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Fiscal Cliff Hits Health Care

Brian Orelli
December 19, 2012

Drug companies are already dealing with patent cliffs, where multiple drugs are going off patent at the same time, cutting into revenue. They don't need any more cliffs to fall off.

Unfortunately, they're not immune to the fiscal cliff. The sector is usually resistant to macro issues -- people get sick even in a recession -- but decisions the government makes, or doesn't make, will ultimately affect health care companies' revenue.

Falling off the cliff
The worst option for the economy in general is also the worst case for health care companies dependent on the Food and Drug Administration for their future revenue.

Many years ago, the industry worked out a deal with the FDA where companies contributed user fees as part of the Prescription Drug User Fee Act in exchange for faster decisions on the marketing applications for drugs. The FDA hired more staff and set goals -- referred to as PDUFA dates -- and review times decreased. Everyone was happy. Or at least happier.

So, the FDA is insulated from budget cuts? According to Regulatory Focus, that doesn't seem to be the case. The across-the-board 8%-cut in budgets will hit the entire FDA budget. The agency will have to lay off employees, which will likely result in delays in approvals of drugs. Even the threat of layoffs or furloughs could have an effect on productivity today. Navidea Biopharmaceuticals (NYSEMKT: NAVB), MAP Pharmaceuticals (NASDAQ: MAPP), NuPathe (NASDAQ: PATH), and others have drugs under review that could potentially be delayed.

Ironically, the drug companies will still have to pay their user fee; the FDA just won't be able to use the extra cash, since it's caught up in some sort of limbo invented by politicians who thought forced cuts were the best way to solve the problem.

Cuts ahead?
In theory, cuts to Medicare and Medicaid in some form or another should hurt the industry. In reality, changes in spending by the government-run programs don't have that much impact. As Merck's (NYSE: MRK) CEO Ken Frazier points out in this editorial, cuts in Medicare just get shifted to the private sector.

With the exception of companies like Gilead Sciences (NASDAQ: GILD), which sells a lot of its HIV medication to Medicaid patients, most companies will be able to make up for losses from government agencies with price hikes elsewhere. The buck has to come from somewhere; gross margins on drugs are high, but after you subtract out the high cost of R&D, pharmaceutical companies' net profit isn't all that high. If they don't shift the cost, they'll be out of business, and private insurers are willing to pick up the tab because they don't have much incentive to hold prices down; the insurers just pass the cost onto their members.

In fact, since Medicare pays the lowest r