How Healthcare Stocks Are Being Impacted By Government Intervention

by: Charles A. Smith

The trends in broad healthcare markets are unmistakable: Congress, federal bill-payers and bureaucrats are putting the screws to all sorts of healthcare firms. Medical device, equipment, drug and service providers are all affected. Some of the increased scrutiny is self-inflicted, and some is a result of a greater emphasis on the part of Congress and the Obama administration on controlling costs from the top down. Here are a few examples of the broader trends:

1. Edwards Lifesciences Corp. (NYSE:EW) recently saw its rating cut by J.P. Morgan after the Centers for Medicare and Medicaid Services issued a National Coverage Analysis for their new transcatheter aortic valve. In their report, the J.P. Morgan analysts basically conclude that in addition to analyzing in fine detail the overall costs and effectiveness of this (what many view as revolutionary) technology, CMS will soon be dictating what medical centers can perform the procedure, what’s required of them, and which patients can be treated.

2. Shares of home health service companies Gentiva Health Services (NASDAQ:GTIV), Amedisys Inc. (NASDAQ:AMED) and LHC Group (NASDAQ:LHCG) fell sharply after the Senate Finance Committee reported that these companies had rigged their service and billing systems to glean maximum revenue from taxpayers without necessarily providing additional care. Shares of these firms had already been sagging since the spring as the specter of Medicare reimbursement cuts became real. In July, CMS cut reimbursement rates by 3.35% for home health providers, representing a $640 million reduction in payments. This announcement came after a 5.5% decrease in reimbursements announced in November of 2010.

3. Omnicare (NYSE:OCR), which provides pharmacy services to long-term care centers and hospitals, saw its shares fall 14.7% on Tuesday after CMS proposed new rules to curb over-prescribing to seniors. Under the proposal, CMS would require nursing home operators to hire independent pharmacists to review residents’ drug regimens. CMS also cast doubt on OCR's proposed takeover of competitor PharMerica (NYSEARCA:PCA), indicating that it would take a dim view of the combination because the three largest firms in the industry already control 90 percent of the market

For investors, these events represent a culmination of risks boiling beneath the surface of the health care colossus for several years, and they're likely to continue. The simple fact is that when CMS and Federal bureaucrats dictate not only who can buy and use your product and under what conditions, but also exactly how much profit you can earn, you've lost control of your business.

This is why we've focused our health care investments on what I call "private pay" providers such as Allergan (NYSE:AGN) and Cynosure (NASDAQ:CYNO). These firms get a majority of their revenue not from taxpayers, but from private insurers, and even more so from the pockets of their individual customers. So called "cosmetic" procedures offered by firms such as these are no doubt subject to the slings and arrows of a gyrating economy, but are much less likely to suffer from sea changes in broader Federal policy like we're seeing today. Again, if
you own a health care business, and the majority of your revenue comes from the Federal government, you can lose control of your business overnight. That is a risk we'd rather avoid.

Disclosure: I am long AGN, CYNO.