Health Care Trends Part 2: M&A, Generic Competition, CROs

If you have not read part one of this three part article, please find the link here.

As I have already highlighted, the health care industry is subject to many swings that are caused by macroeconomic variables, regulation, trends, and beliefs. These changes can be hard to pick up on, especially if you are new to the health care industry or if you are not as familiar with it as with more experienced investors. In the first part of this article, I explained how the Obama Administration and the FDA are shaping the environment for health care companies. It is very important to understand the relationship between companies and their stakeholders and the major forces in the industry in order to properly evaluate a health care company.

Major M&A Activity

Recently, there has been some major consolidation within the industry as companies are positioning themselves to swallow major patent expirations and unfavorable economic climates. Within the past year, Pfizer (PFE) and Wyeth (WYE), Merck (MRK) and Shering-Plough (SGP), Gilead Sciences (GILD) and CV Therapeutics (CVTX), Teva (TEVA) and Barr, and J&J (JNJ) and several smaller companies have already partnered up to weather the storms. The first half of 2008 was stagnant with M&A activity, but throughout the second half of 2008 and the first half of 2009, Big Pharma and Biotech companies have been taking advantage of attractive prices created as a result of the recession. With $150 billion worth of drugs coming off patent protection by 2016, companies are looking to beef up their pipelines to prevent a shrinkage in revenue.

I speculate that most of the big biotech and pharmaceutical companies will complete at least one acquisition when their cash position increases to combat this hardship. Over the next few years, M&A activity will pepper the industry making smaller, flourishing companies attractive targets. Much of a company’s valuation is based upon its ability to replenish the pipeline with successful drugs, and as we move forward, large companies with a strong cash balance and smaller companies with blossoming pipelines will be companies to keep an eye on as far as branded pharmaceutical drug manufacturing goes.

Generic Competition

One man’s loss is another man’s opportunity. The companies that will profit most from the $150 billion in patent expirations by 2016 will be the generic drug manufacturers like Teva, Watson (WPI) and Mylan (MYL). U.S. drug patents last 17 years, and after expiration, generic companies compete to be the first to file for an Abreviated New Drug Application (ANDA), which gives manufacturers a 180-day period of exclusivity to market the drug. Being the first to file an ANDA can make or break some companies since much of the market share is determined by that 180-day period. A lot of the revenue generated by brand drugs will be shifted to generic manufactures as there will be a generic drug for most major brand drugs within the next seven years.

I am very bullish on the generic drug industry because it also complies with Obama’s health care plan. Since health care insurance companies, pharmaceutical distributors, pharmacy benefit managers, and pharmacies all benefit from people switching to generic drugs, they will be the companies to focus on as we close in on 2016. And if you don’t already know, generic drugs have the exact same Active Pharmaceutical Ingredient (API) as their branded counterparts, they just use different fillers.

Contract Research Organizations ((CRO))

Oftentimes, Biotech and Pharmaceutical companies use the help of CROs to aid in the research and development of certain products. The implementation of CROs in the development process allows companies to get an added expertise in a certain field while lowering costs. Furthermore, CROs have historically reduced the amount of time that drugs are tested in clinical trials by roughly 30%. However, more recently, CROs have been overlooked by Big Pharma and Biotech as they choose to use the cash on hand to complete acquisitions after stocks were beaten down in the last quarter of trading in 2008. As M&A settles down in the drug industry and when companies focus on expanding their pipeline organically, look for CROs like Covance (CVD) and Icon (ICON) to succeed in that atmosphere.

By now, you should be getting a quick understanding of what is shaping the current and future environment in the industry. Many investors shovel money into health care companies even if they do not know what factors influence the company’s performance. This mistake is prevalent now more than ever since it is typically thought that health care companies are recession-proof. This is not the case for many companies within the health care industry. In my next and last article on the subject, I will be briefly finishing off the rest of the major trends and forces that have a significant impact on the operations and outcomes of health care companies that some investors may overlook when they invest in a company.

Part three of this article will be released on June 7th.

Disclosures: The Fund the Author is associated with is currently long TEVA and GILD

Comments

[retiredpharma:]

IT is already heavily employed in the docs office. I saw this in Maryland prior to retiring in 2007 and I see it now in Delaware where I currently reside. My new GP office has laptops carried by each doc which they go from room to room every 7-10 mins.

It is an assembly line practice. Billing, Insurance is all integrated!

Every bit of patient info is at their fingertips. My labs,meds, history,personals, etc is there. They can send my RX electronically to whatever Pharmacy I elect and I do not carry out a script anymore. This type of IT is becoming the RULE more and more, faster and faster especially in groups as an economy of scale intervention in a Managed Care World. To think that Obamacare is going to extract much more from this already improved model is ludicrous! They will never pay for it w/ IT improvements because IT is already there! Utilized by most every Mid-Atlantic practice and I retired in 2007 from this Industry!

Unless the rest of the country is so far behind and I doubt it,they better come up w/ another Intervention to cover the $2500/savings they promised!

What we need is more Ted Kennedies going to Duke for Brain Ca tmx paid for by US taxpayors instead of using the Massachussetts Single Payor system he championed!

Jun 07 10:04 AM

[Prudent Man...:]

The VA has automated, though not up-to-date as they do employ bureaucrats, for a decade.

When the government socializes the system and de-incentives it, it will degenerate. Why go to school for twenty years, work for meager pay during your internships to get a GS 10? We will all get a lot of poor quality health care while the Administration and Congress get the cream of the crop. Let them eat cake!

Jun 07 12:24 PM

[bbowen7:]

Retired Pharma - you may be an expert in medicine, but you don't know much about politics. Nobody believes that we can add 50 million folks to the rolls without adding trillions to the deficits already projected. But a big majority wants to do it anyway, so there has to be a fig leaf.

Jun 07 03:38 PM

[svygear:]

I just wanted to add some value-added info to this comment board as well.

A solid up-and-coming pharmaceutical play is Access Pharmaceuticals (ACCP), whose most recent press release can be viewed at pitch.pe/14217

Just wanted to add that they have a new Thiarabine-clofarabine combination study which has proven to be some pretty revolutionary and interesting stuff..... might wanna check it out

Jun 08 03:50 PM