A new home for orphans

IT HAS been a hectic year for drug companies. They did deals worth $230 billion in the first half of 2014, according to Dealogic, a research firm, up 65% from the same period last year. Another giant merger is in the offing: on July 14th Shire, headquartered in Ireland, said its board was looking favourably on a $54 billion bid from AbbVie, an American firm.

The surge of drug mergers is notable for two reasons. The first is the popularity of “tax inversions”. Buying Shire would let AbbVie be domiciled abroad—in this case it has chosen Britain, slashing its tax rate by almost half. This week America’s treasury secretary, Jack Lew, urged Congress to pass a law ending this “abuse of our tax system”. The second is the sheer scale of the industry’s deal-making—the first half of 2014 was the busiest since Dealogic began keeping track in 1995.

But the mergers are just part of the drug industry’s efforts to remake itself. Many of its most profitable treatments have fallen off the “patent cliff”, losing their intellectual-property protection. Their costly research labs have produced too few new blockbusters. Health insurers and governments have become reluctant to pay a premium for new medicines that are only marginally better than old ones.

So, besides cutting their costs, companies have sought to acquire new drugs through mergers and partnerships. Many firms, Shire in particular, have also redirected their attention from looking to treat ailments that have millions of sufferers—such as a pill to lower cholesterol levels—to seeking new drugs for rare, severe conditions. Insurers and governments are usually willing to pay more for these “orphan drugs”, since they treat small numbers of patients in dire need of care.

Orphan drugs are also cheaper to bring to market. Since the patient populations are smaller, regulators let the drugs firms make their clinical trials smaller too; they also offer faster approval. Of the 36 new drugs launched in America last year, 17 were orphan drugs.

When Flemming Ornskov became Shire’s boss, in April 2013, the company’s research programmes were too broad, with high administrative costs. Shire has a big business selling pills for attention-deficit hyperactivity disorder, but this seemed not to offer strong growth prospects. Insurers and governments were continually cheese-paring drug prices. In an interview one year after he joined Shire, Dr Ornskov argued that the best defence against price pressure was one of two things: “Either become more efficient or more innovative.” He has tried to do both, by putting orphan drugs at the centre of the firm’s strategy.

The company’s research spending in the first quarter of this year was 13% lower than it had been in 2013; and almost all of its remaining early research is now concentrated on orphan diseases. Dr Ornskov has also sought new orphan drugs through dealmaking. Shire’s $4.2 billion purchase of ViroPharma, for example, has brought it a drug to treat hereditary angioedema, a rare genetic disease that brings on sudden, dangerous swelling.

Not only may Shire have found a new route to short-term growth; its focus on treatments for small patient populations may make it—and thus AbbVie, if it ends up owning Shire—more profitable in the longer term, as the treatment of all diseases, not just obscure hereditary ones, becomes more specialised. Thanks to genome sequencing, scientists can now identify subgroups of sufferers of a particular ailment, who share particular mutations, and seek drugs that treat them accordingly. “All diseases are turning into rare diseases,” Dr Ornskov has argued. However, it is unclear how willing health insurers and governments will be to keep paying high prices for such drugs as they take a larger share of the market.

So Dr Ornskov’s bet on orphan drugs, and the deals and research cuts he has made to pursue it, are risky. Shire’s strategy “looks OK for now,” says Ronny Gal of Sanford C. Bernstein, a research firm, but “time will tell whether he created value or destroyed value.” Then again, as other drugs giants continue their frenzy of dealmaking, the same could be said of them.