For investors, the healthcare sector is where dreams can be made many times over -- or potentially lost in a flash.
Although all sectors look to the horizon and think about "what might be," no sector is more reliant on the crystal ball than healthcare. From biotech stocks developing the next cancer drug to medical device makers attempting to perfect the next life-saving device, healthcare companies receive a good chunk of their valuation from Wall Street and investors based on the future sales potential of drugs, devices, or diagnostics in their product portfolio or pipeline, or the potential population they could eventually reach (e.g., insurers reaching out to the uninsured).
Another major driver of healthcare valuations are what you might refer to as "megatrends in healthcare," or macro drivers that are shaping investments and future growth within the sector. Right now, I'd suggest there are three megatrends in healthcare that are shaping its future and that investors should be paying close attention to.
Megatrend No. 1: Adaptation to healthcare reform
The passage of the Patient Protection and Affordable Care Act, better known as Obamacare, in 2010 signaled a major change in the way consumers would sign up for health insurance and how health-benefits providers and doctors would eventually treat their patients. Although years went into planning the eventual implementation of the ACA for consumers on Jan. 1, 2014, that didn't mean merely the flip of a switch made everything good to go. Instead, nearly all areas of the healthcare industry are in an ongoing process of transition to meet the dynamic needs of healthcare reform.
Arguably, insurers have had to be the most nimble of all, adjusting their strategies to attract consumers on a transparent marketplace exchange. Prior to Obamacare, it was difficult to make apples-to-apples comparisons of health insurance premium pricing, but the implementation of marketplace exchanges has eliminated most of that confusion and made differentiation of their brand and healthcare plans a tough task for insurers.
Anthem (NYSE:ANTM) (previously WellPoint) has probably been the model which other insurers hold in the highest regard. Anthem enrolled the most new Obamacare enrollees in 2014, and it appears to have carried that success over into 2015. Per the Los Angeles Times, through Jan. 15, 2015, Anthem had enrolled 29.1% of all enrollees on the Covered California exchange, or 353,635 people.
But, it's not just insurers adapting. Hospitals have been scrambling to adapt as well by updating their systems to all-electronic platforms. Even more so, the uncertainties created by Obamacare's rollout in terms of costs have encouraged medical care providers to employ cloud-based resource management platforms.
Healthcare information technology juggernaut Cerner (NASDAQ:CERN) has been at the forefront of this movement, optimizing training, data analysis, and revenue cycle management for hospitals, as well as leading the electronic health records charge. In its fourth-quarter results from February, it announced record quarterly bookings of $1.16 billion and a 16% increase in revenue to $926 million. In sum, IT-based healthcare companies are probably going to be busy for many years to come as Obamacare continues to evolve.
Megatrend No. 2: The evolution of personalized medicine/treatment
Another megatrend in healthcare has been the ongoing push toward personalized medicine. Although we have one-size-fits-all preventative medicines, such as vaccines, "one size fits all" doesn't work with every disease.
For example, one cancer medicine does not cure all types of cancer. Taking into account that everyone has their own unique genetic makeup, and that there are many different types of cancer, it's plausible to assume that no two cancer cases are alike. This is where personalized diagnostic equipment and specialized cancer-focused drugs could come in handy.
On the diagnostic front, Myriad Genetics (NASDAQ:MYGN) is making significant strides to help people better understand their risk factors for developing cancer, as well as providing critical diagnostic testing to help qualify patients for specific cancer treatments.
For years, Myriad's BRACAnalysis test has helped patients decipher whether or not they carry the BRCA1 or BRCA2 mutation. Both mutations have been shown to come with a higher risk of developing breast or ovarian cancer for women. A positive reading for the BRCA mutations was the primary reason Angelina Jolie underwent a preventative double mastectomy in 2013.
In Dec. 2014, Myriad also received approval as a companion diagnostic test for AstraZeneca's advanced ovarian cancer drug Lynparza. Similar to its predecessor test, BRACAnalysis CDx tests for germline mutations in BRCA1/2, qualifying the patient for Lynparza if they've progressed on three or more lines of chemotherapy.
Among cancer drugs, Novartis' (NYSE:NVS) Zykadia is a perfect example of specialized care coming to the forefront.
Approved in April 2014 in the United States as a treatment for late-stage non-small cell lung cancer (NSCLC), Novartis' Zykadia specifically targets the anaplastic lymphoma kinase receptor, or ALK-positive NSCLC patients. While NSCLC comprises 85% of all lung cancer cases, ALK-positive NSCLC amounts to just 2% to 7% of all NSCLC cancers. This is a very specialized treatment for patients with this mutation that in clinical trials shrank the tumors of about half of all patients tested and had a duration of response of roughly seven months.
In the coming years, expect to see diagnostic device makers, drug makers, and even device makers working together to make treatment for all serious diseases, not just cancer, more personalized.
Megatrend No. 3: Consolidation
Finally, a more recent megatrend in healthcare has been consolidation -- although the reasons behind the need to merge or buy out other businesses have varied.
Arguably the less popular but still pronounced reason for healthcare consolidation has been corporate tax inversion. Within the United States, corporate marginal tax rates can fly as high as 40%, the second-highest corporate marginal tax rate in the world, behind only the UAE. The simple solution for U.S. businesses is to purchase a similarly sized business in an overseas market and relocate their headquarters overseas to a lower corporate tax environment.
A good example here is medical device kingpin Medtronic (NYSE:MDT) buying Covidien for $42.9 billion in cash and stock, and then relocating its headquarters from the U.S. to Covidien's home country of Ireland when the deal was done. Ireland's highest corporate marginal tax rate is a mere 12.5%, saving Medtronic potentially hundreds of millions of dollars in the process. For a company growing by low- to mid-single-digits, this could lead to a major boost in shareholder value.
However, the more popular reason for healthcare consolidation could be to mask a lack of organic growth. Big pharmaceutical stocks, for instance, are struggling under the weight of patent losses, which are exposing blockbuster drugs to cheaply priced generic competition. A vast majority of pharmaceuticals have been unable to replace their lost revenue quickly enough, resulting in falling revenue and generally stagnant EPS growth.
This is why we've witnessed Pfizer (NYSE:PFE), which has lost patent protection on the best-selling drug of all time, Lipitor, be so hungry for acquisitions. Last year, Pfizer pursued AstraZeneca to no avail (partly for its tax inversion potential), but wound up announcing the acquisition of Hospira in early February for $90 in cash per share, or close to $17 billion in enterprise value. Hospira's injectable drugs coupled with its growing biosimilars portfolio gives Pfizer instant access to accretive earnings growth potential and helps alleviate some of the $18 billion in revenue that's disappeared since 2010 because of patent losses.
I'm sure more megatrends in healthcare will emerge over time, but for now, I believe these three megatrends will be largely responsible for value creation and innovation within the healthcare sector throughout the remainder of the decade.
Sean Williams has no material interest in any companies mentioned in this article. You can follow him on CAPS under the screen name TMFUltraLong, track every pick he makes under the screen name TrackUltraLong, and check him out on Twitter, where he goes by the handle @TMFUltraLong.
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