The healthcare merger binge on Monday came in the nick of time. While the overall US economy is struggling to grow at anything faster than the puny pace of 2.3% per year, healthcare spending has been on a tear, rapidly grabbing an ever larger part of the economy. If it hadn’t been for the nearly 8% growth in healthcare spending last year, there might not have been much of any growth.
Revenues of healthcare companies in the S&P 500 grew by 10.8% last year, according to FactSet, by far the fastest-growing sector. In Q1 this year, revenues are expected to grow 9.1%, and for the whole year 6.9%. Earnings for the year are expected to soar nearly 16%.
Healthcare has some advantages over other industries. It’s the only place in the economy where consumers have no clue at the time of purchase what the products and services will cost them or their insurers. Yet these could be big-ticket items, costing more than a car or even a house in some cases. Pricing is more than opaque, and purposefully so. The industry knows how to use fear to motivate consumers to buy. And it’s full of state-protected monopolies and anticompetitive structures dedicated to taking an ever bigger bite out of the economy. It wreaks havoc on federal, state, and municipal budgets. It strains consumers. And a considerable part of that glorious revenue stream is sooner or later funded by taxpayers.
The Biotech index NBI is up 56% over the last 12 months, even after last week’s sell-off. It’s up 120% in 24 months and 186% in 36 months. In fact, it has been the best performing sector for five years in a row. “No sector has ever done that,” according to Credit Suisse. In 2000, the peak of the prior biotech bubble, which collapsed mercilessly, there were 67 IPOs. In 2014, there were 82 IPOs. So far this year, 15. But this time, it’s most definitely not a bubble, Credit Suisse said; just a “new era.”
More broadly, the overall healthcare sector is up 110% over the last three years, according to FactSet, followed in the distance by consumer discretionary.
Hobbled by lack of innovation and dreading competition, healthcare companies, and pharmaceutical companies in particular, have gone on a shopping spree. In 2014, pharmaceutical companies set a record of $212 billion in acquisitions. So far this year, the sector is on track to blow out that record. The sector has already announced $89 billion in mergers, up from $56 billion in Q1 2014.
Big drug makers are fretting. Their patents are expiring, and they fear that they have to compete with drugs that are doing the same thing for less. It’s called the “Patent Cliff.” It boils down to this: Big Pharma hates competition.
And it’s short on new blockbuster drugs. So they’re on a shopping spree to consolidate the industry and weed out competition. They’re borrowing records amounts of nearly free money, made readily available by the Fed and other central banks for just that purpose, and they’re buying other drug makers at these record prices. They’re taking advantage of central bank policies that are designed to improve corporate “results” by engaging in financial engineering. Which is a lot easier than actually finding a new drug and competing on price with current drugs.
So Monday, Teva Pharmaceutical, Israel’s largest company by market value and revenue, and the world’s largest generic drug maker, announced that it would acquire US neurology drug maker Auspex Pharmaceuticals. The problem Teva has is that its biggest drug, multiple sclerosis injectable treatment Copaxone, is going to get some competition over the next few years from oral treatments and generics. So it would pay $101 a share or about $3.2 billion, for Auspex, whose shares jumped 41.5%.
Since rumors and insider knowledge of these deals spread long before the deals are announced to the rest of the world, shares tend to rise way in advance. Hence, a look at the movements 30 days and 90 days ahead of the announcement can be illustrative.
The price Teva offered amounted to a 41% premium over the closing price on Friday, a 50% premium over the closing price on February 27, and a 100% premium over the closing price on December 30. Somebody must have figured something out.
Also on Monday, Horizon Pharma, headquartered in Ireland, said that it would buy Hyperion Therapeutics, based in California, for $46 a share, or about $1 billion. This will allow Horizon to add two drugs that treat genetic disorders to its portfolio of “orphan drugs.” Drugs that qualify under FDA rules as orphan drugs – they treat diseases that affect fewer than 200,000 people in the US – are good deals. There are government incentives to develop them. Once developed, drug makers can charge higher prices and can scrimp on sales expenses, which makes for some very fat margins.
The news was apparently better for the buyer: Horizon’s shares jumped 18% on Monday, while Hyperion rose less than 8%. But wait… the 30-day takeout premium was 71% and the 90-day premium a cool 120%. Just about everyone must have known for weeks that something was in works.
UnitedHealth Group, the huge health insurer, said it would acquire pharmacy benefits manager, Catamaran Corp., for $61.50 a share, or about $12.8 billion. UnitedHealth will combine its own pharmacy benefits unit with Catamaran to form an even larger unit that may be able to exercise more control over drug pricing. Catamaran is itself product of a 2012 merger (SXC Health Solutions and PBM Catalyst Health Solutions). Consolidation is hot. Among others, industry leader Express Scrips already bought Medco Health Solutions.
Catamaran shares jumped nearly 24% on Monday. But the 30-day takeout premium was a measly 20% and the 90-day premium 15%. Oops.
Then there’s Fujifilm, Tokyo. It used to be the arch-competitor of Kodak. But when digital photography made rolls of film largely irrelevant, the company reinvented itself: “From making cosmetics and pharmaceuticals to contributing to the exploration of the moon, Fujifilm has been reborn,” it explains on its website.
In that vein, it said it would buy Cellular Dynamics, based in Madison, WI, for $16.50 a share, or about $307 million, which turns out to be a fabulous 18 times revenues for the money-losing company that is “a leading developer and manufacturer of fully functioning human cells in industrial quantities to precise specifications,” as the statement said. Its shares surged 107% on Monday. But they’ve been volatile, with a stunning 30-day premium of 213% but a 90-day premium of 129%.
Even the record-breaking five-year run-up in prices isn’t stopping acquirers from paying big premiums because now, money is essentially free, and it’s at peak valuations that mergers go haywire. Monday’s healthcare merger mania totaled $17.3 billion. But clearly, as Credit Suisse pointed out so eloquently, this isn’t a bubble, but just a “new era” of healthcare stocks.
In the same breath, startup company “valuation” fever has reached a state of delirium. Read… It’s Just a Question of Whose Capital Will Be Destroyed
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