Tuesday, April 7, 2009

Healthcare Sector Review

In the end of the first quarter of 2009, I have a few thoughts on the healthcare industry. The healthcare industry is perceived to be relatively secure during recessionary periods because consumers consider most of its products to be necessities. In the past year, this sector has outperformed the S&P 500 by approximately 15%. This index is currently composed of four subcategories—biotechnology, healthcare facilities, major drugs, and medical equipment and supplies.

In Q1 of 2009, the U.S. M&A deal volume was almost double the total volume in Q4 of 2008. However, these gains were mainly derived from two major deals in the healthcare sector—Pfizer acquiring Wyeth for $68 billion and Merck acquiring Schering-Plough for $41 billion. These two acquisitions alone accounted for more than half of total U.S. deal volume. The justifications behind these aggressive inorganic growth strategies were:

• Pharmaceutical firms have been concerned with the pending patent expirations of its blockbuster drugs, which have driven a majority of their revenues. In addition, generic drug competition will continue to drive drug prices down, and negatively impact the profitability of these firms.

• Even during the market downturn, these companies have continually maintained large cash positions on their balance sheets. This financial flexibility enables firms to expand their businesses when investment opportunities arise.

• An additional bonus is the current low stock prices of target firms, which makes them attractive to larger pharmaceutical acquirers.

As a result of these acquisitions, the combined synergies will bolster product pipelines and lower expenses, thus increasing operating margins and partially-solving the patent problems.

President Obama’s $634 billion healthcare reform plan calls for health coverage affordability. The savings will come from quality incentives, efficiency and accountability, and shared responsibility. In particular, the U.S. government has increased Medicaid rebates from 15% to 22%; however, Medicaid sales as a percentage of overall U.S. pharmaceutical sales remain relatively small (less than 10%). In addition, federal law requires these healthcare companies to pay specified rebates for medicines reimbursed by Medicaid in order to provide discounts for certain healthcare facilities.

In the coming months, the federal administration also plans to crackdown on U.S. companies’ ability to avoid taxation on international earnings. Consequently, Obama has aimed his efforts to shut down offshore tax abuses, which currently amounts to $100 billion each year. This will negatively affect the large pharmaceutical companies that generate a significant portion of sales abroad.

Some people may believe the opposite view, but I can see the healthcare industry will face a certain amount of pressure from the government in the coming year.

No comments:

Post a Comment