Healthcare Companies Report Growth, Surge of M&A Deals

Thursday, drug maker Bristol-Myers Squibb Co. (BMY) reported a 29% jump while Madison, N.J.-based Wyeth (WYE), the world's No. 12 pharmaceutical reported 13% profit gains better than expected second-quarter earnings, helped by cost cuts and rising sales of top products. Both companies faced headwinds from unfavorable currency-exchange rates, the weak economy and competition from cheaper generic drugs. But, like some other drug makers this week, Wyeth and Bristol reported higher-than-expected earnings and boosted their financial forecasts for the year.

Wyeth manufacturers the children's vaccine Prevnar and antidepressant Effexor also hiked its 2009 profit forecast. It was also announced that Wyeth, the world's No. 12 pharmaceutical company by sales, is being bought by No. 1 drugmaker Pfizer Inc. (PFE) this fall for $68 billion -- the industry's biggest acquisition this year. Wyeth said its net income amounted to $1.27 billion, or 94 cents per share. That's up from $1.12 billion, or 83 cents a share, a year earlier.

Separately building on its great earning news, Bristol-Myers Squibb Co. also announced it had agreed to buy partner Medarex Inc. (MEDX) in a $2.1 billion deal that will give the drug giant access to a promising cancer treatment.

In the terms of the deal, Bristol-Myers will pay $16 in cash for each share of Medarex, for a total of roughly $2.4 billion. After adjusting for the roughly $300 million on Medarex’s books, the deal value comes to $2.1 billion. The purchase price, which has been agreed on by the boards of both companies, represents a premium of more than 90% to Medarex’s closing price on Wednesday of $8.40.

The deal comes as Bristol-Myers pursues a strategy of shedding non-pharmaceutical assets, like wound-care and medical-imaging units, and using the proceeds and its cash hoard to build out its pipeline and product portfolio. In particular, New York-based Bristol-Myers hopes to expand its portfolio of biotechnology therapies and specialty drugs, a goal it says Medarex can help it achieve.

The effort comes as Bristol-Myers strategizes for the loss of patent protection on one of its big sellers, the blood-thinner Plavix. The drug loses patent protection next decade and already is meeting with new competition.

Earlier this month, the U.S. Food and Drug Administration approved Effient, also a blood thinner. The drug is made by Japan’s Daiichi Sankyo Co. (4568.TO) and Indianapolis-based Eli Lilly & Co. (LLY), which beat out Bristol-Myers when it attempted to buy ImClone Systems Inc. last year.

In buying Princeton, N.J.-based Medarex, Bristol-Myers will be acquiring the treatment ipilimumab, an immunotherapy currently in Phase III development. The drug is intended to treat metastatic melanoma, a form of skin cancer. The drug, which is also being tested in treating lung and prostate cancer, is being jointly developed by the two companies. Bristol-Myers plans to open a tender offer for Medarex’s shares on or around next Monday. The deal is expected to close 30 days later, pending regulatory approval.

Currently, the Obama administration is wrestling with its universal healthcare plan, which promises to impose a new suite of rules and restrictions on the industry’s players. Already, the U.S. pharmaceutical industry has been coerced into offering $80 billion in cost reductions over the next ten years. They may also be forced to compete with generic imports, which would effectively put a cap on domestic drug prices.

Despite all its risks and drawbacks, though, healthcare is still a very good business. Aside from helping people and saving lives (no small feat), there are notable benefits to being part of the industry as healthcare is a quintessential defensive sector. People still get sick during recessions and they will often continue paying for medicine and treatment even when they cut back on other things.

While profits for the S&P 500 have dropped roughly 30% in the past quarter, healthcare earnings have barely moved. Not bad for the worst recession in sixty years. Additionally, the same regulations that sometimes threaten the industry’s global competitiveness often serve as a barrier to entry and an impediment to potential competitors. Blockbuster drugs have historically provided a consistent earnings flow throughout the entire twenty-year lives of their patents.

U.S. healthcare expenditures are massive, consuming roughly 16% of the country’s economic output. The Obama administration seems set on mandating universal healthcare, which will extend health coverage to the 48 million Americans that are currently excluded. That effectively means 48 million new customers and a host of other benefits (along with its costs).

Additionally, although frightening from a fiscal point of view, America’s aging population of 98 million retiring baby-boomers may provide an additional engine for industry growth. Demand for healthcare is tremendously robust and will only continue to grow as the baby boomers age. While it’s easy to be cynical about the industry’s prospects in the face of product recalls and pending regulatory reform, the advantages in the healthcare sector are significant.

Medical Imaging Diagnostics Consolidations Look Promising

The commercial medical and diagnostic laboratory industry in the US consists of about 5,000 companies with combined annual revenue of $3 billion. Major companies include Quest Diagnostics (DGX) and Laboratory Corporation (LH) in the medical lab segment, and Alliance Imaging (AIQ) and RadNet (RDNT) in the imaging segment. Note that RadNet just closed a $2.1M acquisition of Medical Resources, NJ and it announced the sale of one clinic to Tristate Imaging for $650,000. The industry is fairly fragmented: the 50 largest companies hold just over 40% of the market. Medical labs account for about two-thirds of industry revenue; imaging centers account for one-third.

Competitive Landscape

Demand is linked to the number of people receiving medical treatment. The profitability of individual companies depends on efficient operations and good marketing. For example, there are large economies of scale in the operation of medical labs, which can receive samples from a wide geographical area. Small medical labs can compete effectively by providing specialized analyses, or by serving geographical regions with few medical facilities. Imaging centers don't have similar economies of scale because they must be located close to patients, so small firms can compete effectively with large ones in a particular area. The industry is fairly labor-intensive: annual revenue per worker is $140,000.

Products, Operations and Technology

Medical labs (often called "clinical labs") receive specimens of body fluids (most often blood) or tissues collected from patients, and perform a wide variety of tests to determine the presence and amount of various bio-chemicals to help doctors diagnose and treat medical conditions. Laboratory Corporation offers about 4,000 different tests.

A study released by the Milliken Institute found that 109 million Americans suffered from one or more of the most common, chronic diseases, including cancer, diabetes, heart disease, pulmonary conditions, mental disorders, stroke or hypertension. This means that more than one-third of all Americans have these conditions to one degree or another. The study estimated that one year's cost of treatment of these conditions at $277 billion, but estimated lost economic productivity to be vastly higher at $1 trillion. In other words, lost work and lost output due to these illnesses is reducing the nation's GDP by about 10%. These burdens could be vastly reduced through better consumer practices and better preventative medicine. For example, obesity, lack of exercise and cigarette smoking are immense contributors to these diseases. The U.S. Surgeon General estimates that obesity alone results in 300,000 American deaths and $117 billion in health care costs each year.

Conclusion

The healthcare sector in the U.S. over the next 18-months should be transformed, stimulating further M&A activity with budget pressures driving political policy and cost effective medical solutions. The healthcare sector as a whole will see growth of 7% or more annually for the next 10-years particularly within the fragmented medical diagnostic lab sector, digital medical records technologies and medical imaging niche markets that are ripe for M&A activity.

Disclosure: The Author is the CEO of SVS and enjoys participating as a contributor with diverse private TRUST holdings in global investment sectors.