Healthcare remains a compelling long-term investment theme as the planet's population swells. In the second half of this decade, Americans spent nearly $2.2 trillion on healthcare. This spending accounted for more than 16% of the country's gross domestic product. The story remains similar in both developed and emerging nations. As the world's population continues to grow and age, a greater focus will be put on healthcare. A broad bet, like the Health Care Select Sector SPDR (NYSE:XLV) makes sense as a long-term play. But despite the bullish long-term prospects for healthcare, Big Pharma is facing a big problem: competition from generic drugs.

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Staring at the Edge of the Cliff
Pharmaceutical companies are facing quite a predicament. Billions of dollars worth of patented, protected drugs will go generic over the next few years. In 2011, Pfizer (NYSE:PFE) will lose its blockbuster cholesterol drug Lipitor, which generated nearly $11 billion in sales in 2009. In 2012, more than $70 billion worth of drugs will lose their patents. Singulair, Viagra and Plavix, the Sanofi-Aventis (NYSE:SNY) and Bristol-Myers Squibb (NYSE:BMY) joint effort, are just a few of the major drugs losing patent protection. With innovation stalling at many of the large pharma companies, these patent cliffs are certainly a cause for major concern. However, the majors aren't just sitting on their laurels. Many have already made moves to build up their generic drug operations and are currently looking to another high-tech drug sector to power their pipelines - and it might just be profitable for investors too.

Rare Diseases and Biotech
Studies suggest that by 2014, biotech drugs will account for almost 50% of the top 100 drugs. This compares to just 28% in 2008 and only 11% in 2000. Big pharma has been taking notice of biotech's potential. With a price tag of more than $200,000 a year, Genzyme's (Nasdaq:GENZ) Gaucher disease treatment Cerezyme is one of the most expensive drugs in the world. This drug alone produced $1.2 billion in 2009 sales, and is one of the reasons why it's being actively courted by Sanofi-Aventis. Roche's recent purchase of Genentech and Bristol-Myers Squibb's purchase of Medarex's cancer drug portfolio are just a few more examples of the growing trend in biotech M&A. (For background reading, see Cashing In On Corporate Restructuring.)

With analyst's calling for the "Age of the Blockbuster" to be over, Big Pharma must reposition itself. By focusing on rare diseases and antibodies, the pharmaceutical industry is transforming its drug pipelines and ultimately paving the way for their survival.

Adding Those Antibodies
Overall, biotech investing is like buying a lotto ticket. Generally, companies within the sector are small labs with just one drug under their belts. Their stock prices rise and fall with each round of FDA testing. While investing in early-stage biotechs can certainly be rewarding, adding that amount of risk in the current market environment may not be warranted. In addition, major pharmaceuticals have been choosing companies with well-established pipelines as M&A targets. Investors wanting to play the sector should either bet on the big boys or take a diversified approach.

Both Celgene (Nasdaq:CELG) and Biogen (Nasdaq:BIIB) could be the kind of targets that big pharma is looking for. Celgene has an amazing oncology portfolio generating $2.6 billion in sales and Biogen's multiple sclerosis drug Tysabri is a hit. Both have solid drug pipelines and would make good acquisition targets.

For investors wanting a diversified approach to the sector, SPDR S&P Biotech (NYSE:XBI) and iShares Nasdaq Biotechnology (NYSE:IBB) are two of the largest and most liquid ETFs. The SPDR fund follows 33 different holdings and is more of a "pure" biotech play. The iShares fund follows 128 stocks and includes some biotech equipment suppliers such as Affymetrix (Nasdaq:AFFX). Both include Genzyme in their top holdings and will benefit if there is a bidding war for the company.

For investors who want a play on the acquirers' side, the SPDR S&P Pharmaceuticals (NYSE:XPH) offers a way to add that sector.

Bottom Line
As the world's population grows, so will the need for new healthcare solutions. Big Pharma faces serious problems with regard to its patent cliff, and is seeking to reinvent itself through acquisitions. The biotech space offers a way for Big Pharma to increase its drug pipelines. Savvy investors may want to look for a way to participate in that growth. (To learn more, see The Ups And Downs Of Biotechnology.)

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