12.19.16 | Forbes
By Steve Brozak
To read the entire article on Forbes, please click here.
The gloom at the J.P. Morgan 34th annual healthcare conference in San Francisco last week is still thick in the air – and will likely to hover there for a while, as macro issues and falling investor confidence continue to cause problems for the U.S. pharmaceutical and biotech sector. Compare this to last year’s conference, after which the main debate was whether or not we were in a biotech bubble, with many pundits questioning asset valuations. How quickly times change.
The tenor at JPM matters because JPM is basically synonymous with healthcare investment and sets the tone for the rest of the year.
From its early inception as a boutique event it has become a conference of global proportion, making it a real-time monitor of medical events. The conference, which attracts IB bankers and venture capitalists from across the country, as well as from financial centers in Europe and Asia, is like the Super Bowl of healthcare investing. Mood matters, and if JPM’s investors and presenters are not talking excitedly about upcoming opportunities, swapping tips, and making deals, it’s not a promising sign for Pharma/Biotech/Med Devices.
The reasons for the dismal atmosphere this year are simple, and with the force of hindsight, predictable. Capital markets are in retreat, and there has been little real recovery in the US economy—middle class wages remain stagnant or comparatively lower, the gap in income between the rich and the rest continues to grow, and China’s economy is swinging sideways, putting the US capital markets in hibernation. In other words, winter has come.
Two events that used the conference as their backdrop are emblematic of the main issues pushing medical industry stocks down. The first was Shire Pharmaceutical’s announcement that it was finalizing its acquisition of Baxalta Incorporated, a smaller company with several important drugs that treat rare diseases. The other was the WWE-like throw-down between Anthem, Inc., the second largest healthcare insurer in the nation, and its pharmacy benefit manager PBM, Express Scripts Holding Co., over the amount of savings in prescription drug costs Anthem has demanded from its PBM. The two seemingly unrelated events are joined together in the perception driving both business decisions.
Shire Plc’s roughly $35 billion purchase of Baxalta including its debt reflects a reaction to a continued slow downward spiral in biotech markets. Baxalta is a leader in the hemophilia treatment sector that also and wants to push into oncology treatment development through a partnership with a small Danish company.
But the Shire deal is clearly based on a suspicious view of biotech’s near future, the same perspective that shadowed the JP Morgan meeting: Shire’s not buying Baxalta because it’s seeing growth in the hemophilia markets. It’s more likely Shire wants to lock onto a safe stream of revenue to tide it through the coming downturn.
Too many M&A arrangements in the last year were predicated on protection of current assets, tax inversions or stockpiling revenue, all of which attracted negative attention in the media. As though he was already trying to fend off criticism, Shire’s CEO told the media that the acquisition of Baxalta was not about cost savings or tax benefits but about being “the undisputed leader in rare diseases,” still adding there would be at least $500 million in savings from the Baxalta deal.
The open fight between Anthem and Express Scripts is likewise rooted in concern about the lack of growth in the critical capital markets that have aided immensely in financing the explosion of the medical care industry This fracas is about a major insurer looking to protect its bottom line in the face of potentially declining returns in the markets and if that means going after someone else’s bottom line, well then, that’s just business.
Anthem wants Express Scripts to produce an additional $3 billion in savings in drug costs; a figure that many analysts at J.P. Morgan’s conference said was too high a figure to meet. Anthem has threatened to find another PBM, which would be a significant blow to Express Scripts.
In the meantime, by taking their fight to the streets, Anthem and Express Scripts will continue to put pressure on the government to address healthcare pricing concerns, further squeezing healthcare stocks. These are the kinds of tremors analysts look for when attempting to predict where markets are heading. Express Scripts has been slogging it out with some drug makers – notably Gilead Sciences, Inc. which makes the expensive hepatitis C treatments Sovaldi and Harvoni.
At least Gilead can make the case that its drugs can largely cure hepatitis C. But many other drug companies are also raising prices and Anthem’s hackles. And most of those development medicines are treatments for chronic disease, not cures. Anthem wants to see more savings from drug costs contributing to its revenues – again, likely efforts to storehouse revenue in preparation for a downswing, sorry a correction, in biotech markets. If this sounds too negative, take a look at the biotech index – the NASDAQ Biotechnology (NBI). Its path looks remarkably like oil’s trend line. Biotech is big in immunology, but it hasn’t found a way to make itself immune to price collapses in other major industries.
This level of political and global uncertainty is taking its toll on biotech investors who may have confidence in the sector, but don’t have the patience required to weather the coming economic storm. There’s a maelstrom in the energy markets, worry bordering on panic some mornings from US to China and back again, and a tumultuous political season in which healthcare costs are in play – on January 26, the House Oversight Committee is holding a hearing on drug pricing at which Valeant’s Interim CEO is due to appear. Turing’s ex-CEO Martin Shkreli has also been invited but is unlikely to show. Given all of this, it’s no wonder that JPM 2016 was so gloomy.
The big question remains, what should investors do? While the mood at the J.P. Morgan conference may have been subdued about the general state of the capital markets, companies all around the city were moving forward and making progress on their business plans for the upcoming year. It’s still early in the year, and we’re about to head into earnings season. With the Shire/Baxalta merger announced, and the Pfizer/Allergan merger still working its way to closure, other major M&A is expected as companies become emboldened by these mega transactions. As for China, the U.S. and other economies of the world should become less sensitive to the daily gyrations there as their own markets stabilize. If so, by the time the next J.P. Morgan conference rolls around, the pundits might be complaining about another boom in the biotech markets.