After witnessing delays in approval, Pfizer's (PFE) much anticipated drug Xeljanz (tofacitinib) has finally managed to receive the U.S. Food and Drug Administration approval for rheumatoid arthritis (RA). Tofacitinib will be used to treat patients who do not respond to other standard oral treatments.

The approval will help douse recent concerns about the pharmaceutical's pipeline of drugs, which of late has faced several setbacks. While Pfizer must be much relieved with the approval, Abbott Labs (ABT) will have to brace itself for the competition ahead.

We currently have a $26 price estimate for Pfizer and $67 price estimate for Abbott, 5% above their respective current market prices. We are in the process of revising our price estimates to reflect their earnings.

Drugs like tofacitinib hold the key for Pfizer's future growth as the company has been grappling with the issue of patent cliff and has seen its sales slump in the last couple of quarters. Lipitor, which generated close to $10 billion in 2011, has lost more than half of its sales in a relatively short time frame. The looming patent expiration for Enbrel and Detrol, among others, in 2012 will also hurt revenues.

The RA drug market is expected to clock close to $20 billion in sales. And about 30-40% of RA patients do not respond to current treatments, which opens a significant opportunity for the drug. Tofacitinib will cost about $2,000 for 30 day dosage. One can gauge the revenue potential as about 1.5 million people in the U.S. alone suffer from RA.

While many have pegged the peak sales of tofacitinib in the range of $2 billion-$3 billion a year, the figure could be much higher because the drug is targeting other autoimmune diseases as well. Recently, the drug was proven to be effective for the treatment of Ulcerative Colitis (UC) in phase II clinical trials. The company will soon begin phase III studies to verify the drug's efficacy and safety in UC patients, and it plans to test higher doses of the drug. (Read Pfizer May Extract More From Tofacitinib, Drug Further Delayed)

What it could mean for Abbott?

Abbott is the market leader in the RA segment with its blockbuster drug Humira, one of the world's largest selling drugs, and is likely to face competition from tofacitinib. Humira is injected in the body, whereas tofacitinib has the advantage of being an oral pill. For the same reason, we expect Humira's growth to slow going forward, as can be seen from the trend-chart below. Humira has enjoyed double digit growth till the recent past.

However, we don't see tofacitinib to present a significant challenge in the near term because it may be difficult to change a physician's prescription habits for biologics. Further, Pfizer had earlier expected tofacitinib to be mostly used in patients who failed major RA treatments such as Abbott's Humira and Johnson & Johnson's (JNJ) Simponi. In addition, we believe there is no major cost advantage of tofacitinib over Humira.

Further, to take on Pfizer's tofacitinib, Abbott has struck a deal with Galapagos to develop and commercialize an oral JAK1 inhibitor in Phase II development. The collaboration will give Abbott a channel to fend off new entrants and help retain its market leading position in autoimmune market.