Plans to repeal and replace Obamacare weighed heavily on insurers ahead of Donald Trump's presidency, so now that he's been in office for 100 days, it's time to check in and see how these companies are doing.
On this episode of The Motley Fool's Industry Focus: Healthcare podcast, analyst Kristine Harjes and contributor Todd Campbell sit down to discuss UnitedHealth Group Inc. (NYSE:UNH), Anthem Inc. (NYSE:ANTM), and Centene Corp.'s (NYSE:CNC) first-quarter performance, and what could be next for these companies.
On the show, the cast also weighs in on an increasingly heated battle between healthcare giants Anthem and Express Scripts (NASDAQ:ESRX), and they discuss Fresenius' (NYSE:FMS) recent acquisition of Akorn (NASDAQ:AKRX), too.
A full transcript follows the video.
This video was recorded on April 26, 2017.
Kristine Harjes: Welcome to Industry Focus, the podcast that dives into a different sector of the stock market every day. Today's sector is healthcare, and it is April 26. I'm your host, Kristine Harjes, and fool.com healthcare contributor Todd Campbell is calling in to Fool HQ in Alexandria, Va. Hi, Todd! What's new?
Todd Campbell: Hi, Kristine. It's Wednesday, and that means I give all of the listeners the update on the weather forecast for lovely New Hampshire.
Harjes: [laughs] All right, let's hear it.
Campbell: Rainy, cloudy, and chilly. It's basically the worst weather that you could ever want for someone in New Hampshire who's so eager to see some sunshine and get the warm weather going. But it's the perfect day to sit down and chat with you.
Harjes: Fun fact about D.C. weather today: It's supposed to be the warmest at midnight, because it's going to be so darn hot tomorrow that it's going to get warmer and warmer all day today, so the high is at 11:59 p.m.
Campbell: That is a fun fact.
Harjes: There you have it, the weather report. And now, on to healthcare. On today's show, we'll be covering pharmacy benefit managers and also look at how insurers have fared under the first 100 days of Trump's presidency. But first, we wanted to give a quick answer for Shiraz, one of our listeners who is currently stationed in Tokyo, who wanted us to cover the Fresenius and Akorn deal. I hope that I'm saying that word right, Fresenius, which is a German healthcare giant. They acquired this smaller drugmaker called Akorn yesterday in a $4.3 billion deal.
Campbell: Fresenius is very well known to many if you've driven by and seen their dialysis centers. It's a very large European company, but they get 70%-plus of their sales here in North America, and they get the bulk of all the revenue by providing these services to dialysis patients. What we're seeing them do recently in the last year or so, they have a new CEO in place who's very focused on diversifying out his revenue streams. Specifically, he wants to bulk up on his exposure to medicine. As part of that, he has agreed to spend $4.3 billion on Akorn, plus assumed debt. That works out to about $34 a share.
Harjes: Right. There a couple different reasons why they're doing this. As you mentioned, this is a company that's looking to expand. They've had a bunch of different deals around Europe, and this buyout will actually expand their geographical footprint within the U.S. as well, particularly because it gives them access to Akorn's distribution channels. The deal is supposed to be accretive to net income by 2018. This has been really good news for Akorn shareholders.
Campbell: Yeah, there's a huge pop in shares because this was a nice, big, fat premium. One of the things that always comes up when you talk about deals like this is, do you think there could be another suitor that could emerge? Should I stay in my Akorn shares, or should I sell them? You have to realize that this is an international company buying Akorn; there's going to be some review that needs to occur from a regulatory perspective. The deal probably won't close until 2018. Personally, who knows if somebody else steps up and tries to make a counter-bid? I don't think the odds are necessarily high for that, and I tend to always advise people to say no. Usually, it's dead money. This is not a stock deal. I think Fresenius said they're going to finance it by taking on some debt. It's not like you're going to hang on and eventually get the Fresenius shares, it doesn't sound like, to me, reading through the press releases. I think your money is probably best used somewhere else because of the opportunity cost.
Harjes: Right. There could potentially be some triage opportunity, I think shares today are a little bit over $33. But that's not worth it to wait until 2018, to gain less than $1 per share. So the way that I see this, I agree with you, Todd, I don't think anyone else is going to swoop in here. There has been speculation about this deal for quite a while. And actually, the majority of the pop in the stock happened when the rumors were leaked, rather than the confirmation, which came out yesterday. I don't see somebody else stepping in here and making an even bigger offer. If that does happen, I will be quite surprised. If I were a shareholder, I would probably just collect my cash now and exit, put your money to work elsewhere.
Campbell: It's probably a better bet, Kristine, to take a look at Fresenius shares. That's a company that's growing high single digits on the top line and the bottom line. Obviously, it's being run by someone who is expansion focused, focused on growing the company. Usually, these foreign companies fly a little bit underneath the radar for investors. So sometimes there can be opportunities in looking at these companies that are a little bit more underfollowed than some of the big names that we're more familiar with in the U.S.
Harjes: Right, plus you get that international diversification, which is helpful if you want to be fully diversified. Good advice.
I mentioned right at the beginning of the show that at some point, we were going to talk about pharmacy benefit managers, which are also PBMs -- we'll probably refer to them exclusively by the acronym. That time is now. We have some news to dig into regarding one of the nation's major PBMs, but first, I figure we should give some background on what exactly is a PBM?
Campbell: To keep it very top level and make it very easy to understand, each one of these payers, insurers, or it could be a company that self-insures their employees, has to go out individually and negotiate with drugmakers on pricing. That's not very efficient. You're not likely to get the best deal, because you don't have a lot of bargaining power. So what PBMs do is allow a lot of different insurers and different payers to bond together under this umbrella, and they'll negotiate the best price for you, pass along that savings to you, and take a small piece for themselves.
Harjes: Right. They're basically leveraging their size to try to get prices down, and they take a cut of those savings. Because of that, they've been painted in a sketchy light lately, especially by drugmakers, saying, "We're not responsible for astronomical drug prices; it's actually the PBMs." I don't know, I think they've been kind of successful in tainting the reputation of PBMs. That might not even be the right way to phrase it, because I don't think they had a reputation before people really started thinking about this issue.
Campbell: Yeah, Kristine, I think a few years ago, they were being looked at as part of the solution. I think the drug industry has painted them now as part of the problem, and they've done a pretty good job marketing that to individuals.
Harjes: Yeah. It's interesting. Personally, I don't know what my opinion is on whether they're good guys or not, but I think it's important to understand that they are part of this whole relationship, and they're just one more cog in the wheel, they're one more piece of this puzzle, and they're going to take a cut. So they are part of the equation of why drug prices are the way they are, for better or for worse.
Campbell: Yeah. The argument would be that they have to save you more, and they're only taking a cut of what those savings would be, so if they didn't exist, the cost would be higher. That would be the counter-argument, and the value they add. But maybe the value they're adding isn't as great as it sounds, at least according to Anthem.
Harjes: Exactly. That brings us to the news-y part of the segment, and why we wanted to address this to begin with. Express Scripts, which is one of the major United States PBMs, lost about 12% of their stock price yesterday, Tuesday, on the news that Anthem, which is one of the big health insurers, is not planning on renewing its contracts that it had with Express Scripts when they get to their expiration in 2019.
Campbell: This is an ongoing battle between Anthem and Express Scripts that's been going on more than a year.
Harjes: Yeah. It was the very first thing that Express Scripts addressed in their earnings call. They basically said, "This is the latest on this deal, Anthem has signaled to us that there is no way we can reach a compromise, so they're not going to renew their contracts." Express Scripts, to their credit, was extremely transparent about exactly what will happen financially when/if they lose this as well as some other big clients. Anthem, in general, has been very pushy about demanding things from Express Scripts. They want Express Scripts to give them $3 billion a year in order to keep this contract. When Express Scripts opened up their books and said, "Look, this is how much money we're making from this deal, this is what you're asking for," it just wasn't possible to make those ends meet.
Campbell: Yeah. This all began back in 2009, when Anthem sold their internal PBM business to Express Scripts and, at the time, inked a 10-year deal for Express Scripts to handle this part of the business for them.
Harjes: Right, hence the 2019 expiration.
Campbell: Yeah. As part of that language, they were supposed to be able to get some price rebating back at the end of the year. They had been projecting that to be a fairly large sum. Last year, Anthem came out and said, "Listen, we think Express Scripts is charging us $3 billion a year too much for the drug that it's handling. They're not passing those savings along to us that they have promised to pass along." Shortly thereafter, Anthem filed a lawsuit, saying to Express Scripts, "Either pay up or we're going to walk away. Give us the option, either or." Obviously, the two could not find a middle ground on this, and that's what prompted Express Scripts, finally, to say on their earnings call, "Listen, they told us they're not going to renew in 2019, and that means we're going to lose a big chunk of our EBITDA." To put that in perspective for investors on why this was such a big deal and caused shares to plummet, last year, Anthem's business represented almost a third of Express Scripts' EBITDA. So this is very substantial, their biggest customer, very substantial part of the business. No wonder investors were like, "Oh my God, what's going on, what's going to happen in a few years?"
Harjes: Right. Express Scripts' stock has suffered pretty considerably because of this. They're down about 30% since the fighting with Anthem began. If you look at the aftermath and what's actually going to happen, it'll take a little bit of time to be fully felt. When Anthem first came to Express Scripts, back in 2009, as you were saying, it took three full years for the transition. Even post-2019, the impact won't be immediate. But still, it will be really difficult to replace this business. I can't imagine what other health insurer Express Scripts might try to forge a deal to replace what they're losing with Anthem. You have UnitedHealthcare, that's a huge insurer, but they have their own PBM. Humana has its own, Cigna has a 10-year contract with Catamaran, which was acquired by UNH. Then, Aetna has a contract with [CVS Health], which also has a PBM that expires in 2019. So that could be kind of interesting.
Campbell: Yeah, this is an area where there are always companies in payers moving back and forth, but it's usually not the big ones. It's usually not the players like Anthem.
Harjes: Right, because they're long-term contracts.
Campbell: Yeah. Now, I think you might look at the shares today, if you're listening to this on the day we record here, and say, "But shares are up." That's because there was some conversation on Anthem's investor call today that indicated that maybe the door was still open for some negotiation. Obviously, Express Scripts doesn't want to give Anthem all the money that Anthem wants, Anthem seems to want that money, I don't know where they would find a middle ground. But it's giving a little bit of support after that big drop in shares today, at least.
Harjes: Right. Express Scripts has made it very clear that they're still willing to negotiate. It seems like Anthem is playing hardball here, but I honestly wouldn't be shocked if Anthem ended up finding some way to compromise.
Campbell: One of the takeaways here, Kristine, for investors should be, always be a little bit cautious when one customer accounts for a very big percentage of a company's business. Right?
Harjes: Absolutely, that's a great takeaway. That single risk factor is not something to be discounted.
Campbell: Now, that doesn't mean that you can't go in and make some money on Express Scripts. I think there's still a need for a business like Express Scripts. The debate would be, is Express Scripts the biggest player in the PBM business? Or the best player, I should say, from here in the PBM business? Maybe CVS is the best player because they have the most gain.
Harjes: Yeah. If CVS won Anthem, that would certainly make them the biggest PBM.
Campbell: Yeah. You also have the potential for UnitedHealthcare, which is obviously a lot more diversified because it runs its own PBM, but it's also the largest health insurer as well. An investor might not want to own a PBM and a separate health insurer in their portfolio, they want a combination of the two, then UnitedHealthcare fits the bill in that way.
Harjes: Right, lots of different ways to work that. We covered the PBM side. Let's pivot now to the insurer side. Todd, this was your idea, you wanted to talk about post-100 days of Trump, we're coming up on it, it's in less than a week at this point. How are the major health insurers doing?
Campbell: We're on Trump-100-day-watch, and we want to know what the impact is on insurers. We came into 2017 expecting that there would be a repeal-and-replacement deal put forth in Washington. I was a little surprised that it happened as quickly as it did. But sure enough, things are hard to do when you're talking about winning support from so many different people in both the House and, potentially, later on, in the Senate. As a result, that derailed Trump's first foray to try and repeal and replace. That was called the American Health Care Act, which you and I, Kristine, discussed at some length in a show a couple of months back, if anybody wants to go back and listen to that. Obviously, as part of Trump's policy agenda, health insurance was going to be a huge part of that. So I thought it might be helpful to go back and say we're one quarter in, Q1 in the books -- how did health insurers do? Was there any evidence that Trump's election was a good or bad thing? Or is it just business as usual?
Harjes: Right. Let's start, first off, with UnitedHealthcare, who we've already mentioned a little bit on this show today, that they are an enormous health insurer in the United States. They're kind of an interesting case because they basically opted out of Obamacare by saying, "We're not making any money here, so we'd rather not; no, thanks." That put them in kind of an interesting position looking at healthcare reform, because you would think that because of their lack of exposure to Obamacare it wouldn't really affect them much whether Obamacare was repealed and replaced or not. How did that end up panning out?
Campbell: It's all upside for UnitedHealth; think about it that way. They were losing money on the Obamacare plans, so they stopped selling them. That brings some back to flat. Now, if a replacement plan gets put in and, theoretically, it becomes more favorable to insurers -- which, I think, broadly speaking, people were anticipating that it would be more profitable for insurers, because you need to have insurers play ball in order to have any kind of a system succeed. So I think there was a potential for a lot of upside. But it's really just business as usual for UnitedHealthcare in Q1. This is, like you mentioned, a Goliath. They're expected to do $200 billion in revenue this year. If you look at their Q1 numbers, premiums alone were up 12% to $39 billion. They made 12% more on premiums year over year in the quarter. Of course, that translated into earnings growth, too. You had non-GAAP EPS that was reported in the quarter of $2.37. That was up 31%. So you have earnings growing much more quickly than revenue, and both of them growing solidly in the double digits.
Harjes: Right. As you mentioned, UnitedHealth is extremely diversified; they are huge. Let's look at the other side of the spectrum there, at a more niche player like Centene, who is mostly a Medicaid player.
Campbell: Centene is an interesting story, too. If the replacement plan had been put into place, then you'd be wondering, what's going to happen with Medicaid expansion states? Centene gets the majority of its business from running Medicaid programs for different states. Part of the replacement plan was to cap enrollment in Medicaid expansion states in 2020, and block-grant money to states from there on, which would create a significant amount of uncertainty for their business. Again, since this is on hold, it's business as usual for the company. They reported strong revenue growth, but again, that's a little messy, because they did an acquisition last year. So it's probably better to look at their EPS growth. In the quarter, their earnings growth was up 51%; they reported $1.12 in non-GAAP EPS. So this is a company, obviously, that's making some money. It's important to recognize that not only are they interesting, at a minimum, to recognize that UnitedHealthcare has said, "We don't want to have any part of Obamacare," Centene has said, "We think it's a good business to be in. In fact, we're looking to expand our participation in it in 2018, assuming that everything continues as is." They handle about 1.1 million Obamacare enrollees, and that's up from around 680,000 last year.
Harjes: Two completely different approaches. Let's touch on one more. I'm picking them because we were just talking about them in the PBM section. How about Anthem?
Campbell: Anthem just reported this morning. Unfortunately, I wasn't able to listen to the conference call yet. It's on my agenda for later on. But I did go through and tear through the press release. Again, like UnitedHealthcare -- UnitedHealthcare is the biggest, Anthem is the second biggest -- everything seems to be going well. Anthem still participates in Obamacare; they offer plans in a dozen or so states. They reported total revenue was up 11% to $22.5 billion. Strong, double-digit year-over-year growth again. Their non-GAAP EPS in the quarter was $4.68, which was up 35% year over year. So regardless of all of the other chatter that we hear about Obamacare, not Obamacare, whatever, you look at UnitedHealthcare's results and Anthem's results, and from a growth perspective on a top and bottom line, they're kind of comparable. It doesn't seem like not participating or participating is really that big of a needle mover, in terms of how much these companies are growing year over year.
Harjes: Yeah, that's interesting. One other point that stood out to me when I was looking at this, I was looking earlier today at different lobbying budget across healthcare. America's Health Insurance Plans, a lobbying company, decreased their budget going from 2016 to 2017, which really stood out in contrast to what some other healthcare lobbyists were doing. That was a 25% decline in their budget. Of the top 25 spenders in that area, they were one of just four to cut their budgets. This is a group represents Anthem, Cigna, Centene, Humana. I don't know, I just think it's a really interesting dynamic, to see what's going on in Washington, how are the different lobbyists reacting to it, how are the different insurers reacting to it, and how are the stock prices reacting to it? This is absolutely still something that remains in limbo, but it's still fun to tease of the effects of the chatter.
Campbell: Yeah. Of all of these companies we discussed today, if you want to go back and read one earnings transcript for interest, go read Centene's, because they really put this front and center and talked a lot about Obamacare, and how tough it might be, or, the challenges that might be, to unwind it and get a replacement plan across the finish line. This is not going to be easy. The AHCA, they didn't vote on it yet, there's a lot of chatter that it may be brought back out in front of legislators to vote on. Who knows how that middle ground will be found in the House, and then it's going to go to the Senate, and middle ground has to be found there. I don't know. I think the point that Centene's management was trying to make is, we're ready to adapt to whatever the market throws at us. As it stands today, we're OK and we're doing fine. If it changes, we'll adapt to it. I think that's a big takeaway for investors. Never underestimate insurance companies' ability to adapt to a changing marketplace.
Harjes: So they're optimistic. Whatever does happen, we will have you covered here on Industry Focus: Healthcare. As we wrap up our episode, I wanted to point out that you can always get the show transcripts of our episodes online by searching for that episode, or if you can't find it that way, feel free to email me at firstname.lastname@example.org. I must have mumbled the name of Pacira Pharmaceuticals last week on the opioid-addiction show, because a bunch of you wrote in asking me what the company name was. In case you didn't hear it but also didn't email me, the ticker is PCRX. Hopefully that scratches that curiosity itch.
As always, people on the program may have interests in the stocks that they talk about, and The Motley Fool may have formal recommendations for or against, so don't buy or sell stocks based solely on what you hear. For Todd Campbell, I'm Kristine Harjes. Thanks for listening, and Fool on!