High barriers to entry and high pricing levels of drugs that treat orphan diseases will continue to drive acquisition activity in the pharmaceutical sector, according to Moody's Investors Service in the report High Hurdles and High Prices Make Orphan Drugs Appealing M&A Targets.

Orphan diseases are rare, serious conditions that affect fewer than 200,000 patients who require treatment for life at a cost that can exceed $500,000 per year. To encourage pharmaceutical companies to produce treatments for these diseases, the regulatory environment for orphan drugs is very favorable, with longer exclusivity periods from generic competition than those for more widespread diseases.

"Nearly half of the recent M&A activity in the pharmaceutical sector has been for deals involving orphan drugs," said Michael Levesque, Moody's senior vice president. "Favorable credit characteristics of pharmaceutical companies that produce orphan drugs include high barriers to entry and the life-threatening nature of orphan diseases that require patients to stay on therapy for life."

Companies with experience in orphan diseases include the Genzyme division of Sanofi, the Baxalta division of Baxter International and Horizon Pharma.

The high barriers to entry significantly reduce competitive pressures for orphan drugs. In the U.S., a drug that has been granted orphan status has an exclusivity period of seven years, while in Europe and Japan, the period lasts 10 years.

Patents also protect orphan drugs from competitive threat and often extend protection beyond the expiration of the exclusivity period. In addition, it is very difficult for a competitor looking to enter the space to find patients to enroll in a clinical trial, as the small number of people with the disease already take the approved drug.

Further, many orphan drugs also are biotechnology products, which have significantly higher hurdles for generics compared to traditional products because of their manufacturing complexity.

Despite high barriers to entry and high prices, companies making orphan disease products still have certain credit risks that are typical of other pharmaceutical companies. These include highly regulated manufacturing processes that can face supply disruption if there are quality problems, and high product concentration risk for some companies.