNC, MOH and WCG on bullish prospects for Medicaid HMOs; and, DVA and FMS for the likely gross margin effects of generic forms of Epogen

Where we’re BEARISH: PBMs facing loss of generic dispensing margin as the AWP pricing benchmark is replaced (e.g. ESRX); Drug Retail as dispensing margins are pressured by narrowing retail networks and replacement of AWP (e.g. WBA, CVS); Research Tools & Services companies as growth expectations and valuations are too high in an environment of falling biopharma R&D spend (e.g. CRL, Q, ICLR); and, suppliers of capital equipment to hospitals on the likelihood hospitals over-invested in capital equipment before the roll-out of the Affordable Care Act (e.g. ISRG, EKTAY, HAE)

Despite VRX’s relatively small share of total US Rx sales, and the relatively small average size ($58M) of VRX’s US Rx products, VRX has been a major driver of market-wide US Rx net price inflation for well over a year (Exhibit 1). Because of this, formulary managers (e.g. PBMs, HMOs) are effectively compelled to limit VRX’s inflationary impact. This has forced the question of where the balance of power lies in the relationship between VRX and formulary managers; our aim in this note is to offer a fact-based framing of exactly this question

To do this, we first placed 61 of the company’s largest US brand Rx products (accounting for 96% of US brand Rx sales) into one of three categories:

  1. AB-rated substitutes are available (pharmacists can substitute a generic alternative for the VRX product unless the Rx is designated ‘dispense as written’)
  2. Therapeutic substitutes are available (a different dose, formulation, or molecule is available and is an accepted treatment for the same condition the VRX product is typically written to treat); or
  3. No substitutes are available for the VRX product

We found that 24% of VRX’s US brand Rx net sales fall into category 1 (AB-rated substitutes available), 49% into category 2 (therapeutic alternatives available), and 23% into category 4 (no substitutes available)

Our designations of which products are substitutable, and to what degree, with corresponding percentages of VRX US Rx sales by product, are provided as Exhibit 2. Notes explaining our substitutability designations can be found in Appendix 1. Relative net premiums or discounts of VRX products versus either generic or branded alternatives, as applicable, are provided in Exhibit 3, with accompanying methodological notes in Appendix 2. Positive values indicate a VRX premium to the alternative, and vice versa

We believe this analysis shows that formulary managers have tremendous leverage over VRX. An NDC-lockout[2] of VRX products with AB-rated alternatives (category 1) is very straightforward – by definition any affected patient could get an exact copy of the VRX drug – and this would reduce VRX’ trailing 3Q15 YTD sales by 24%

Denying coverage of the VRX products we’ve designated as category 2 (therapeutic alternatives are available) is perfectly feasible, but less straightforward than denying coverage of category 1. In the case of category 2, the beneficiary’s only covered options are for different molecules and/or doses/forms. In the case of category 1, any pharmacist can dispense the AB-rated alternatives to the VRX product without having to contact the physician that wrote the prescription[3]; however, for drugs falling into category 2, the pharmacist can only dispense the alternative to the VRX drug if the physician writes an entirely new prescription for that alternative[4]. Because of this, denying coverage of VRX drugs in category 2 creates a disruption to the care process that isn’t part of denying coverage to VRX drugs in category 1, though bear in mind that therapeutic substitution of this sort has become commonplace nevertheless

A more novel issue formulary managers face in restricting VRX’s category 2 drugs is the matter of handling appeals and exceptions. Traditionally, formulary managers (at plan sponsors’ request) offer a process for handling appeals and exceptions whenever a drug is excluded from coverage. This way plan sponsors can be reasonably sure that beneficiaries who genuinely need the excluded drug can get affordable access to it if necessary. Setting up an appeals process requires training call centers on how to handle an appeal in a given drug category for a given plan sponsor. If the appeal occurs frequently enough, the cost of establishing and operating the appeals process is worthwhile. However, we suspect that many of VRX’s category 2 products are too small and spread across too many categories for an appeals process to be economically feasible. This means that placing NDC locks on VRX’s category 2 products can probably only be done without corresponding pathways for appeals and exceptions – so we have to acknowledge that blocking these products implies a more aggressive form of therapeutic substitution than is typical. The less severe the condition, and the closer matches the available substitutes represent to the VRX products, the more feasible it becomes to run a simple NDC lock-out without a corresponding appeals / exceptions process. For the products we’ve designated as category 2, we specifically believe that these products can be NDC locked, without provision for appeals

Appendix 2: Methodological notes to Exhibit 3

Premiums / discounts represent estimated net price for VRX’s product relative to estimated net price (likewise received by manufacturers) for substitutes. For VRX products, net price is reported or estimated net sales divided by third party-reported units (i.e. one pill/tablet, one gram, or one mL); net sales at the form/dose level within products are allocated consistent with third party-reported gross sales for the product’s forms/doses. VRX products’ net prices are sensitized over a +/- 10% range. For generic subs, Average Manufacturer Price (AMP) or National Average Drug Acquisition Cost (NADAC) is the basis of calculation for net price. If AMP is the basis, a default 2.0% discount is further taken from AMP to reflect discounts to net price not captured by AMP (e.g. prompt pay, service fees). If NADAC is the basis, a default 45.8% discount (with +/- 20% sensitivity range) is further taken to reflect the AMP-NADAC spread[5], plus the aforementioned 2.0% discount to AMP. For branded subs, net sales per unit is used as with VRX’s products, with the same +/- 10% sensitivity range; if net sales are unreported, a conservative 20% discount is applied to third party-reported gross sales

A hierarchy of net price per unit > net price per mg > net price per treatment course / year is used for benchmarking. If generic subs are available at the same dose of the VRX product, and AMP per unit is available for those subs, AMP per unit is the preferred benchmark basis. If AMP isn’t available (typically due to an insufficient number of manufacturers), NADAC per unit is the basis. If generic subs are available for the same molecule but different doses, AMP per milligram is the preferred basis; if AMP is unavailable, NADAC per mg is the basis. If only different compound therapeutic subs are available, net price per treatment course or year[6] is the benchmark basis, with AMP again preferred over NADAC.[7] For branded subs, the same hierarchy of net price per unit > net price per mg > net price per treatment course / year is used; as aforementioned, net price for branded subs is based on net sales per unit instead of AMP or NADAC

  1. AB-rated alternatives are exact copies that pharmacists can substitute for VRX products, without the need for a new prescription
  2. All FDA approved prescription products have a unique National Drug Code or ‘NDC’ number that identifies the manufacturer, drug, dose, and package size. An NDC lock-out is a step formulary managers can take to block coverage of a specific drug. In the case of an NDC lock-out, when the pharmacist enters benefit information to verify coverage, a message is received that coverage for that specific drug and dose is denied
  3. Assuming the prescription has not been marked ‘dispense as written’
  4. Typically this is accomplished by the pharmacy contacting the physicians’ office and asking, on the patient’s behalf, that the physician write a prescription for the alternative drug. This commonly avoids the need for patients to visit their physician’s office, and often can avoid the need for a second visit to the pharmacy
  5. Consistent with empirical analysis of AMP-NADAC spreads since 2013
  6. Using average dosing assumptions consistent with product inserts and treatment guidelines
  7. Xenazine and Targretin are exceptions, as neither AMP nor NADAC data are available for the recently approved generic equivalents. The displayed premium / discount equals Wholesale Acquisition Cost (WAC) per unit for VRX’s brand vs. average WAC per unit for the generic products


©2016, SSR, LLC, 1055 Washington Blvd, Stamford, CT 06901. All rights reserved. The information contained in this report has been obtained from sources believed to be reliable, and its accuracy and completeness is not guaranteed. No representation or warranty, express or implied, is made as to the fairness, accuracy, completeness or correctness of the information and opinions contained herein. The views and other information provided are subject to change without notice. This report is issued without regard to the specific investment objectives, financial situation or particular needs of any specific recipient and is not construed as a solicitation or an offer to buy or sell any securities or related financial instruments. Past performance is not necessarily a guide to future results. In the past 12 months, through a wholly-owned subsidiary SSR Health LLC has provided paid advisory services to Pfizer Inc (PFE) and to Merck (MKGAY) on both securities-related and non-securities-related topics

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