The competitive dynamics between branded drug and generic-drug companies, like tectonic plates, continue to shift, and the stakes have never been higher. We estimate that over the next three years about $50 billion of revenue from currently marketed branded drugs will be targeted by generic-drug companies. To the generic companies that were the first to file Abbreviated New Drug Applications (ANDAs) with the Food and Drug Administration (FDA), that opportunity presents enormous profit potential, in our estimation.

For their part, branded drug companies, realizing that many generic drugs are quite profitable and gaining increased regulatory acceptance, are increasingly making strategic moves in generics. Last year, for instance, Sanofi-Aventis bought Medley, a fast-growing Brazilian drug company, to become the biggest generic-drug competitor in Latin America and GlaxoSmithKline bulked up its generic-drug distribution network in the emerging markets by making a deal with South Africa’s Aspen.

It would be a dramatic oversimplification to say that branded drug companies are morphing into hybrid branded/generic firms. Branded drug companies continue to wage bloody legal battles and make backroom settlements in an effort to restrict the advances on their turf by the generic-drug companies. But the branded drug companies realize that the competitive plates are indeed shifting and are positioning themselves accordingly.

This heightened interest by Big Pharma in generic drugs is motivated by pragmatism: the growth rate of the generic-drug business has been, and seems likely to remain, superior to that of the traditional brand-name drug business. From 2004 to 2008, U.S. prescriptions for generic drugs grew, at a compound annual rate of 12%, while prescriptions for branded drugs declined, at a 6% rate, according to Wolters Kluwer Health, which monitors the industry. Generic drugs now account for the majority of U.S. prescriptions, 2.4 billion out of a total of 3.8 billion. And over the next four years, sales of generic drugs in the U.S. and overseas are projected to grow at a double-digit annual rate, while sales of branded drugs are expected to rise 3-6% annually, says IMS Health, a research firm.

Big Pharma’s push into generic drugs, in the view of The Wall Street Journal, serves as "a reminder that the pharma pendulum is swinging back. In the 1990s, when branded drugs were all the rage, drug companies spun off peripheral businesses to focus on branded blockbusters. Now that the branded drugs business is getting tougher, Big Pharma is looking to diversify."

Generic drugs now constitute a $78-billion business globally, but they have barely penetrated the international market, which we think should be a source of above-average growth. Generic drugs represent a mere 10% of global pharmaceutical revenue, Barron’s reports.

As we see it, the fundamentals of generic drugs are driven mainly by these four catalysts:

*Generic drugs, according to Barron’s, are priced on average about 70% less than branded drugs -- a fact that hasn’t been lost on Medicare, the Obama Administration, private employers, and pharmacy-benefit managers that administer corporate health-care benefit plans. They are among the most ardent supporters of generics as cost-saving alternatives to branded drugs.

All of them have found it difficult to control health-care costs. But given the generic options available in most drugs -- in statins and antidepressants, for instance -- they’ve seen how it’s possible to provide clinically effective drugs and control costs. For example, health-care benefit plans are popularizing the use of variable co-payments, such as three-tier formularies, where the lowest priced generic occupies the top tier. To stimulate demand for generic drugs, benefit plans in some cases are offering co-payments for that top tier of drugs ranging from zero to $10. In contrast, more expensive branded drugs are often placed in the third tier, with $40-50 co-payments.

The Obama administration sees generic drugs as a means to help rein in the nation’s escalating health-care costs. As one major priority, the administration and Congress are constructing what’s called a regulatory pathway for cheaper copies of expensive biotechnology drugs, or biogenerics. This is easier said than done, however. By definition, most biotech drugs are complex proteins that are difficult to replicate -- unlike traditional drugs, which typically are composed of small-molecule chemicals that are much easier to copy. We will be watching the developments here closely, as the impact on the biotech industry may be sizable. Among other things, it’s unclear how the FDA will ensure the reliability and safety of biogenerics. The FDA verifies the safety and effectiveness of all drugs, be they branded or generic, but the hurdles to proving unequivocally that biogenerics are safe and as clinically effective as branded drugs may be quite high, in our estimation.

*The patents of a large number of branded drugs are expiring over the next three years, providing a steadily flowing stream of opportunities for generics. We estimate that $7.5 billion in sales of branded drugs will lose patent protection in 2010, $20 billion in 2011, and $24 billion in 2011. The number of major drugs going off patent should peak in 2012, at 15.

According to Barclays Capital, drugs going off patent include Wyeth’s Effexor (annual U.S. sales $2.1 billion) in 2010; GlaxoSmithKline’s Seretide/Advair ($2.8 billion) and Eli Lilly’s Zyprexa ($2.3 billion) in 2011; and AstraZeneca’s Seroquel ($4.1 billion), Novartis’ Diovan ($3.1 billion), and Bristol-Myers Squibb’s Plavix ($5.0 billion) in 2012.

*Prices of generic drugs in the past year have stabilized, reflecting greater consolidation in the industry, as some competitors fail and others are acquired. Previously prices were declining by as much as 20% annually, a vestige of what financial journalist Johanna Bennett has characterized as the "cutthroat" economics of the business, in which pricing wars among the competition routinely hurt profit margins. Now, however, consolidation is shrinking the number of providers of generic drugs and in the process firming up their pricing power.

An especially noteworthy act of consolidation was last year’s acquisition of Barr Pharmaceuticals by Teva Pharmaceutical Industries, the world’s largest generic-drug company. And Mylan, a competitor, has been an active acquirer, buying global generic manufacturers such as Matrix this year. These acquisitions have enabled Teva and Mylan to expand their geographic reach, bolster their vertical integration of manufacturing, produce greater quantities of active pharmaceutical ingredients that are sold to other drug companies, and enhance the leverage of their distribution networks.

*The well-managed generic companies are strengthening their competitive positions as a consequence of some hapless generic peers running into regulatory problems. The FDA has stepped up regulatory oversight of the industry after several embarrassing product recalls and shut down some generic operations. Specifically, Ranbaxy Laboratories, Sandoz (a division of Novartis), and KV Pharmaceutical are now stuck in the regulatory doghouse. It’s unclear when they will be able to compete again. In the meantime, the better managed survivors are free to capitalize on a less crowded marketplace.

So in all, we think the demand for generic drugs could accelerate for some time to come. Perhaps the biggest potential damper on demand is the restrictive regulatory environment in Europe, where use of generic drugs is not as widespread as in the U.S. In Europe the prices of branded drugs are controlled by the national governments and in some cases are only modestly higher than those of generics. As a result European governments have been slow to endorse (and pay for) generic drugs in their countries’ universal health systems, although that hesitancy is diminishing as time passes. On the low end of the European spectrum, generics have captured less than 20% of the prescription market in France, Italy, and Spain, and on the high end of the spectrum, generics hold a market share of more than 50% in the United Kingdom, the Netherlands, and Germany.

Among generic-drug companies, we think Teva Pharmaceutical Industries (market capitalization: about $40 billion) has the best prospects in the near term. Based in Israel, Teva is the low-cost and, as noted, biggest manufacturer in the industry. Standard & Poor’s expects Teva’s sales to hit $14.3 billion this year, up from $11.1 billion in 2008. The company thinks it can generate $20 billion in sales by 2012. For our part, we think Teva’s low-cost structure, vertically integrated manufacturing, and diversified line of more than 300 products should help the company to achieve double-digit earnings growth annually over the next three years.

As of early 2009, the company had more ANDAs awaiting approval from the FDA than any competitor did. In the process of submitting ANDAs so prolifically, Teva has aggressively litigated to challenge the patents of branded drugs. The company has more than 120 patent challenges pending and in recent years has settled patent disputes with the likes of GlaxoSmithKline, Wyeth, King Pharmaceuticals, and AstraZeneca International. Challenging patents is much in Teva’s self-interest financially, as the downside for failure is minimal and the upside for success is considerable. Teva has been successful 79% of the time in winning or settling a patent case, compared with an average of 70% for the industry, according to RBC Capital Markets.

In the U.S., Teva holds a 24% share of the market for generic prescriptions, double that of Mylan, its nearest competitor, according to Jefferies & Company. Teva considers Europe and Asia its greatest prospective growth markets and bought Barr Pharmaceuticals partly because of Barr’s substantial presence in Eastern Europe. Teva has been a prominent consolidator in the industry, making five acquisitions since 2004. Teva also has established a joint venture with Kowa, a Japanese pharmaceutical firm, which the company projects will result in generic sales of as much as $1 billon by 2015.

We think Teva is likely to gain greater market share in Europe and Japan, due in part to what we foresee as a gradual acceptance of generic drugs in those regions. In Europe in particular, even though the difference in price between branded and generic drugs may sometimes be only marginal, the necessity to temper costs in universal health systems, which are consuming an ever greater slice of national budgets, is becoming more compelling to its political classes.

In short, as part of the competitive tectonics in the pharmaceutical industry, the cost-effectiveness of generic drugs is slowly but surely winning out.

The views expressed represent the opinions of Turner Investment Partners as of the date indicated and may change. They are not intended as a forecast, a guarantee of future results, investment recommendations, or an offer to buy or sell any securities. Opinions about individual securities mentioned may change, and there can be no guarantee that Turner will select and hold any particular security for its client portfolios. Earnings growth may not result in an increase in share price. Past performance is no guarantee of future results.

Turner Investment Partners, founded in 1990 and based in Berwyn, Pennsylvania, is an investment firm that manages more than $14 billion in stocks in separately managed accounts and mutual funds for institutions and individuals, as of March 31, 2009.

As of April 30, 2009, Turner held in client accounts 6,180 shares of GlaxoSmithKline, 1.6 million shares of Teva Pharmaceutical Industries, 221,680 shares of Wyeth, 446,767 shares of King Pharmaceuticals, 3,260 shares of AstraZeneca International, 334,982 shares of Mylan, and 160 shares of Bristol-Myers Squibb. Turner held no shares of Sanofi-Aventis, Novartis, Eli Lilly, Ranbaxy Laboratories, and KV Pharmaceutical.