Richard Lloyd

Last week we published an interview with Kyle Bass, the hedge fund investor who together with Erich Spangenberg, has petitioned to challenge a series of pharmaceutical patents through the inter partes review (IPR) process at the Patent Trial and Appeal Board (PTAB). Because of SEC rules, Bass was unable to talk in much detail about his investment strategy - although it was pretty clear that his plans are a lot more sophisticated than simply shorting the stocks of the pharma companies that he has been challenging.

In this guest blog, Zachary Silbersher of Markman Advisors, looks more closely at Bass’s IPR filings and gives his own thoughts on how he might be profiting (Silbersher’s colleagues Gaston Kroub and Sergey Kolmykov also contributed to the article). As Silbersher suggests, Bass’s strategy might be targeting the pharmaceutical sector as a whole, not just the companies he has filed reviews against. Here’s what he has to say:

Hedge fund owner Kyle Bass has made waves throughout the pharmaceutical industry since February, when entities associated with his Hayman Capital began filing IPR petitions with the US Patent and Trademark Office (USPTO). Each petition seeks to invalidate pharmaceutical patents purportedly used by drug companies to protect their valuable drug revenue. To date, Bass has filed approximately 16 IPR petitions challenging 12 patents owned by eight brand pharmaceutical companies. 

This assault on Big Pharma has not gone unnoticed. Pharma companies that have already landed within Bass’s sights include Celgene, Shire and Jazz Pharmaceuticals. They are doing their best to fight back in the USPTO, Congress and in the court of public opinion. Other potential targets within the pharmaceutical industry are scrambling to figure out not only what Bass is doing, but what an IPR actually is. Notably, one of the keynote addresses at Cantor Fitzgerald’s Healthcare conference this year was directed to “Making Sense of IPR proceedings”.

While Bass’s filings have been hard to miss, his underlying investment strategy remains a mystery. There has been much speculation, but few concrete answers. In a letter to Congress in April 2015, Bass put some broad brushstrokes on his strategy. He “intend[s] to challenge less than 1% of the existed branded drug universe”; his cause, he claimed, is to “police the abusive patent tactics used by the worst offending drug companies”: a worthwhile social cause to pursue,  perhaps, but hardly an illumination of how Bass intends to use his novel IPR strategy to boost returns for his investors.

Rumours originally circulated that Bass had no intention to see the IPRs through, but was angling to take payouts from the targeted companies to drop the petitions that he filed. Celgene has claimed that one of the entities behind the IPRs against its patents “previously threatened to file IPRs against the challenged patents unless Celgene met their demands”. For rather technical patent law reasons, Bass’s IPR petitions contain numerous persons and entities identified as being behind them. However, it is unclear which entity Celgene was referring to, what the demands were or whether or not that entity was affiliated with Bass when the demands were allegedly made. 

More tellingly, in April, Bass told Congress that: “Hayman will NOT accept settlement payments in order to drop our challenges.” (That emphasis on the word “not” is his own.) He continued: “[W]e are filing merit-based IPRs at the USPTO with the full expectation of seeing the challenge through to a final decision by the PTAB.”  Unless he is lying to Congress, that statement basically quells any suspicions that Bass’s strategy is to use IPRs just to shakedown drug companies. 

The more popular theory is that Bass is shorting the companies he is attacking. The Wall Street Journal reported that Bass is using his IPRs to “bet against, or short, the shares of companies whose patents Mr. Bass believed to be specious”. Dan Ravicher has perceptively observed that for most of the companies hit by Bass, their share prices are not suffering, which has forced some investors to question Bass’ short strategy.

An IPR petition, however, takes 18 months to complete. It will be more than a year before any of the challenged patents are invalidated. Bass may not have put on any short trades yet, but is waiting until institution or even final decisions of invalidity by the before taking positions. But even in that case, a closer look at the IPRs actually filed by Bass suggests that his alleged strategy of short-selling the companies he is attacking may be overstated.

A brand pharmaceutical company will typically list the patents covering a drug in an FDA-maintained database called the Orange Book. While brand pharmaceutical companies typically list numerous Orange Book patents covering a drug, the company only needs one valid patent to keep out generic competition. What that means is for Bass to short a pharmaceutical company by invalidating its patents, he presumably needs to take away the company’s chances of extending the drug’s exclusivity through its patents. But to do that, he needs to invalidate all the patents listed in the Orange Book covering that particular drug.

But Bass does not appear to be doing that. In most cases, he has yet to attack each of the Orange Book listed patents covering the drugs he has targeted. For instance, Bass attacked two of the Orange Book patents covering Acorda’s Ampyra drug, but the drug is covered by five patents. He attacked two of Horizon’s patents covering Vimovo, but the drug is covered by 11 patents. He attacked one of Jazz Pharmaceutical’s patents covering Xyrem, but the drug is covered by 15 patents in the Orange Book. He attacked six of the Orange Book patents covering Celgene’s blockbuster Revlimid, but the drug has over 20 patents listed in the Orange Book protecting it. Bass cannot bring these companies to their knees, and rob them of years of exclusivity pricing, by attacking only some of the patents listed in the Orange Book. He has to attack them all. But to date, he hasn’t done that.

Perhaps most telling is the type of patents Bass is attacking. Not all patents are equal. Pharmaceutical patents generally fall into a few categories: compound, method of use, dosage, formulation and REMS. Compound patents are typically the strongest (meaning the hardest to invalidate), but they are also typically the first to expire, and therefore less valuable for extending the exclusive life of a drug. By contrast, method of use, dosage and formulation patents are typically weaker. But because they will expire later than compound patents, they can be critical to extended exclusivity. REMS patents cover restricted distribution programmes to avoid selling drugs with harmful side effects to those most vulnerable, such as pregnant women. They typically have little to do with the drug itself and patent lawyers generally view them as especially weak.

Bass has primarily avoided attacking compound patents. He has attacked one of Celgene’s REMS patents covering Revlimid with four separate petitions. But the market is aware that Celgene’s REMS patents are not its Achilles heel. Rather, there are a handful of polymorph patents expiring in roughly 2025 that are viewed as more important to extending Revlimid’s exclusivity. In the pending Hatch-Waxman litigation against Natco, the REMS patents are a side-show - not one of them was even addressed during the Markman hearing. If Bass was really intent on teeing up Celgene for a short by attacking Revlimid’s patents, he appears to have chosen the wrong ones.

Similarly, Bass attacked only one of the patents covering Jazz Pharmaceutical’s Xyrem drug, but the patent he attacked is a REMS patent. This patent will expire in roughly 2022. But Jazz has other method of use patents that will expire much later. It’s unlikely that Jazz views the REMS patent attacked by Bass as critical to extending the exclusivity of Xyrem.

Indeed, out of the 16 IPR petitions Bass has filed, six of them relate to a REMS patent. In other words, he is not going for the jugular in terms of being able to pave the way for earlier generic entry against his targets. From a patent perspective, REMS patents are generally much weaker than method of use or dosage patents. Most patent practitioners recognise these patents may all amount to invalid business method patents under a 2014 decision from the Supreme Court. But that may hint at Bass’s strategy. Even if these patents create little vulnerability for the drug companies themselves, Bass’s chances of invalidating these patents are much higher. This supports the thesis that Bass’s early strategy may be to aim for a high batting average in invalidating patents he has attacked, rather than setting up shorts of the companies targeted.

Tellingly, even apart from the REMS patents, most of the other patents Bass attacked don’t appear that strong to begin with. He mostly attacked patents covering dosages or formulations of otherwise known pharmaceutical compounds. Biogen’s patent covering many years of exclusivity for its blockbuster Tecfidera for treatment of MS is not directed to the compound itself, but simply to administering 480 mg of the drug per day. Horizon’s Vimovo patent that was attacked doesn’t cover the compounds naproxen or esomeprazole that treat arthritis and other pain, but just administering them to patients at 200 mg and 5 mg, respectively. Pharmacyclic’s Imbruvica patent doesn’t actually cover the ibrutinib compound used to treat mantle cell lymphoma, but instead it simply covers dosing it once a day between 420 and 840 mg. Acorda’s patent covering its Ampyra drug for treatment of MS does not actually claim the active pharmaceutical ingredient 4-aminopyridine, but simply the sustained release of that drug using methods that may have been known for a long time. For instance, Acorda’s patent claims a homogenously dispersed matrix or controlling polymer to sustain the release of the drug. Even though the patent was filed 2011, matrices and controlling polymers for sustained release have been used for decades.

Bass appears to have teed up patents that are easy to pick off. He has avoided compound patents and focused instead on dosage, formulation and REMS patents. More than anything else, this suggest that Bass aims to establish, through his early IPR challenges, that there are a lot of bad pharma patents.

Yet, there is more to the data than just the patents Bass has challenged. Another important factor is the prices of the drugs attacked. Hayman Capital is using vehicles to bring the IPR petitions that are aptly named the Coalition for Affordable Drug Prices. That name, perhaps, says it all. The drugs that Bass has attacked are not cheap. Pharmacyclics’ Imbruvica is over $100,00 a year. Celgene’s Revlimid is over $10,000 per month. Biogen’s Tecfidera is over $55,000 a year. Acorda’s Ampyra is over $12,000 a year. Attacking bad patents, which are propping up high-priced drugs, may therefore be another component of Bass’s long-term strategy.

Overall, divining Bass’s strategy is speculation. But the data hints it may comprise more than just shorting the specific companies he has attacked. Here are some possibilities:

  • One thesis is that we are witnessing the early stages of Bass’ strategy. Right now, he wants to hit a high batting average in invalidating patents. The ultimate goal is to raise money from investors that will help fund later, and perhaps more serious, IPR challenges that can knock out all the Orange Book listed patents for a particular drug, thus setting up veritable shorts of particular companies. This strategy might be coupled with going long on generics that will benefit from brands losing exclusivity. IAM previously reported after speaking with Bass that “Bass sees a range of short-term and long-term opportunities” and speculated that these may include “investing in generic companies that might benefit from certain patents being rubbed out and innovative companies with strong IP and interesting pipelines”.
  • Another thesis is that Bass is going to short a large basket of pharmaceutical companies. But instead of sinking their share price by knocking out their Orange Book listed patents, he will target companies that are culpable of high-drug prices, but simultaneously relying upon dosage, formulation, REMS and other weak patents to extend their exclusivity pricing. This way, he can target more companies than just the ones he hits with IPRs. Any brand companies that fit the mould—high drug prices combined with weak patents—can be shorted, even if no IPR petitions are filed.
  • A final thesis is that Bass is going big. The “short” being set up is the entire brand pharmaceutical industry. He is going to short the entire sector. And the thesis is simple: drug prices are getting higher, meanwhile brand pharma is gouging the sick by stretching out their monopoly pricing based on weak, obvious and invalid patents. Bass’ proof will be in the pudding. He targeted a small sampling of high-priced drugs, filed IPR petitions against the patents, and successfully invalidated most of them. If Bass can show that his small sampling is infected, then what will that say about the $450 billion brand pharmaceutical industry as a whole?

Right now, any conclusions about Bass’ ultimate investment strategy remains speculation, but the data suggests his plans may be much more interesting than initially suspected.