The prospect of generic versions of expensive biologic drugs, as outlined in U.S. President Barack Obama's proposed budget Thursday, is seen as inevitable, but it faces a long, tough road to realization.

Biologic drugs are made by culturing specially engineered organisms and no pathway for generic version exists in the U.S., but such legislation has been expected to be in Obama's agenda. If such a law is passed, the producers of these complex generics will likely face tough regulatory scrutiny, as well as high development and marketing costs. Furthermore, many prominent biotech drugs will remain under patent protection for a number of years.

"While we believe biosimilars are inevitable, the proposal did not contain any new details on the path forward," Oppenheimer analyst Bret Holley said in a note to clients. Like many, the firm expects legislation to pass later this year.

Regardless, the very notion that these drugs could face competition spooked investors Thursday. Amgen Inc. (AMGN) dropped 9.4%, Biogen Idec Inc. (BIIB) fell 5.7%, Celgene Corp. (CELG) lost 5.1% and Genzyme Corp. (GENZ) dropped 6.4%.

Christopher Raymond, an analyst with Robert Baird & Co., believes the market's reaction was overblown. Furthermore, he says the included proposals aren't exceptionally harsh, and they could be altered as the budget weaves its way through congressional approval.

 
   Tougher Road

Under current law, generic drug makers can receive approval of copycat small-molecule drugs, like cholesterol-fighting statins, after their five years of exclusivity expire. The administration's budget says it will seek exclusivity for generic biologics that is "generally consistent" with that limit.

Following the passage of legislation, the Food and Drug Administration will likely determine the approval process for biologic drugs and may do so on a case-by-case basis.

Because of their complexity, many drugs may be "biosimilars" approved for the same uses but having their own brand name and not be automatically substitutable for the original, as happens with small-molecule generics.

In applying for approval, small-molecule generics show they have the same active ingredient and the same action as the brand-name version, which allows them to depend on the original clinical trials and avoid having to pay for new ones.

But biologics are large proteins that are sometimes thousands of times bigger than small-molecule drugs. Their manufacturing makes them sensitive to minor changes in the process, potentially altering their complicated structures and even how they work in the body.

The FDA has shown it is sensitive to the issue and last year decided that a version of Genzyme's Myozyme produced on a larger scale had slight differences and had to be reviewed as a separate product with clinical data. The larger-scale product will be called Lumizyme, and Genzyme expects an FDA decision on its approval as soon as Friday.

If generic biologics have their own brands, then pharmacists won't be able to substitute them for the original, which means that generic companies will be forced to market their version of the drugs to physicians. Small-molecule drugs typically see generic substitution as high as 90%, a level not expected with branded generic biologics.

 
   A Different Market

The cost of the marketing, and clinical trials to get approval, would make the industry drastically different than that for small-molecule drugs.

Cowen & Co. analysts that cover the biotech and generic drug industry estimate that 2007 revenue from major biologic revenue totaled about $25 billion. If all those products were made generic, at a 30% to 50% price discount, the total generic market would be $12 billion to $14 billion.

But with the lack of substitution, the firm only sees generic penetration of 20% to 50%, which means that total revenue would be $3 billion to $7 billion.

Aside from this, many drugs still have patent protection and won't be open to competition unless that expires or is successfully challenged in court by a generic drug, as is the small-molecule model.

Some biologics face patent expiration in coming years, including Biogen's multiple sclerosis drug Avonex, and Amgen and Wyeth's (WYE) Enbrel for arthritis and psoriasis. But the story is different for others: the patents on Genentech Inc.'s (DNA) cancer blockbuster Avastin don't begin expiring until 2017 and Amgen's Aranesp anemia treatment is protected until 2024.

These multiple barriers to entry to sell generic biologics would likely limit the number of participants.

Last week, Teva Pharmaceutical Industries Ltd. (TEVA) Chief Executive Shlomo Yanai estimated that producing a generic small-molecule drug costs about $5 million to $10 million, while developing a generic biologic will likely cost $100 million to $150 million. Building the plants to produce such drugs will cost $300 million to $400 million, he estimated.

"Generic biologics will only be for a few players," he said at a meeting in New York. Teva is making a push into making such drugs, but Yanai estimated that "only two or three" other companies will likely pursue such a route.

The high cost means that entrants may actually come from within the drug making industry itself, because the larger companies have the necessary cash, the relevant marketing experience, and/or already possess the technological capabilities.

In December, Merck & Co. (MRK) established a division to develop generic biologics and devoted $1.5 billion in research and development spending for the unit by 2015. Novartis AG's (NVS) generic unit Sandoz is expected to enter the market as well because of its parent company's technology and manufacturing capabilities.

-By Thomas Gryta; Dow Jones Newswires; 201-938-2053; thomas.gryta@dowjones.com