Dr. David Gershon is the Chairman of the National Institute for Healthcare Economics and Regulatory Policy, is a designated Standard & Poor's 'Industry Leader,' and currently serves on the Advisory Board of Pictet & Cie, one of the largest Swiss private banks with $400 billion under management, and Sectoral Asset Management, a Lifesciences Hedge Fund and member of the State Street Global Alliance with $4 billion in assets under management. He has over 20 years experience as an oncology physician-researcher, healthcare economist, and healthcare regulatory attorney with expertise in FDA drug and medical device approval processes and CMS and private payor pricing and reimbursement. If you have comments about today's piece, you can email Dr. Gershon at [email protected].
What does the global economic downturn mean for the healthcare sector? And how will the new White House Administration reshape the healthcare landscape given the current macro-economic backdrop?
Global Economic Downturn: Credit Crisis and Possible Deflation
Deflation is a real possibility in 2009 as a consequence of a global recession. Currently there are 16 countries in recession, including 5 of the G8 with Russia and France not far behind and China, India and Brazil likely to continue to show slower downward growth for several quarters.
Several key indicators are predicting a deflationary environment going forward. US Consumer Price Index readings indicate a drop in pricing that has not been seen for 61 years and Producer Price Index readings also indicate a strong trend downward. Manufacturing readings are at an 18 year low. Jobless claims at a 26 year high. And State revenues continue to plunge due to drops in sales tax and property tax revenues.
Asset classes in most sectors are continuing to decline, led by real estate, energy and commodities. A sobering reflection of this is the loss of $30 trillion dollars in equity prices globally.
Credit markets and specifically Treasury Bond prices corroborate the real fear of deflation, which could have dire negative consequences on pricing power and therefore valuations in pharma and biotech companies.
St Louis Federal Reserve President James Bullard said the US central bank may need to take more dramatic steps, including "quantitative easing", to stop deflation, reminiscent of the unprecedented large Bank of Japan injections of liquidity in the 1990s once their interest rates went to zero.
While deflation is a low probability given the strong measures available through monetary and fiscal policy, the negative downward momentum on pricing power is significant and is likely to impact all sectors of the global economy, including life sciences.
New Head of HHS Rolls Out White House Healthcare Policy
In addition to these economic pressures, new White House healthcare policies will likely heavily regulate and reshape the healthcare industry.
The new head of the Department of Health and Human Services (HHS), Tom Daschle, is likely to put forth an agenda that has significant impact on healthcare services and insurance, as well as pharma, biotech, PBMs (Pharmacy Benefit Managers), CROs (Clinical Research Organizations), generics and device companies.
This could be expected to include a multi-year plan to roll out government negotiated drug pricing, drug re-importation for Medicare Part D, and a heavy emphasis on generic substitution that favors generic reimbursement over brand drugs (including bio-generics in the distant future), as well as patent reform legislation and FDA oversight and safety legislation. All of this will be underpinned by a new national healthcare program and State-by-State healthcare reform initiatives that are likely to be based on a cross between the UK's NICE and the Swiss mandatory insurance model. This could lead to a long-term down trend for small molecule and biotech drugs.
What is the prognosis of the American healthcare system? Perhaps we should all take two aspirins and call again in four years to find out. But I would suggest that maybe there's a silver lining.
A Silver Lining?
While these policy initiatives and economic pressures may pose significant risk to revenue growth, the silver lining is that this may support significant M&A and promote a much-needed industry consolidation. This may roll out as a full consolidation, over time, between pharma, biotech and generics companies.
Evidence of this trend can be seen in Pfizer's recent bid for Indian generic drug maker Ranbaxy and Daiichi's acquisition of the company. Other examples include Lilly's purchase of ImClone as part of a move towards biotech, Schering-Plough's purchase of Organon BioSciences, Roche's offer to buy Genentech and AstraZeneca's purchase of MedImmune.
While these mega-deals may represent a first phase in a consolidation trend, it is likely that we are in the early stages and that M&A among small and mid-sized companies will continue. These deals involve the purchase of Sirna Therapeutics, NovaCardia, Coley Pharmaceutical Group, Domantis, Cambridge Antibody Technology and Omrix, and mark a long-term attempt at pipeline replenishment to bring growth back to the industry.
According to Business Insights, "4 percent of M&A deals since 2003 have been valued at more than $500 million, while 70 percent were for less than $100 million. The average deal value for the five year period was $94 million." With the strength of the current credit crunch and economic downturn, valuations will likely continue to decline as cash starved smaller companies are acquired.
In a recent publication by Steven Burrill, he cited that nearly a third of publicly traded biotech companies were facing delisting because of their drop below the minimum price and market cap requirements for the Nasdaq.
The Irony of Our Times
The irony of our times is striking. The US government is spending hundreds of billions of dollars to bail out insurance companies, investment banks and auto companies who abandoned risk management regimes and employed excessive leverage to increase revenues. Yet the critical areas of healthcare and pharmaceuticals--which arguably have greater intrinsic value than the products created by these other industries--will not only be ineligible for government assistance, but will be subject to tighter regulation and pricing pressures.
Where was the government when tens of thousands of jobs were lost as large pharma cut jobs and as small and mid-sized biotech companies halted clinical studies and closed their doors?
Shouldn't we--as part of the Obama era of change and as a matter of good policy--be promoting science, innovation and the development of next-generation medicines to promote the public health, rather than saving companies that demonstrated (arguably) reckless behavior?
Ultimately, with the large amount of cash and the strong cash flow in the pharma industry, acquisition and consolidation of pharma, biotech and generics companies over the next several years should mold an industry that is more cost effective and sensitive to the needs of the new direct to government model that recognizes that government is the new driver of sales and revenues and not the consumer.
With increased M&A, we are likely to see a single drug manufacturing industry with strong economies of scale, diversification in product mix and, in general, a new compelling growth story. One that will be good for the healthcare industry and our aging society, which is increasingly demanding better medicines and treatments. - Dave Gershon