Healthcare Profits: Assessing Company Sensitivity to Obamacare

National healthcare wherever it is implemented squeezes prices and profits of the private businesses involved in the system.

Obamacare in the U.S. will be no different. For investors in healthcare companies, it is a good idea to begin to think through which companies will be most severely negatively impacted or least impacted, to potentially make deletions or substitutions.

One dimension of healthcare companies is research and development, which has been an important driver of future growth and value for many companies in the biotech, pharmaceutical and medical devices industries.

To the extent that the rewards of research and development are reduced by price pressures due to national healthcare, research and development will decrease, and therefore growth in sales, profits and value of those private companies will slow.

One way to begin the process of determining the sensitivity of biotech, pharmaceutical and medical device companies to a switch from a private to a public U.S. healthcare system is to identify what portion of their total revenue comes from the U.S. Those with a greater U.S. revenue exposure are more likely to be damaged by Obamacare than those with less U.S. revenue exposure.

This chart identifies 21 healthcare companies that have expended for R&D on average for the past 7 years at 15% of sales or more, and that have a current market cap of $10 billion or more.

click image to enlarge

Company symbols in the table image: STJ, AMGN, CELG, AGN, BMY, BSX, MRK, LLY, GILD, BIIB, JNJ, GENZ, WYE, ESALY, NVS, GSK, AZN, PFE, RHHBY, NVO, SNY, SGP.

While there are many other questions to ask about a company in order to judge its sensitivity to potential U.S. national healthcare, looking at geographic revenue segmentation is a good place to start.

Some, but not all, of the other factors, you will probably want to analyze as you do your investment research are:

• current profit margins on U.S. revenue versus non-U.S. revenue
• split of consumer products that are not covered by current insurance, nor likely to be covered by Obamacare (e.g. aspirin and cold remedies)
• sales and growth rate contribution from the U.S. versus other countries
• what they have already in late state development or clinical trials
• the duration of patents on their key drugs or devices
• the current degree of market adoption of their key drugs or devices

While the answers to the above questions could prove more important than geographic revenue segmentation, preliminary logic would say that large companies with lower U.S. revenue exposure are candidates as potential substitutes for large companies with higher U.S. revenue exposure.

Even though companies with less U.S. revenue may have substantial European revenue, the national healthcare impact from those countries is already a known.

One of our clients who is in the medical services business told us that a national healthcare official there told him that European healthcare officials recognize that the profitable private market in the U.S. has enabled much of the research and development by healthcare companies around the world. He said the flow of new drugs, treatments and devices that they rely upon is dependent on companies being able to profitably develop them for the U.S. market. European officials are concerned that their national healthcare will consequently suffer a decreased flow of new drugs, treatments and devices if the U.S. eliminates its private healthcare system.

Whether that is correct, we don’t know, but it is an interesting issue from an investment perspective. It suggests that even though there are important European companies doing research and development, they may not do so much of that if they cannot sell new products into the United States at higher prices than they can at home.

The story points to the need for a large private healthcare market somewhere to make development of new medical technology economically attractive to private companies.

Without private research and development, we are left with politically directed research which is more likely to be incremental as opposed to breakthrough. There certainly are some examples of government directed and funded research creating breakthroughs, most notably in space exploration and in military technology. However, those types of programs were not characterized by cost containment as a key objective, but cost containment is one of the key goals in any national healthcare system.

All this leads us to think that healthcare investing would need to refocus on the “Walmarts” of healthcare (high volume, low margin); that biotech venture capital would have to be rethought; and that large pharma and device companies may need to merge to create larger more efficient, but less research oriented entities.

There will still be success stories and investment profits to be made, but not with the same old investment selection models.

We aren’t entirely sure what the new models would look like, but we do think a re-think of what a good healthcare investment would be is essential.

For starters, the U.S. versus non-U.S. revenue mix is a dimension to consider.

Approach healthcare providers, biotech companies, pharma companies, medical device companies, and medical or psychiatric REITS with an extra dose of investment research and caution until the U.S. sorts out its healthcare system plans.

Disclosure: We do not own any company identified in this article.

Comments

[Steve in Gr...:]

Thanks, Mr. Shaw, for the helpful note.

"...the profitable private market in the U.S. has enabled much of the research and development by healthcare companies around the world..."

Buy long-dated puts on global pharma companies with large R&D budgets, if Obama gets his health care bill. These guys have no where to go without the U.S.

Oct 30 09:03 AM

[grandad:]

Are you serious ? Why the hell should U.S. citizens pay more for drugs so that foreign companies can have money to do research. I don

Oct 31 09:19 AM

[Richard Shaw:]

grandad: we aren't suggesting what ought to be, just the way it has been and the consequence of the way it would become -- there is no political or social agenda in the article, just a statement about the investment implications of a change in the way things work.

Oct 31 09:33 AM

[Jade Queen:]

The FDA just sent a threatening letter to Dr. Weil for advocating use of an herbal preparation that many use and have reported benefit from.

While Dr. Weil likely won't want them to point their guns at him and take his business, the news of this will pump the herb, which I take myself, prescribed by a Chinese herbalist.

Underground and offshore, ordinary people are using plant analogs for substances now made generally with leftovers from industrial processes.

Attempts to bully particular practitioners with much to lose will work to restrain the businesses of celebrities, but it won't stop word of mouth about what works.

In addition to this phenomenon, Equador has just broken patents, with the acquiescence of some pharmaceutical companies, to manufacture and provide medications it wants for its people at costs they can afford. This is another area where old ways of doing things are breaking down.

Substantial change is evolving rapidly in this area. I didn't even mention side-effect lawsuits, which tend to have gags attached, but putting a gag on a long-term user of psych meds seems maybe as if it might not work perfectly.

Caution seems indeed in order. Thanks for bringing this up.

Oct 31 12:18 PM

[skwestorange:]

I suspect the concern raised by the author is overblown. Other than adding more lives to be insured and saddling the taxpayer with more burden to pay for it, the health-care bill will do nothing to change status quo. After all the Congressmen and Senators want to be reelected and want the big bucks they get from Pharma companies.

Oct 31 02:39 PM

[searcher:]

Herbal or alternative or fringe etc. medications are not the issue. Hard science pharma (or a reasonable facsimile in view of the delusional activities of quite a few R&D pharma outfits) is very very expensive and will definitely suffer. Perhaps I'm prejudiced but socialist schema tends to have a static as opposed to dynamic world view. I fear a concern with a apportioning the 'pie' will eclipse efforts to grow the 'pie'. If you think the accountants force triage healthcare now, just wait till the government has strangled the private sector with the Trojan horse of the public alternative.

Oct 31 02:58 PM

[c smith:]

A better measure of sensitivity to ObamaCare is percentage of revenue which is "private pay"; i.e.; that which is not publicly funded via Medicare or Medicaid. Allergan, which derives the great majority of its revenue from elective and cosmetic procedures (which are not paid for w/public dollars) is the hands-down winner by this measure.

Oct 31 08:37 PM

[Richard Shaw:]

c smith: nice point

Nov 01 10:40 AM

[Richard Shaw:]

c smith: if you have that private pay data readily available for the other companies, that would be good data to share

Nov 01 11:03 AM

[Steve in Gr...:]

Listen Grandad. Pharma research is exactly like defense. In the past, the U.S. has defended the rest of the world because the other countries 1) would not defend themselves and 2) could rely on us to do it.

If we stop defending, the rest of the world descends into chaos. If we stop researching, there are no drugs developed. I am perfectly OK with both results. Are you?

On Oct 31 09:19 AM grandad wrote:

> Are you serious ? Why the hell should U.S. citizens pay more for drugs so that foreign companies can have money to do research..."

Nov 01 10:19 PM

[E Nuff Sed:]

How do explain the fact that US Pharma companies spend 2 - 3 times in BME (business development, advertising, marketing and lobbying) than R&D. Look at the income statement of any big pharma.
The fact is that most drugs are me-too molecules marketed the hell out by armies of expensive sales reps.

Nov 02 11:03 PM