Investment Opportunities In Healthcare: An Interview With Alan Brochstein

by: H.S. Ayoub

Alan J. Brochstein, CFA
AB Analytical Services

Investment Opportunities in Healthcare

BioHealth Investor: Let's start by giving us your near term outlook on the healthcare sector in general.

Alan Brochstein: Well, I am very concerned about the domestic economy and the near-term outlook for stocks in general. I do believe, though, that Healthcare stocks could fare well over the balance of the year. So far this year, Healthcare has more or less just tracked the overall market.

BHI: Which industries in healthcare do you think investors should focus on right now?

AB: As we head into a national election year, when there will surely be a lot of focus on healthcare cost containment, I think that it is important to focus on companies that are helping to take cost out of the system. One big theme that I have recently researched more in depth is the broad industry of “in-home” services providers. I think that there is a lot of concern that since the industry caters to Medicare and Medicaid populations, there is significant reimbursement risk. I believe that this is a knee-jerk response. In fact, many of these companies save the public considerable expense by keeping chronically ill patients out of the hospital. I personally own Lincare (NASDAQ:LNCR), an oxygen provider, and OptionCare (OPTN-OLD), a hybrid distributor of specialty pharmaceuticals and provider of in-home infusion. I follow Amedisys (NASDAQ:AMED), a provider of skilled nursing for rehabilitation and other services, very closely. Gentiva (NASDAQ:GTIV) is a similar company, while Apria (AHG) overlaps with both LNCR and OPTN.

Another example of cost containment is the PBM industry. I have a personal investment in HealthExtras (HLEX), which is smaller than its large rivals and has a different business model that I prefer. Express Scripts (NASDAQ:ESRX) and Medco (NYSE:MHS) along with CVS (NYSE:CVS), which acquired CareMark, are the big players in that space.

BHI: What's your outlook on the pure biotech plays?

AB: Well, as you know, I follow these companies, especially those leveraged to Cancer, but I find this to be a very challenging group of companies in which to “invest." For every winner, like Amgen (NASDAQ:AMGN), Genentech (Private:DNA), Gilead (NASDAQ:GILD) or Celgene (NASDAQ:CELG), there are so many companies that bleed to death over time.

I created a universe of stocks today with all of the U.S. based biotechs with market capitalization in excess of $50mm. It is clear why so many investors are attracted to the market, as the payoffs can be quite extreme. In fact, thus far this year, nine companies have gained in excess of 75%, including Opko Health (NYSEMKT:OPK), Celsion (CLN), Bionovo (OTC:BNVI), Onyx (NASDAQ:ONXX), BioSante (BPA), Cleveland Biolabs (NASDAQ:CBLI), Seattle Genetics (NASDAQ:SGEN), Biopure [BPUR] and the infamous Dendreon (NASDAQ:DNDN).

On the other hand, 6 stocks have been cut in half: Pipex (PP), Coley (COLY), Encysive (ENCY), Curagen (CRGN), Cell Therapeutics (NASDAQ:CTIC) and Dynavax (NASDAQ:DVAX).

Looking at the entire list of almost 200 names, the median return thus far in 2007 is slightly negative, well behind the broad market. These same companies had a median return of about zero last year, again well behind the market. Additionally, several of this year’s winners were huge losers last year, so it is a very difficult game to play. Dendreon, which remains up year-to-date and looks technically sound from a stock point of view, is a great example of the inherent volatility in the space. I hear conflicting views on whether Provenge will ever actually get approved. If I had to guess, I would venture that it would, but I won’t put even a dime on that one!

I prefer investments with better risk-reward profiles that approach the same area. One of my holdings over the past two years has been Intuitive Surgical (NASDAQ:ISRG), the robotic surgery company. If ever there was a “cancer play,” this would appear to be the case. But, a lot of biotech players want an even more aggressive upside/downside ratio. For investors excited, as they should be, about biotech growth, they should consider the Contract Research Organizations (CROs). I follow Pharmaceutical Product Development (NASDAQ:PPDI) and Covance (NYSE:CVD) very closely, but there are several other players. One of the reasons this derivative play makes sense is that the biotech companies outsource all of their clinical trial work to the CROs, while Pharma outsources a portion. So, as biotech grows, the CROs benefit. In fact, CVD has signed agreements with AMGN and other big players for dedicated space in Phase 1 labs. Many of these companies offer ancillary services as well.

There are other ways to play biotech in a safer manner, including tools providers. With that said, there is a company that is somewhat speculative that I follow closely and would buy a couple of points below where it trades, Myriad Genetics (NASDAQ:MYGN). While the company is not yet profitable, it has a profitable diagnostics provider supporting an exciting therapeutic development business, with two big drugs in the pipeline that address Alzheimer’s and brain cancer. The financials are solid, and the management team and the Board of Directors are leaders in the field.

BHI: Do you believe the recent surge in acquisitions of medical device plays will continue?

AB: I do. There are several drivers, including personalized medicine, the gap between patent expiration and innovation for pharmaceuticals and the improving technologies, especially ones that permit the devices to be installed with minimal invasiveness. Additionally, some of the devices are for cosmetic purposes, offering the additional benefit of reducing reimbursement risk to the buyer (like Allergan’s (NYSE:AGN) purchase of Inamed).

BHI: Can you give us two stocks that would be on the top of your buy list right now?

AB: Well, getting back to the theme of in-home service providers I detailed earlier, I would point to two that I own, LNCR and OPTN. I have followed LNCR closely for years and owned it in the past. It is an extremely well-managed company. I believe that investors are too pessimistic regarding reimbursement risk there. If the government is too punitive, they will leave senior citizens suffering from COPD with no choice but to go the hospital. While perhaps reimbursement is trimmed to some degree, I believe that this will only ultimately help LNCR as the leader and a consolidator of the industry.

OPTN is a neat little company well positioned on two fronts. On the one hand, its specialty pharmaceutical distribution business is leveraged to growth in biotech. Its pure-play competition has been gobbled up by PBMs over the last few years (Priority Healthcare, Accredo), leaving them as the leading independent. The big win with BCBS of Michigan last year is very telling, as this was a takeaway from Medco (MHS) after it had acquired the business when buying Accredo. Apparently, the client wasn’t too happy with the service from the PBM. It probably didn’t help that Medco went after Ford (NYSE:F), who had previously been a customer of BCBS of Michigan. Its other business is in-home infusion, again very leveraged to biotech. While Medicare reimbursement is extremely limited for this service broadly, there is legislation on the floor of Congress that could mandate it. Again, this service is a very big cost containment play.

BHI: How about a couple of stocks that you are wary of right now?

AB: I am concerned about Hologic (NASDAQ:HOLX). The company, which provides digital mammography equipment and other related products, has a very high valuation (28X forward earnings). On top of that, they recently announced a huge and expensive acquisition (of CYTYC (CYTC)). I have been concerned that the adoption ramp for digital mammography, spurred by very positive research conveyed to the public in the New England Journal of Medicine 1.5 years ago, would be extremely steep initially. I think that there is a risk now of a flattening of the demand. Expensive stock and huge acquisition are not two things that go well together often.

Another company that could disappoint investors is WellCare Health Plans (NYSE:WCG). The company provides Medicare and Medicaid insurance exclusively. My concern is that a year ago, the company began implementing a huge contract with the State of Georgia for Medicaid. The company, which had never had a presence in the state, beat out WellPoint (WLP), which was the largest provider in the state (BC/BS of Georgia). I believe that the company may have been too aggressive in its bid. Due to the nature of insurance accounting, it takes at least a year for the true medical loss ratios to be reflected in the income statement. This stock commands quite the premium to the other Medicaid players as well as the Managed Care companies in general, trading at about 18X forward EPS. A member of my family does have a short position in the stock.

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