Yoh, the world is mad. And this time, it’s not angry with a dentist and his bow-and-arrow fetish.

This guy is playing gangsta:

Some tweets (screen-capped before he made his twitter account private):

So the summarised story (in case you’ve missed it):

• Daraprim is a 62 year old drug that is used to treat Toxoplasmosis.
• The drug is owned globally by Glaxosmithkline – but it sold off the US marketing rights in 2010, and those have been moving between pharmaceutical companies ever since.
• Martin Shkreli was fired from his last job at a biotech company (after doing some price gouging there), and started a new start-up called Turing Pharmaceuticals.
• Turing Pharmaceuticals acquired the US marketing rights to Daraprim a few weeks ago for $55 million.
• And recently, it upped the price from $13.50 a pill, to $750 a pill.
• This had everyone is a ragey froth. Even Hilary Rodham climbed firmly atop that froth and led the rally to her court.
• Also, Martin Shkreli didn’t deny that manufacturing costs were less than $1 per pill (here’s my reference: Samantha Allen at the Daily Beast).
• You might be asking: “But what of generics if the patent has expired?”
• The trouble is: tightly-controlled distribution makes it very difficult for generic-producers to get their hands on the samples they need for the required testing (ie. you can’t just pick it up in a pharmacy – you have to get it directly from the distributor).
• And also: it’s quite pricey to build this kind of production plant. If needed, the distributor can drop the price back to the $1 per pill it was under GSK’s distribution (no jokes!), and drive you under.

The defence for the price hike

This amused me:

“If there was a company that was selling an Aston Martin at the price of a bicycle, and we buy that company and we ask to charge Toyota prices, I don’t think that that should be a crime.”

Except, normally, people could choose to use something other than an Aston Martin.

Then this:

“This isn’t the greedy drug company trying to gouge patients, it is us trying to stay in business.”

So let’s evaluate that statement.

Here is what we know (from here, here and here):

• Each pill originally cost $13.50.
• According to Shkreli himself, “This drug was doing $5 million in revenue. And I don’t think you can find a drug company on this planet that can make money on $5 million in revenue. Most costs are much higher than that.”
• Then there’s this “less than a $1 per pill of manufacturing cost”. Which Shkreli does not deny – he simply says that there are other costs as well (“operating costs, marketing expenses, access plans, education efforts”). And this $1 manufacturing cost does have some evidence, because as mentioned earlier: the pills would retail for about $1 each before GSK sold the US marketing rights.
• We also know that Shkreli intends to give half the pills away for almost-free: “Half our drug we give away for $1. So I think that shows our commitment to patients.”
• The new cost of the drug was meant to be $750 (in the last few hours, Shkreli announced that he would be pulling back from that price).
• The higher profits were meant to be poured back into new medical research.
• But also, the old pills were mispriced and this was “missed” by the market.
• And even at the new prices, Shkreli is not sure that the new venture will be profitable.  As he told NBC: “We’ll know in several weeks how profitable the drug is, if at all. It may turn out that’s it not even profitable at all, even at this price.”

What we can extrapolate from that:

• About 370,000 pills a year are being sold – that’s based on $13.50 per pill × 370,000 pills = about $5 million a year in revenue. That’s also assuming that no drugs are being distributed for free just yet.
• Estimated cost of production is $370,000 – that’s based on that “less than $1 per pill to manufacture” estimate.
• Based on the new price of $750 per pill, and half the pills being given away for $1 a piece, projected revenues under the new price regime will be $138,950,000*.
  *$750 per pill × 185,000 pills + $1 per pill × 185,000 pills = $138,950,000.
• Estimated costs of production will stay more or less the same.
• Meaning that the old owner of Daraprim (Impax Laboratories) completely missed the fact that they were losing out on $138,600,000 of potential bottom line.

For the record, Impax Laboratories had a fairly good year in 2014. Here’s a snapshot of their Income Statement:

Those fools.

Didn’t they know that they could practically triple their bottom line?

And that works both ways – whether you think that they were losing hundreds of millions of dollars on these 370,000 pills a year, or whether you think that they were missing out on hundreds of millions of dollars worth of potential revenue.

Either way: seems unlikely.

And as for the “New R&D” line…

Well, that’s just not how it works.

The cost of Research and Development is recovered by the monopoly granted to the inventor by the US patent system: the monopoly is created so that the producer can recover the cost by charging higher prices.

If you flip this around and say: “Actually, new R&D must be paid for by the sales of existing products…” then you negate the need for patents. Because then the only thing that the pharmaceutical company needs to recover when it sells the new drug is the cost of manufacture – and not the capitalised cost of investment from the years of R&D spend prior to FDA approval.

That said: the cost of bringing a new drug to market is outrageous

Some pharmaceutical folk say that the average cost of bringing a new drug to market is $1.3 billion (see here), and it takes about 12 years to get a new molecule to market. I make that about $108 million per year – which is suspiciously close to the “extra revenue” figure that Shkreli was aiming for, with some change for bonuses, etc.

But there are other Big Pharma folk who are outraged by this underestimation of cost, and present this table to anyone asking:

The argument being: you can’t just look at the direct cost. You also have to consider the failed projects in the cost (about 9 failed projects for every successful new drug).

Which is perhaps why Mr Shkreli feels that the new prices may not be profitable enough.

Although someone needs to tell him that he’s using the cost of future sales to determine the profitability of existing sales.

And that’s bad accounting. Tsk.

To close, I give you this:

Nuff said.

Rolling Alpha posts opinions on finance, economics, and the corporate life in general. Follow me on Twitter @RollingAlpha, and on Facebook at www.facebook.com/rollingalpha.