The Empty Medicine Cabinet

Drug companies are spending a lot of money in Washington to make sure President Obama' health care reform is to their liking. But the far greater issue facing them: expiring patents and weak product pipelines.

That's the view of Michael Krensavage, who has followed drug companies for more than a dozen years.

"A lot of companies have serious patent cliffs," says Krensavage, who runs New York-based Krensavage Partners.

Krensavage, a value investor focused primarily on pharmaceuticals, says he's still buying drug stocks because they are cheap, trading at their lowest levels in years, but he's still concerned about these companies replacing so many top-selling medicines. He doesn't disclose his holdings.

Bristol-Myers Squibb Co.'s blood thinner Plavix will lose patent protection in 2011, Merck & Co.'s allergy and asthma medicine Singulair patent expires in 2012 and Eli Lilly & Co. will see patents on four top-selling drugs, including anti-psychotic Zyprexa, sunset by 2013. In some of these cases, generic drug makers already are challenging the patents.

Then there's Lipitor, the world's best-selling drug with 2008 revenue of $12.4 billion. Pfizer Inc.'s patent on Lipitor expires next year.

Pfizer is buying rival Wyeth for $68 billion, a move Krensavage says bails the giant drugmaker out of its R&D problem.

"Drug companies are having a difficult time producing new medicines. I don't think Pfizer would need to buy Wyeth if Torcetrapib worked," he says, referring to a cholesterol drug Pfizer scrapped in late 2006 because of death risks.

Like Pfizer, Merck & Co. is buying a rival, Schering-Plough Corp., for $41 billion. In announcing the deal, Merck touted Schering-Plough's drugs in development, particularly in areas such as cancer and neuroscience.

Ultimately, this lack of promising drugs coming out of company labs will lead to more mergers, Krensavage predicts.

"There's more pressure on the remaining drug companies' infrastructures," he says. "R&D is not supporting the cost base."

Bristol-Myers "is at some point a merger candidate," he says. "Lilly is in pretty bad shape with patents," Krensavage adds.

Lilly has adamantly rejected the idea of merging with another company. And since there are fewer large U.S. drug companies, the next big merger may be with an overseas competitor. For instance, France's Sanofi-Aventis could buy Bristol-Myers, he says. The companies co-market Plavix.

As for health care form, which carries some risk for any player in the industry: "I believe it's a wall of worry for (drug stocks) to climb," Krensavage says. "But it probably won't be as bad as people expect. Drug companies protected themselves with a deal with the White House. I don't think it will be bad."

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Brett Chase covers health care for Portfolio.com and writes the blog Heavy Doses.