It’s a story as old as business. An industry is burdened with poor fundamentals, including an excess of capacity and a lack of pricing power. The industry then consolidates, and the surviving companies eliminate the extra capacity, which subsequently improves their pricing power. And when demand picks up, the industry goes on to thrive.

That’s the story of the plasma-products industry, a $6.9-billion business that a few years ago was struggling under the weight of poor pricing power and an oversupply of blood plasma, the substance used to produce life-saving products for patients with maladies ranging from liver disease to hemophilia. As a result the industry was compelled to close many plasma-collection centers, thus reducing the supply of plasma by an estimated 28% from 2000 to 2005, according to Morgan Stanley. It was part of a wave of consolidation in the industry, in which a number of companies exited the business.

Due to these actions and increasingly productive manufacturing, the industry today enjoys a significantly greater degree of pricing power and profitability. And demand for plasma products, driven in part by new applications and new markets overseas, is outpacing supply. Consequently, in our estimation, the fundamentals of the industry currently are as strong as they have ever been. As we see it, plasma-products companies are poised to generate growth in earnings per share of about 15% annually over the next two years.

Plasma products now command prices that are markedly better than the companies themselves or Wall Street analysts foresaw just two years ago. For instance, the price of a gram of intravenous immunoglobulin (or IVIG, which prevents infectious diseases and treats immune deficiencies) in liquid form is now more than $55, compared with a price of about $40 in 2003. And the price of a gram of albumin (which maintains and expands the blood volume of patients who have suffered a traumatic injury, burns, or severe liver disease or who have undergone surgery) is now about $2, versus $1.20 in 2004. Both IVIG and albumin prices are likely to head higher over the next two years, in our view.

With supplies of plasma now tight, the amount of plasma collected from donors is expected to rise going forward, from 16,152 International units in 2007 to 17,665 International units in 2010. The plasma collected is converted not only into IVIG and albumin but also coagulation products, which treat bleeding disorders such as hemophilia. As with IVIG and albumin, prices for coagulation products are expected to rise.

Of these three broad categories of plasma products, IVIG is the most profitable. We think sales growth in IVIG can be sustained at high single-digit annual rates for years to come. Should new therapies emerge, the growth rates could be even higher.

For example, Baxter International is investigating the treatment of Alzheimer’s disease with its IVIG product, Gammagard, which is already being used in immune-deficiency applications. At this point, Baxter’s Gammagard study, involving 24 Alzheimer’s patients in New York, has only reached an early Phase II stage. But with the incidence of Alzheimer’s expected to grow as the 77 million baby boomers age, it does offer a good example of the potentially huge markets that new IVIG therapies could serve. Preliminary results from the study have been "encouraging enough to trigger the launch of a more comprehensive Phase III study," The Wall Street Journal reported. "Phase III studies are generally used to generate the kind of evidence needed to secure regulatory approval, which could happen in a few years for Baxter if the research progresses well."

The plasma that’s the raw material for current and future products is collected in two ways: 1) plasmapheresis, a process in which blood is extracted and fractionated, or separated, into plasma and red cells (the plasma is kept and the red cells are returned to the donor via an infusion of saline solution) and 2) conventional blood donations. Plasmapheresis accounts for 16.3 million liters of plasma annually and is the most productive collection method: individual donations can be made as often as every three weeks. Conventional blood donations, in contrast, yield about 8 million liters of plasma annually, and the maximum frequency of individual donations is four times less than that of plasmapheresis, or once every 12 weeks.

Plasmapheresis is almost exclusively the method of choice at plasma-collection centers. About 80% of the centers are now owned by plasma-products companies such as Baxter International, CSL Limited, Grifols, and Talecris Biotherapeutics. This represents a complete reversal in ownership since 2000, when 80% of the centers were independent enterprises. The companies acquired the centers for four reasons: to achieve greater vertical integration of their business, to gain greater control of the plasma supply, to ensure the plasma collected met their quality standards, and to reduce their costs.

About 70% of the global supply of plasma comes from the U.S. In terms of consumption, North America constitutes 40% of the global plasma-products market, followed by Europe at 32% and Asia at 19%, according to the Marketing Research Bureau, which monitors the industry.

Demand for plasma products is rising most rapidly in the emerging nations, especially in China, the Middle East, and South America, reflecting the increasing standards of living there. Greater global affluence and economic growth are bringing about improvements in public health and reductions in the mortality rate, due in no small part to the greater use of plasma products and other sophisticated health-care therapies. As The Economist notes, "Almost half of humanity, spread over more than 40 nations, lives in countries growing at 7% a year or more, a rate that doubles the size of an economy in a decade. This is twice the number of fast growers that existed in the years between 1980 and 2000."

And in developed nations such as the U.S., plasma products have considerable growth potential, in our judgment. For instance, 230,000 Americans suffer from immune deficiencies that could be treated with IVIG, yet only 55,000 are currently being prescribed it, our industry contacts say.

Patients’ use of plasma products tends to be lengthy, since the products help alleviate the symptoms of disorders such as immune deficiencies and hemophilia -- but the disorders unfortunately have no cure at present. As a result individual patient regimens involving plasma products generally are measured in decades, not months or years, which contributes to a steady stream of demand for the products.

We think that steady stream of demand, plus new streams that bubble to the surface with each passing year, should benefit three leading plasma-products companies whose shares are traded publicly: Baxter International, CSL Limited, and Grifols. Also, two private companies, Octapharma and Talecris Biotherapeutics, are major players. Baxter and Talecris are based in the U.S.; CSL, in Australia; Grifols, in Spain; and Octapharma, in Switzerland.

CSL has the largest manufacturing capacity, producing about 6 million liters of plasma products annually (a 24% market share), compared with about 4 million liters for both Baxter and Talecris (a 17% share each), 3.4 million liters for Grifols (a 14% share), and 1.8 million liters for Octapharma (a 7% share).

Baxter (market capitalization: about $36 billion) is the biggest and most diversified of the five competitors, deriving about 20% of its sales from plasma products. Baxter, a core holding in our growth portfolios over the past two years, has benefited especially from the healthier fundamentals and pricing power of plasma products. In an effort to develop new plasma products (as well as new medical devices, pharmaceuticals, and biotechnology products), the company in recent years has been increasing its research and development spending at a rate of more than 16%, which is greater than its rate of sales growth, about 10% annually. According to Citigroup, Baxter’s margins on earnings before interest, taxes, depreciation, and amortization (EBITDA) should remain above 24% through 2009.

CSL Limited (market capitalization: about $14 billion) is not only the world’s largest producer of plasma products but the world’s largest collector of plasma as well, receiving 4 million donations annually. CSL has one of the strongest balance sheets in the health-care sector, and we think the company could be debt free by 2009. Its operating cash flow is expected to reach $500 million this year. And we’ve noted that Wall Street analysts have been raising their earnings estimates for CSL since 2006.

Grifols (market capitalization: about $4.6 billion) invented plasmapheresis, the process that helped make the plasma-products industry possible in the first place. Grifols now operates 72 plasma-collection centers worldwide, 16 of which have been added in the past two years, mainly by acquisition. In discussing Grifols, analysts invariably comment on the company’s remarkably consistent record of growth: the company’s sales have risen every year since 1975, at a compound annual rate of 19%. For our part, we’re impressed by the company’s near-term earnings prospects: its EBITDA margins may approach 27% by 2009.

Octapharma (annual revenue: about $390 million) has increased profits by 291% from 2003 to 2006, to a level now equal to 20% of revenue. Octapharma managers report that the demand for IVIG is more acute in Europe than in the U.S. and that orders for coagulation products have outpaced the company’s ability to fill them; indeed, in the past two years the company has actually turned down new overseas business in coagulation products.

Talecris Biotherapeutics (annual revenue: about $1 billion) was created mainly by the acquisition of Bayer AG’s plasma-products business in 2005. Talecris itself was created with funding by private-equity firms Cerberus Capital Management and Ampersand Ventures. The company plans to operate 58 plasma-collection centers in 2010, up from 25 in 2007, and we expect it to remain soundly profitable during that time.

In sum, the financial skies are now sunny for the plasma-products industry. What could turn those skies gray? Perhaps the biggest risk is the reverse of that old story in business: an industry with above-average profitability typically attracts new competitors, who add supply to the point where pricing power is eroded, which in turn helps instigate a down cycle. As a result of the consolidation earlier in this decade, the plasma-products industry today has characteristics of an oligopoly. But as we see it, that oligopoly and its profits would likely be diminished with the entrance of a new set of competitors. At least for the time being, though, the fundamentals of the industry should remain bright, in our judgment.