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.

IN PICTURES: 8 Great Companies With Top-Notch Healthcare Benefits

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.)

Use the Investopedia Stock Simulator to trade the stocks mentioned in this stock analysis, risk free!

Related Articles
  1. Stock Analysis

    3 Resilient Oil Stocks for a Down Market

    Stuck on oil? Take a look at these six stocks—three that present risk vs. three that offer some resiliency.
  2. Economics

    Keep an Eye on These Emerging Economies

    Emerging markets have been hammered lately, but these three countries (and their large and young populations) are worth monitoring.
  3. Stock Analysis

    Is Pepsi (PEP) Still a Safe Bet?

    PepsiCo has long been known as one of the most resilient stocks throughout the broader market. Is this still the case today?
  4. Investing

    The ABCs of Bond ETF Distributions

    How do bond exchange traded fund (ETF) distributions work? It’s a question I get a lot. First, let’s explain what we mean by distributions.
  5. Investing Basics

    Top Tips for Diversifying with Exotic Currencies

    Is there an opportunity in exotic currencies right now, or are you safer sticking to the major ones?
  6. Mutual Funds & ETFs

    The 3 Biggest Mutual Fund Companies in the US

    Compare and contrast the rise of America's big three institutional asset managers: BlackRock Funds, The Vanguard Group and State Street Global Advisors.
  7. Stock Analysis

    3 Stocks that Are Top Bets for Retirement

    These three stocks are resilient, fundamentally sound and also pay generous dividends.
  8. Professionals

    5 Top-Rated Funds for Your Retirement Portfolio

    Mutual funds are a good choice for emotional investors. Here are five popular funds to consider.
  9. Investing News

    Are Stocks Cheap Now? Nope. And Here's Why

    Are stocks cheap right now? Be wary of those who are telling you what you want to hear. Here's why.
  10. Investing News

    4 Value Stocks Worth Your Immediate Attention

    Here are four stocks that offer good value and will likely outperform the majority of stocks throughout the broader market over the next several years.
  1. Can mutual funds invest in IPOs?

    Mutual funds can invest in initial public offerings (IPOS). However, most mutual funds have bylaws that prevent them from ... Read Full Answer >>
  2. How do dividends affect retained earnings?

    When a company issues a cash dividend to its shareholders, the retained earnings listed on the balance sheet are reduced ... Read Full Answer >>
  3. What is the difference between called-up share capital and paid-up share capital?

    The difference between called-up share capital and paid-up share capital is investors have already paid in full for paid-up ... Read Full Answer >>
  4. Why would a corporation issue convertible bonds?

    A convertible bond represents a hybrid security that has bond and equity features; this type of bond allows the conversion ... Read Full Answer >>
  5. Does index trading increase market vulnerability?

    The rise of index trading may increase the overall vulnerability of the stock market due to increased correlations between ... Read Full Answer >>
  6. What does a high turnover ratio signify for an investment fund?

    If an investment fund has a high turnover ratio, it indicates it replaces most or all of its holdings over a one-year period. ... Read Full Answer >>

You May Also Like

Trading Center
You are using adblocking software

Want access to all of Investopedia? Add us to your “whitelist”
so you'll never miss a feature!