As we complete the worst January in the history of the U.S. equity markets, we are surprisingly optimistic about the prospects for healthcare equities from both a fundamental and technical perspective.
For much of the market, and in particular the healthcare sector, the November lows appear to us to have the making of a significant long-term bottom. Essentially every major healthcare sector appears to be in the midst of a classic bottoming process based on technical analysis. Furthermore, year-end earnings results to date have been unexpectedly strong at the vast majority of major healthcare companies. It??s clear that the industry has long been preparing for a shift in healthcare policies concurrent with the ending of the Bush administration and it??s eight-year period of lax oversight. Finally, and most importantly, we believe that 2009 will finally be the year of enormous consolidation in healthcare, particularly in the large capitalization, pharmaceutical and biotechnology companies.
Today??s challenges facing big Pharma have been well documented and include a slowing global market forecast, more conservative regulatory agencies, increasing therapeutic substitution and continued pricing pressures. The culmination of these forces is that by 2012, generic drugs will account for an estimated 80% of all our Rx??s written and by 2015, 55% of big Pharma??s 2008 U.S. revenues will have eroded due to expirations. During recent years, big Pharma has responded by increasing licensing activity, while slowly embarking on cost cutting initiatives (mainly within their commercial organizations) to make up for the steady deterioration in U.S. prescription growth to its current flat to negative level. However, the recent workforce reduction announcements by Pfizer, Glaxo SmithKline, Bristol-Myers Squibb and Schering-Plough signal a new level of desperation: These cuts were mainly in their R&D and manufacturing organizations. This suggests to us that big Pharma may not be able to make their numbers through operating expense reductions alone and without any major blockbuster products in their pipelines to save them, they are left with only one option: Consolidation.
The following is a list of our favored acquisition targets in the pharmaceutical and biotechnology sectors at various market capitalizations:
Market Cap: $25B+
WYE: Sold to PFE for $68 billion.
BMY: Current market-cap $43.7 billion. A perfect fit with many other large cap pharma??s; BMY spends nearly $10 billion on SG&A and R&D that could be mostly redundant to an acquirer.
Target $35+
Market Cap: 10B to $25B
BIIB: Strong franchises in neurology and cancer as well as a burgeoning pipeline. Could be worth $72-$75 to a strategic acquirer.
AGN: The dominant global franchise in economically insensitive ophthalmology as well as world leader in cosmetic dermatology with Botox, breast implants, dermal fillers and new Latisse eyelash growth drug. Target $65
Market Cap $1B to 10B
SHPGY: Leading global player in drugs for Attention Deficit Disorder as well as orphan drug categories. Spends 64% of sales on SG&A of R&D that could easily be rationalized by acquirer. Target $60-$65
CEPH: Leading franchises in neurology and new cancer treatment Treanda for Non-Hodgkin??s Lymphoma. Could be worth $125 to strategic buyer.
MRX: This leading dermatology company will soon introduce Reloxin, the first U.S. alternative to Botox. It??s new Liposonix non-invasive liposuction product line could be introduced in the U.S. in 2010. One year target $25-$30.
Beyond the prevailing consolidation theme, we also believe that 2009 will usher in a period of broadening coverage for those without health insurance in the United States. In our view, the broadening of health insurance coverage to the nations 47 million uninsured bodes extremely well for one of the most depressed healthcare subsectors, the hospital industry. Despite a horrendous performance by the group in the fourth-quarter of 2008, we believe the outlook is increasingly favorable for the U.S. hospital sector. With approximately 20% of billed revenues uncollectible as ??bad debt? for the uninsured, there could be a surge in industry profitability as the Obama Administration delivers on its promise of healthcare coverage for the uninsured. Highly levered balance sheets at Tenet Healthcare Corp. and Health Management Associates position these equities to surge as declines in ??bad debt? propel the company cash flows and profits and as the financial markets begin to thaw and allow favorable refinancing opportunities.
Summary
A depressed and gloomy investment environment has always been an opportune time for experienced investors to prosper within the growing dynamic healthcare sector. As we enter our 20th year as the nations most tenured healthcare hedge fund, we are actively positioning our portfolios to capitalize on the opportunities presented by this global credit crisis. With approximately one-half of our capital base comprised of equity from the general partner, we remain supremely confident in our ability to bounce back and prosper as the inevitably growing demand and undeniable advances in technology propel the global healthcare industry forward.
For our investors, there has never been a question regarding our liquidity and our integrity. We have never changed any of our fund liquidity terms. Our firm utilizes an independent third-party administrator to review and verify all of our investing activities. We have always operated within the various guidelines prescribed by each of our different fund structures and have prospered over the last two decades by doing so.
We appreciate your ongoing support and look forward to rewarding our partners in 2009 and beyond.
Sincerely yours,
LARRY N. FEINBERG
