Tobin Smith: Generically Speaking

11/01/2002 12:00 am EST


Paul Abel

Portfolio Manager, Kinetics Medical Fund, Kinetics Asset Management

ChangeWave Investing according to Tobin Smith is simply about identifying transformational change in industries. He explains, "To identify waves, we’ve recruited over 3,700 professional to be our eyes and ears. We don’t care if a CEO says that sales are doing well. We'd rather survey 500 salespeople." Tobin monitors about 20 different industries in search of these waves. One such ChangeWave is generic drugs.

"A true ChangeWave grows irrespective of the economy. Think of it as wind behind the back. ChangeWave’s are often created by regulatory change. Often there is regulation that creates more demand than supply. An example is generic drugs. Look at Prozac. Lilly made billions in profits from this drug, until when? The day it went generic. Then in a month, 87% of the prescriptions filled for Prozac were generic. The generic wave is just starting to hit. The generic drug model is so much better than the pharmaceutical industry. Pharmaceutical companies often go after 100 different products for each one that reaches the market. So the first pill off a product line for a drug costs something like $800 million. Eventually, they will be able to produce that pill for a penny and sell it for a dollar, which makes it a good business. But the generic business is better. It lets all the research get done by the big guys. When a drug comes off patent, it makes that pill for a penny and sells it for 20 cents. The generic wave is going to grow, no matter what. 

Eon Labs (ELAB NASDAQ) currently has about 100 generic products and they are working on another 150. Growth is in the 50% to 60% percent range. E-labs not only makes generics but also manufactures for others. It’s selling at a forward p/e of less than 20 times its earnings.

Dr. Reddy’s (RDY NYSE) is an Indian company with a great business model. Why? Because their costs are about 80% lower than comparable companies over here. Their engineers and scientists work for about 90% less. The combination of low cost plus the ability to distribute in India and in the US makes this a great company. It is growing faster than its earnings p/e and it has multiple products on line coming in. 

Teva Pharmaceuticals (TEVA NASDAQ) is an Israeli company and, as a result, the stock is selling at a ‘war discount.’ In our view, this discount is silly, given that 95% of their revenues come from the US and Europe. Although it does some research out of Israel, most of their research is done here. This company has a leading position in generics and the discount to revenues and earnings is way overdone.

“Also in the generic food chain, we like two companies that do manufacturing of generics for other companies: BRL Inc. (BRLI NASDAQ) and Lannett (LCI AMEX). Both companies have FDA registration, which is key in this market. It is very, very difficult to get FDA approval to manufacture generics.”

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