A Non-Scientific COVID Thought

HealthCare

The Case for Low-Occupancy Elevators 

I was listening to the Washington Post Reports on podcasts while running this morning.  At the end, the podcast had a little blurb on elevators that I found interesting, but unsatisfying.  In it, the reporter, Ben Guarino, talked about elevators being unique, enclosed, etc., then made reference to a few things that “we” should do (e.g. use high efficiency air filters, maintain spacing), primarily based on his opinions.  That was it.  If felt like the piece lacked a bit of what’s referred to as “solutions journalism”, which essentially means you report the information, but you also offer some specific (even evidence-based) advice.  Here’s just a bit more on the subject of elevators, if you are returning to work in the time of COVID: 

Case 1.  Touching. 

I’ll take the most liberties v/v science here, just based on personal experience.  Most people don’t touch one another in an elevator, unless it is packed.  In the era of COVID, I’m guessing people will try to avoid packing elevators.  Don’t touch other people if you can help it. 

Case 2.  Respiration and Synchronous Occupancy. 

Say you’ve been working from home and staying healthy.  You wake up Monday and get to the office first.  You ride the elevator alone up to your floor and begin work at your desk.  That elevator ride sure seems low-risk.  The chance of you giving yourself a new coronavirus infection is, um, zero.  Say, instead, you arrive at the same time as another eager beaver and ride the elevator together.  Now, the chance of one of you sneezing, coughing, breathing and giving the other coronavirus is non-zero.  However, it’s still low, because the chance of one of you having COVID is based on two persons, conditional probabilities and the prevalence rate for your population.  Say, instead, there are three of you.  Not only do the risks and consequences of transmission increase because there are now three people who might pass on the virus, but because there are twice as many potential recipients as in the two-person case.  The bottom line here is that you want as few people on the elevator as possible at any given time. 

Case 3.  Respiration and Asynchronous Occupancy. 

You might also be worried about riding an elevator after an infected person rode it.  If that person coughed or sneezed, are there droplets on the surfaces of the elevator?  Are there still smaller droplets floating around the elevator compartment?  Based on a review of some literature on the subject, I would assert that small droplets are the bigger concern.  According to an article by Justin Morgenstern, found here: https://first10em.com/aerosols-droplets-and-airborne-spread/, droplets are often “divided into small dropletsand large droplets. Large droplets drop to the ground before they evaporate, causing local contamination. Disease transmission through these large droplets is what we often refer to as “droplet/contact spread”, where disease transmission occurs because you touch a surface contaminated by these droplets, or get caught within the spray zone when the patient is coughing. Aerosols are so small that buoyant forces overcome gravity, allowing them to stay suspended in the air for long periods, or they evaporate before they hit the floor, leaving the solid particulate (“droplet nuclei”) free to float very long distances, causing what we often refer to as “airborne” transmission. (Nicas 2005; Judson 2019).”  Just as with other surfaces, you can wash your hands or use antiseptic after touching the surfaces of elevators (buttons, handrails, etc.).  Thus, large droplets are a risk you can manage.  Aerosols remain in enclosed spaces for several minutes after someone sneezes or coughs.  Just how much and for how long is determined by air exchange (e.g. elevator doors opening and closing, ventilation systems, etc.).  In a situation in which you enter an elevator and don’t know who was in it before you, it is hard to judge or control your aerosol risk. 

Case 4.  Combined Synchronous and Asynchronous Risk. 

Xiaoping et al., conducted a study in which the authors simulated respiratory droplet distribution that can be found here:  https://www-tandfonline-com.du.idm.oclc.org/doi/full/10.1080/10789669.2011.578699 

In the study, the authors found that there were two risks to a room co-occupant – direct and indirect. The greater risk, as modeled, was direct exposure to droplets.  This is when someone sneezes or coughs in your direction.  The lesser risk was indirect droplets (small droplets that aerosolized and filled the room).   

The following table comes from the Morgenstern article, although it’s adapted from a 2006 study by Morawska: 

Note the numbers and distribution of small aerosols.  While it’s highly unscientific, I draw the following conclusions from these data and my readings on this subject: 

  1. Wear a face covering.  Most people reflexively tell you to do so to protect others (which is true), but I also think it protects you in this case.  Check out the simulated cough data from the Xiaoping study: 

Ask yourself — would you rather have a barrier between you and the person doing the coughing?  Sneezes and coughs travel, so “social distancing” in an elevator isn’t sufficient.

  1. Exit the elevator if someone does cough or sneeze (maybe even hold your breath?).  As you can see from the time measurements above, it takes seconds for a room to fill with aerosolized particles (or carbon dioxide, as is modeled in this case), once someone coughs.  Indirect exposure is inevitable, but you can minimize the time you are exposed. 
  1. Don’t talk (or sing) in the elevator as a courtesy.  You may be infected and asymptomatic, and everybody should do their part.  Plus, who knows if you can carry a tune. 
  1. Encourage your company or building manager to take steps to reduce risk.  A simple rule might be to limit elevator occupancy to four people at once (if it’s an ordinary office-building sized elevator).  The building manager could also conduct cleanings more frequently, take elevators out of service periodically if there’s a concern around asynchronous transmission, etc.  Your employer might offer added flexibility around work hours in order to reduce peak elevator utilization. 
  1. Pay attention and adapt.  If you are worried about riding the elevator, use it at off-peak times or take the stairs.  Maybe even learn a bit about the elevator’s ventilation system and whether it helps with airborne viruses. 

The following two articles are interesting reads that provide some added information on the topic: 

https://www.nytimes.com/2020/05/13/well/live/can-i-get-coronavirus-from-riding-an-elevator.html?auth=login-email&login=email 

https://www.govtech.com/em/emergency-blogs/disaster-zone/covid-19-transmission-scenarios-explained.html   

Media:  Some Opening Thoughts

Media & Communications

After having spent some time reading, communicating and listening on the topic, I’m ready to start posting on my new passion, Media and Communications.  I intend these first posts to inform in the era of COVID, and to draw readers’ attention to the podcast, which I believe is (at least currently) a superior form of news dissemination.

Movies. 

In the movie industry, much has been made about the successful release of Trolls World Tour, which was released directly to streaming services in April.  According to an article by The VergeTrolls World Tour took in nearly $100mm in its first three weeks of availability, which is certainly quite respectable in the context of a $90mm budget and in light of a more favorable split of gross revenues to the studio.  However, I believe it’s important to remember that this is possibly a best-case scenario for such a release.  First, Trolls World Tour was released in early April, when the countrynew infection rate and travel restrictions were at a peak.  In other words, people had few alternatives but to tune into new theatrical releases over streaming services.  Second, Trolls World Tour was one of only a handful of movies to be released, rather than postponed.  This will almost certainly not be the case by next summer, when the industry’s inventory is bulging at the seams. 

United States new coronavirus cases – accessed May 28, 2020 

Source: University of Washington coronavirus model 

Arguably, the near-future presents significant challenges for studios.  The model had been to release new blockbusters to 4,000 screens and make a significant amount of money in a relatively short period of time.  Here’s Trolls’s box office take, according to boxofficemojo.com (accessed May 28, 2020):  

As states and theaters reopen, people won’t be spending as much time at home.  Studios won’t initially be greeted with the possibility of 4,000 open and packed theaters as a means for content distribution.  Only a fraction of these theaters will be open, and audiences will likely be much smaller for each showing.  Theaters, confronted with their own economics (i.e. that of making most of their profits on weekends) will have to make a calculated decision regarding when and whether to open at all. 

In others words, at least in my opinion, the economics of a theatrical release won’t look that great, and neither will a pure digital release.  For those that are interested in trying to read tea leaves, watch for news on Christopher Nolan’s “Tenet”, which is still slated for a July 17 theatrical release.  Warner Brothers spent over $200mm to make the film ($300-350mm, if promotion is included, according to IndieWire)so the stakes are certainly high.   

Podcasts. 

Switching gears, I wanted to highlight a recommendation.  For those of you who are interested in factual reporting and haven’t actively engaged with journalism podcasts, I am here to encourage you to do so.  Podcasts offer several advantages over other forms of journalism, and they may represent one piece of the remedy for the partisanship that seems to pervade mainstream and online journalism.  As I see it, podcasts offer you the following: 

  1. The truth (more or less).  I’m sure you need to be choosy, but I’ve found that many of the podcasts put out by even mainstream franchises offer a much less biased view of the facts.  The example I will give here is Rabbit Hole, by the New York Times.  While it’s true, Rabbit Hole is still a product of a north eastern narrator and narrative, the product is more of an exploration of the effects of social media outlets like YouTube than a polemic on the persons profiled within. 
  1. Access.  Podcasts are usually free.  I listen regularly to the Washington Post’s Post Reports podcast, where I’m unwilling to subscribe to the Post, which uses a hard paywall for its content.  As with Rabbit Hole, I find Post Reports to be relatively unbiased (borderline didactic in some cases), which makes for low blood pressure listening. 
  1. The voice.  Unlike with the written word, podcasts let you hear the voice of those doing the reporting and those being reported on.  It’s a different and often better experience.  The only thing you don’t get is a visual representation. 
  1. Time assurances.  For those with a schedule, podcasts are ideal.  If you are going on a run, you can pick a podcast that fits your budget.  It’s right there!  If you have 45 minutes before your next Zoom meeting, bingo! 

For anyone who wants a recommendation, my current three favorites are Inside the HivePost Reports, and Reveal. 

SORRY FOLKS, PARK’S CLOSED

HealthCare

Why Governor Polis won’t sign a Public Option into law this year. 

First.  Sentence.  I am not here either to support or express opposition to the Colorado State Option for Health Care Coverage (the new name for the Public Option).  I am here to analyze the situation... 

It was January 14th, and state lawmakers descended on the University of Denver campus to kick off the legislative year with their “Big Ideas”.  (With the temperature hovering right around freezing, and with snow beginning to fall, I decided to take in the event via a live stream.)  Governor Polis kicked off the session by talking about a “Public Option” for Colorado citizens, and why it would both reduce health care costs and the ranks of the uninsured.  He has since advocated vociferously on its behalf.  However, by January 19th, the CEO of Centura Health posted an editorial to the Colorado Sun explaining how adopting the Public Option was unsustainable and would potentially cause employers to drop coverage, thereby reducing access.  At various times, hospital and health plan industry groups have expressed their opposition to the proposal. 

As I see it, there are at least two major reasons the Public Option will not be passed into law this time around.  One is a policy reason, and the other is a marketing reason.   

Background: 

For those who still struggle with what the Public Option is, here is a concise version.  Some people buy health insurance the way they buy car insurance.  They shop for and buy an individual policy that covers them or them plus their family.  If there is a Public Option, the government would artificially set the price for hospital care below the price the hospitals would otherwise charge and pass that savings on to people who buy individual health insurance.  According to Connect for Health Colorado, about 170,000 Coloradoans have private medical insurance purchased through the exchange (roughly 3% of the state’s population).  https://connectforhealthco.com/metric-and-reports/

Policy: 

From a policy point of view, I believe the proposed legislation (HB20-1349 for those who want to look it up here: https://leg.colorado.gov/bill-search?search_api_views_fulltext=HB20-1349) lacks one key ingredient – carrots for Colorado hospitals and health plans.  As a consequence, it is not surprising to see those industry participants oppose the legislation.  Here are their respective statements: 

Colorado Hospital Association: 

https://cha.com/colorado-hospital-association-opposes-colorado-state-option-legislation/ 

Colorado Association of Health Plans: 

https://colohealthplans.org/proposal-for-government-insurance-plan-falls-short-for-most-coloradans/ 

In order to help the hospitals partner to reduce health care costs, the Public Option needs to help hospitals become more efficient.  For background, here is an example of what a hospital’s financials might look like: 

By reducing the hospital’s revenue without helping reduce its cost, you are driving it from break-even to loss-making.  (Yes, there are many Colorado hospitals operating well above break-even, but there are also many who are notexplaining the bill’s varied intended effects offers a high degree of difficulty).  Politically, it is difficult to get after labor costs (50%), because those are salaried doctors, nurses and so forth.  It is also difficult to get after “other” expenses, b/c those are items like rent, repairs and maintenance, insurance, etc.  What might work is getting after supplies expense.  Just as with prescription drugs, many supplies are highly priced and quite profitable for those that manufacture them.  Hospitals pay very different prices for these supplies, and there is very little transparency around contracts.  Colorado might explore the creation of a purchasing pool for high-priced, high value supplies and let hospitals and other appropriate entities in the state participate.  If, by doing so, hospitals could reduce their supply costs by 15-20%, this would create room for the State Health Option.   

For the insurers, the main complaint, beyond the fact that you are creating a bad precedent, is that the Public Option proposal puts an awful lot of power in the hands of the Commissioner of the Department of Insurance.  Among other elements, which can be found in the Bill, the Commissioner would be required to ensure that there are at least two health insurance carriers offering the Public Option in every county in the state.  Currently, Anthem Blue Cross/Blue Shield is the only carrier in 22 counties.  Thus, if the Bill is not amended, the Commissioner would be authorized and compelled to make at least one other carrier compete in those counties.  This is the equivalent of telling Burger King – “folks in Summit County only have a McDonald’s in town, so you have to open a store”. 

Marketing: 

Governor Polis and other proponents of the Public Option have primarily argued that “it’s the right thing to do.  Colorado hospital prices rank among the nation’s highest, and Colorado hospital profitability is second only to Alaska.  However, one of the main arguments against the Public Option is that it will hurt smaller hospitals and, potentially, force those to reduce services lines or, worse yet, close.  Indeed, in January, Memorial Regional Health in Craig closed its labor and delivery department.  According to the Colorado Rural Health Center, 18 rural hospitals in Colorado are loss making and, according to a report produced by FTI consulting in concert with the Partnership for America’s Health Care Future (an industry lobbying organization), 23 rural Colorado hospitals would be at risk of closing should the Public Option pass. 

Paradoxically, part of the intended effects of passing the Public Option into law is to redistribute wealth amongst the state’s hospitals.  Many rural hospitals would actually fare better financially with the Public Option in place, compared to the status quo.  However, the Bill’s proponents and sponsors have not latched on to this message.  The title of the Bill ought to be “Defending Access to Quality Health Care in Rural Colorado”.  Proponents could then speak to the fact that many rural hospitals need help, many rural communities do not have enough practicing physicians, and many rural residents have access to only one health insurance carrier. 

Summary: 

Before the Bill text came out and the world fell victim to COVID-19, it was not clear whether HR20-1349 would pass.  Now that 1) the proposal is in print, including not only the issues I present above, but the enumerated expansion of the Public Option to the small employer market2) stakeholders have developed their positions fully, 3) COVID-19 has ripped through hospital financials like a tornado, and 4the legislature is not set to reopen until May 18 (reminder: the fiscal year begins July 1), I think we’lbe revisiting this in 2021. 

 

EXAS: A Class Assignment Turned Investment Idea

Investments

As with everything that I will post to the investing section of this blog, the following should not be construed as investment advice.  It is simply meant to be the ramblings of a now-retired individual with some time on his hands.  I am not affiliated with any organization and have no interest in publishing other than for the intellectual exercise.  While I make an effort to be accurate with my facts, I do not assert that any of the following information is 100% reliable.  If I own a stock upon which I comment, I will always say so.  In  this case, I own Exact Sciences (EXAS) in a personal account.

So, the background to my interest in Exact Sciences stems from having done research on colorectal cancer screening for a class on multicultural health communications.  In doing so, I came to appreciate that efforts to improve screening adherence were significant, and that there were several populations that Exact could access with Cologuard.  In aggregate, these opportunities should allow Exact to grow at substantial rates for the foreseeable future. 

Quick Background: 

Exact Sciences sells Cologuard, the stool-based test that is approved for colorectal cancer screening and included in guideline recommendations as one alternative.  The company takes in about $480 per test and generates a mid-70s% gross margin.  These are good numbers for a medical technology company, since the price is reasonable, and the margin is strong enough to support high FCF margins at scale.  In the fourth quarter, Exact’s screening revenues grew 60% to $229.4mm (>$900mm annualized). 

Colorectal cancer is one that, if caught early, can be treated relatively effectively.  I won’t go into all the details, but local and regional CRC boast 5year survival rates of 90% and 71%, respectively.   Patients diagnosed with advanced CRC have a 14% chance of being alive 5 years post diagnosis. 

For years, the U.S. Preventative Services Task Force and the American Cancer Society (ACS) recommended that persons begin screening for colorectal cancer at age 50.  However, CRC impacts a lot of persons younger than 50, and they tend to be diagnosed with more advanced disease as a result.  These are persons in their prime, so the impact on them and loved ones is outsized.  The rate of CRC incidence in persons under the age of 50 is growing at an outsized clip, which is in part why the ACS recently changed their recommendation to persons aged 45 and above.

 

 

Given the weight of the ACS recommendation, a lot of other entities have begun to follow suit.  In Colorado, for example, legislators should eventually hear a Bill that would mandate that all insurance companies regulated by the DOI cover screening beginning at age 45. 

Racial/ethnic disparities exist when it comes to colorectal cancer screening.  I’ll skip the detailed data here, but there are several reasons for this.  African Americans, Latinxs and Asian Americans do not trust the medical establishment as much, they tend not to have access to colonoscopy facilities to as great a degree as whites, and there is a stigma associated with screening for some subpopulations.  As the U.S. ages, the percent of persons of color reaching the age where screening ought to begin is growing.  Today, 30% of candidates are non-white.  Importantly for Exact Sciences, 1) there are significant efforts being made to close these racial disparities (in the form of PSAs, outreach, etc.), and 2) many of the barriers to screening lie with colonoscopy, not Cologuard. 

Issues: 

There are a few approved and recommended CRC screening technologies.  Two of these, in theory, compete directly with Cologuard.  These are FOBT (Fecal Occult Blood Tests) and FIT (Fecal Immunochemical Tests).  However, FOBT and FIT are not as comprehensive as Cologuard, nor are they as easy to take.  Most importantly, however, they are much less well known.  I spoke with a friend recently who indicated she wasn’t even aware of the non-invasive alternatives until she saw the Cologuard commercials.  The other primary competitor to Cologuard is colonoscopy.  It is an entrenched way of screening for a couple of reasons.  First, it allows doctors to remove polyps (cancerous or pre-cancerous) during the exam.  If you get Cologuard and a positive result, you must schedule a colonoscopy as a reflex exam.  Second, colonoscopies are big source of revenues for gastroenterologists and the facilities in which they work.  Thus, I don’t think we’ll see colonoscopies go away entirely.  However, I do think Cologuard will fit into the continuum as a complement to colonoscopies.  For populations for which colonoscopies carry a big stigma (African American malefor example) or for which colonoscopy represents a monetary and structural challenge (rural populations, those of low socioeconomic status), Cologuard is clearly the better first option. 

Based on a review of Exact Sciences’ advertising and promotional activity, I think the company has some (productive) work to do.  Thus far, I think the company has largely ignored the low hanging fruit from an adherence point of view.  Advertisements target a white audience with white characters and messages.  There no Spanish-language advertisements I’ve been able to identify and the Cologuard patient welcome guide was only recently made available in other languages using a literal English translation. 

Governance (based on behaviors and documentation) and management appear to be pretty good.  I know and like several members of the B.O.D., although I don’t know the executive team.  Most of the executives from Genomic Health have left, so the transaction is clean.  Still, it remains to be seen how the cultures mesh (or don’t). 

Market Opportunity: 

According to Exact, there are about 106mm persons aged 45-85 in the U.S. at average risk of developing CRC.  We will never screen 100% of the recommended population.  Based on data for the most adherent populations (high socio-economic status whites), it’s possible we’ll achieve screening rates between 70% and 80% with time.  At 70% adherence and assuming persons get screened every three years (the current ACS recommendation and Medicare reimbursement schedule), the market opportunity in the U.S. alone is $12bn.  (In its presentation, the company points to an $18bn market, using a slightly higher price per test and not haircutting for practicality.) 

Today, the company has about 5% of the U.S. screening market.  Whether Cologuard runs out of gas at 15%, 25% or 35%, there’s a long way to go in theory. 

Other Assets: 

Genomic Health.  Exact is trying to build a diversified cancer testing company.  In July 2019, Exact announced it was buying Genomic Health for $2.8bn.  In November, the company closed the transaction.  Genomic Health is a breast cancer testing company, not dissimilar in focus to Exact.  The company sells a product called Oncotype Dx, which is used to grade breast cancer and determine what therapy to take, as well as a woman’s risk of experiencing recurrence.  It is not growing nearly as fast as Cologuard, but it is a valuable, high-margin diagnostic, and the business model is moreorless the same (in this case, the doctor obtains a specimen and sends it in).  There are potential integration risks, but there shouldn’t be any funky revenue-recognition alignment issues, etc. 

https://leadingcancerdiagnostics.com/wp-content/uploads/2019/07/EXAS-GHDX-Transaction-Press-Release.pdf 

Liquid Biopsy.  I’m not sure if what Exact Sciences has in liquid biopsy is any good or not.  If it’s good, it’s very valuable.  If not, I hope the company realizes as much and shuts things down.  Liquid biopsy is probably the hottest area in cancer diagnostics right now.  It involves screening and diagnosing cancer from a blood sample, which turns hard to access and early cancers into tractable problems.  Guardant Health is probably the leading publicly-traded company pursuing liquid biopsy, and it has a near-$7bn market cap (on 2020 revenue guidance of $280mm at the mid-point). 

Valuation: 

In rough numbers, EXAS bought Genomic Health for $1.1bn in cash and 17mm shares.  The company is now approaching 150mm shares outstanding, and the stock price is ~$60/sh.  Based on the timing of the close and EXAS’s cash balance, it looks like the cash has transferred — ergothe year-end balance sheet ($320mm cash/MS, $830mm debt) should represent the current stateofaffairs.  On these numbers, Exact’s EV is roughly $9.5bn, against previously issued revenue guidance of $1.6bn for 2020 (~6x).  Exact’s management recently withdrew 2020 guidance on COVID-19 disruption, so it’s unclear what the near-term run rate is going to look like.  I think it’s safe to say, though, it’s going to look quite bad.  Colorectal cancer screening is clearly not top-of-mind right now, and it probably won’t be for a quarter or two after COVID-19 fears subside.  For this reason, I think it probably makes sense to be patient with EXAS.  That said, when the dust settles, I think this is a very intriguing opportunity.   

Reducing Prescription Drug Costs in Colorado

HealthCare

An Evaluation of the Department of Health Care Policy and Financing Report, Reducing Prescription Drug Costs in Colorado

Last week, the Colorado Department of Health Care Policy and Financing (HCPF) published a report on prescription drug costs in Colorado and what might be done to bring them down. It’s an extensive report, so I thought I’d distill some of what was discussed, as well as provide an evaluation of some of the proposals contained within.

For those who are interested in a little background and rhetoric concerning trends in drug prices, costs and utilization, feel free to read pages 11-14 of the report. These pages are concise and informative.

The true conclusions HCPF draws begin on page 15, within a section entitled “Major Drivers of Prescription Drug Prices”. HCPF covers 11 drivers, to which I’ll add my two cents below:

  1. Patent Protections. HCPF faults the pharmaceutical industry’s habit of evergreening patents in order to extend the period under which companies enjoy high prices and exclusive marketing rights. A simple example of evergreening might be to reformulate a pill that’s taken three times a day in order to provide the convenience of once-a-day dosing. The manufacturer would then ask for a new patent on the improved formulation. While evergreening is definitely something the industry does, it is much less successful than it was years ago. Today, Pharmacy Benefits Managers (PBMs) and their clients (states, employers, etc.), simply won’t pay for these incremental improvements. Thus, in most cases, drug exclusivity and monopoly pricing usually expire at the time the composition-of-matter patent expires on a drug. What’s more, while evergreening does add to the cost of pharmaceuticals in the U.S., there isn’t an obvious fix to what we do already. Generic companies challenge patents all the time and now even use a new technique known as Inter Partes Review, which accepts a lower standard for defeating patents.
  2. Anticompetitive Practices and Price Fixing. In addition to evergreening patents, HCPF alleges that the industry engages in anti-competitive behavior in order to protect profits. Specifically, the report asserts that brand companies pay generic companies not to introduce low-priced alternatives. As a point of fact, this is a correct statement. However, the reverse payments brand companies make to generic companies aren’t terribly common, nor are they usually major drivers of pharmaceutical cost. The most important element is the fact that brand and generic companies “split the baby” by settling on a date upon which the generic company can launch. This is usually a date after the expiration of an early patent, but before the expiration of a later patent. By agreeing to a date certain launch, both sides take the risk of a total legal defeat out of the equation. In my experience, companies do abuse this stratagem, but not egregiously. What’s more, the issue has been challenged legally on numerous occasions, with the industry position being upheld virtually every time.
  3. Specialty Drugs. Look up the definition of a specialty drug online, and you’ll get 100 answers. In theory, a specialty drug is one that requires special handling, packaging, patient support, supply chain management, etc., but the practical answer you’ll get from pharmacists is that a specialty drug is just an expensive drug (usually for a small population). In its report, HCPF points out that the industry has focused its R&D efforts disproportionately on specialty drugs and that their introduction is contributing significantly to costs. This is all true. However, this is an artifact of a few factors. First, the industry is struggling to identify widespread diseases with addressable unmet needs. Certainly, this issue should be the industry’s to solve. However, because the industry hasn’t yet figured out a solution, it’s turned to charging very high and sometimes unjustified prices. Second, the Medicare Part D drug benefit splits the costs of catastrophic coverage 95% government and 5% patient. Thus, by charging extremely high prices, the industry knows it can put the onus on the Federal government disproportionately. There are some green shoots regarding new value-based models of drug pricing, as well as Part D reforms that might help blunt the specialty drug trend, but I don’t think we should expect any dramatic changes near-term.
  4. Hospital Pricing Mark-up and Site of Care Pricing Differentials. This is probably the first issue on HCPF’s list that both can and should be addressed. At issue is the fact that providers direct where a patient receives outpatient injectable drugs. Since health insurers and governments typically pay more in a hospital outpatient setting when compared to a clinic or doctor’s office, providers direct patients to get their infusions at the hospital. Drug companies certainly help sustain this practice when it is in their interest. Johnson & Johnson, for example, made it very difficult for physicians to prescribe Pfizer’s Remicade biosimilar, Inflectra, by contracting aggressively with hospitals and physician groups. Unfortunately, industry lobbying and litigation works, and both hospital and pharmaceutical trade associations have fought hard against “site neutral payment policies”, which is the term of art for this issue. In fact, the Trump administration is currently appealing an adverse ruling relating to its own site-neutral payment policy governing evaluation and management services. While I consider this to be a tractable problem under the umbrella of runaway drug costs, injected and infused drugs administered by medical professionals are a smallish part of the overall drug bill. For reference, the Kaiser Family Foundation estimates that Medicare Part D (patient-administered) drug spend runs nearly 4x that of Medicare Part B (drugs administered incident to medical professional services).
  5. Medicare’s Inability to Negotiate Prices. When the Medicare Part D drug benefit was created, legislators included what’s known as the “non-interference clause”, which prevents the Federal government from negotiating prices with manufacturers directly. HCPF would like to see this change, because it would no-doubt lead to lower drug prices. I agree. Perhaps we’ll see movement on this issue once the next election cycle has been concluded.
  6. Prescription Drug Rebates. The report covers a few of the elements of why rebates are ground zero in the debate over drug pricing. Conceptually, a rebate is a reduction in price offered after the achievement of some performance goal (for example, a certain level of market share), where a discount is a price reduction offered up front. What makes drug rebates so problematic is that PBMs and their counterparties keep all their rebate contracts secret. Thus, buyers don’t really know if they are getting the best deal, and patients don’t know what to expect from year to year in terms of out of pocket expenses. Because the rebates aren’t part of the net price known at the outset of a plan year, patients end up paying co-insurance on an inflated price.
  7. Pharmacy Benefit Managers (PBMs): Pricing, Profits and Consolidation. HCPF asserts that industry consolidation has helped engender an acceleration in PBM industry profits. This is probably true to some degree, but large customers (states, large employers) have never enjoyed many options when it comes to PBM services. Often there are only a few PBMs involved in a price check or Request For Proposal (RFP), and survey after survey suggests that price is only one component of a client’s ultimate decision. As with intellectual property reform and the pay-to-play debate, I doubt we’ll get relief regarding antitrust issues any time soon.
  8. Prescription Drug Promotional Marketing. Number eight on the list has to do with the fact that the U.S. is one of the only countries in the world that permits prescription drug companies to advertise directly to consumers (DTC). While I don’t have empirical evidence beyond the anecdotal here, I think that HCPF may have a decent argument. It’s not uncommon for a consumer to hear of a new drug and ask for a trial from his or her doctor. A doctor isn’t in the business of denying care, so he or she may comply so long as the drug is perceived to be safe and well-tolerated. Earlier this year, the Trump administration tried to take a small bite out of drug companies’ DTC advertising efforts by mandating that companies disclose their prices in DTC ads; however, industry challenged Trump’s rule and a judge subsequently ruled in industry’s favor.
  9. Marketing to Physicians. Drug companies still market aggressively to physicians. However, where efforts used to include lavish trips and gifts, the industry and physician groups have self-policed to a significant degree. There’s little question offering speaker bureau appointments and conducting continuing education symposia lead to higher levels of prescribing (if they didn’t, industry wouldn’t bother), but the impact of these activities is probably much reduced from years past.
  10. Lobbying Contributions to Drive Industry Policy. HCPF rightly raises lobbying efforts as a major driver of drug costs. As with clandestine rebate contracts, I put this one high on the list of culprits. Drug companies spend like no one else, and they defeat nearly every initiative designed to uproot their outsized levels of profitability (HCPF could easily write another 50-page report on the various wins industry has racked up over the past decade). I’m repasting a graph from the report for effect. For context, remember that drugs are only a small part of our health bill; however, the industry is immensely profitable and very well organized, which is why we rarely see Congress take action.
  11. Rising Prescription Drug Manufacturer Profits. Number eleven is simply a corollary to number ten. A typical prescription drug gross margin is better than 90%. Operating margins, before R&D expense, typically approach 50-60%.

(Pages 28 and 29 of the report highlight other states’ initiatives, in part to inform some of the recommendations for Colorado that HCPF covers in the ensuing pages.) 

 

What does HCPF recommend for Colorado, and does it make sense? 

Beginning on page 30, HCPF outlines its “Solutions for Colorado”.  The Department offers a long list of specific proposals and potential areas of exploration.  Thus, for the sake of brevity, I’ve classified these proposals into three broad areas – transparency, value-based pricing and drug benefit best practices.  I’ve also quickly included a fourth area – the notion of importation. 

Transparency: 

HCPF offers several remedies intended to help customers 1) better understand how drugs are priced, 2) get the best deal, and 3) protect themselves from arbitrary price increases.  These initiatives make sense, and many should be enacted/promulgated immediately.  Here are some examples: 

  • Mandate that manufacturers provide ample notice when they plan to take a price increase of greater than some percentage (10% seems like a good #).  Moreover, demand that manufacturers provide an explanation for the price increase.  Sometimes, it might be justified:  for example, if they have to source from a different active ingredient supplier, leading to increased input costs.  Other times, it may have to do with nothing more than a desire to “hit numbers” or take advantage of a competitor’s supply issues. 
  • Mandate that PBMs disclose and pass on 100% of any remuneration received from manufacturers for market share, formulary access, etc.  This includes, but is not limited to, rebates.  For Colorado in particular, this kind of initiative could be very impactful.  The state’s Medicaid receives 100% of rebates from its PBM partner, resulting in the trend we see below (from the report): 

Notice not only the absolute dollars at stake ($557mm in 2018!) but the year-on-year trend in rebates paid (26% compounded over four years!).  Without 100% pass-through, Colorado’s pharmacy expenditures would have grown 14.7% instead of 5.7%, on a compounded basis.  As the report notes, Colorado is a small business state.  These are exactly the kinds of organizations that don’t have the negotiating power or sophisticated human resources consultants at the ready in order to obtain comprehensive pass through arrangements with PBMs.  Thus, it’s great to see the state supporting full transparency and pass through arrangements.  

  • In a section that bridges transparency and best practices, HCPF encourages the adoption of utilization best practices (implementation of tools like prior authorization and step therapy), as well as PBM negotiation best practices (e.g. working to avoid common PBM tactics like offsetting lower rebates with higher administrative fees, disadvantageous terms on mail order fulfillment, etc.).  HCPF suggests that there’s room to provide employers with information and support in this regard. 

Value-Based Pricing: 

Under the value-based pricing umbrella, HCPF riffs on ways to avoid unjustified price increases and paying for overpriced therapies.  The report does not specifically cover what I’ll call Intelligent Pharmacy Benefit Design (iPBD) — customized financial constructs that incentivize consumer and vendor behavior in a more bespoke manner – although this could, in theory, be a part of the solution. 

  • HCPF suggests that the cost of new treatments be compared to that of current treatments.  This is what’s known as comparative effectiveness, and really ought to be employed for all health care products and services.  Health Technology Assessment (HTA) organizations do this kind of work and already reside both within health insurers and independent entities.  
  • HCPF recommends evaluating patents for evergreening, and this too could be handled by HTAs.  If a new product only offers incremental value, it’s perfectly reasonable to incentivize the use of a currently available alternative. 

iPBD, a Term I Just Coined

For better or worse, health care coverage usually spans a year, at which time you choose to renew or change plans.  Obviously, you can stop paying premiums at any time, at which your coverage will lapse.  Drug benefits mirror this construct.   While today’s pharmacy management systems permit creative plan designs, most plans incorporate only a few blunt, and sometimes counterproductive tools (clinically speaking).  For example, each time a patient picks up a supply of medication, he or she pays a co-pay or co-insurance.  Insurers call this “skin in the game”.  However, co-payments don’t really make a ton of sense for most prescription drugs.  A patient can only receive supply enough for one individual (to go beyond this, the doctor would be committing fraud), and benefits and side effects are specific to that drug and disease.  If the patient ought to be getting the therapy (they’ve paid for access through their premiums and the physician thinks it’s appropriate), why provide them a financial disincentive to do so?  One obvious stopgap would be to have the patient pay a co-pay for the first script in a plan year, then nothing more so long as the patient continues to pay his or her premiums.  If this approach were to be adopted, significant consideration would need to be paid to two issues, 1) front loading any financial incentives to choose one therapy over another and 2) the comparative effectiveness of various alternatives.

  • Today, many plan designs include a deductible that must be met before benefits kick in.  Thus, for persons in high-deductible designs, the notion of a front-loaded year is already well understood.  HCPF, the DOI or others directing health policy in Colorado could take into consideration desired vs. current consumer behaviors in crafting a one-time financial obligation (deductible + co-payment) that must be met for therapies of various clinical values.  In my opinion, the state should have PBMs and payors do-away with straight co-insurance designs.  If a plan design incorporated enough granularity, it could do an adequate job of discriminating between a variety of net price points and product profiles without the need for percentages.  These dollar amounts could then be posted at the beginning of the year so that consumers wouldn’t be surprised at the pharmacy. 
  • Today, PBMs and manufacturers negotiate formulary status between tiers (generic, preferred brand, non-preferred brand, specialty), and the level of exclusivity that prevails within various therapy categories.  They could still do this, just with the new financial construct, and patients wouldn’t be put in a position of having to switch therapies or ration therapies throughout the year (this happens). 
  • Finally, PBMs and payors could keep in place prior authorization requirements (maybe even refine these) but might be able to forego step therapy (the idea of having to try a cheaper drug and fail it before being granted access to a more expensive therapy).  Frankly, this latter tool isn’t terribly well aligned with best practices anyway and is often gamed.   

Drug Benefit Best Practices: 

  • HCPF is negotiating with bidders to develop and distribute a prescriber tool for physicians.  Such a tool would be implemented in two phases, with the first phase providing a prescriber patient-specific copayment information, as well as his/her plan’s financial obligations for a given drug.  Phase 2 would provide the prescriber plan-specific health improvement program information to be considered and/or recommended.  HCPF believes making this tool available will help change prescribing behavior and improve clinical and financial outcomes for the state and its residents.   
  • HCPF suggests that the state explore options relating to manufacturer coupon programs.  This is a good idea, if implemented carefully.  To my prior point, the state shouldn’t dissuade consumers from remaining compliant with their medications.  However, manufacturers don’t coupon old, low-margin drugs; they coupon new, expensive drugs.  Thus, the state should consider comprehensive programs that blunt unjustified efforts to promote low-value-added prescription drugs. 
  • Two new boards?  HCPF suggests that Colorado could benefit from the establishment of a Prescribing Best Practices Board, and a Prescription Drug Affordability Board.  Arguably, these boards would sit at the intersection of best practices and value-based pricing/reimbursement.  Experts would make recommendations that would feed into prescribing tools and electronic medical records, and the affordability experts might be called upon to recommend upper limits to what the state and other customers pay for certain drugs. 

Importation: 

  • HCPF recommends that SB 19-005, which already permits drug importation from Canada, to be amended to include other countries.  I guess this can’t hurt should the notion of importation take hold.  Developed territories like Australia and western Europe might offer opportunities to augment affordable supply.  However, I just hope that the state of Colorado appreciates how different the environment can be from country to country, even in areas falling under a single regulatory body like the European Union.  I’d also stress that compliance and inspection conditions vary from country to country even if facilities are FDA approved. 

(Pages 42-45 cover solutions for “All Americans”, which I don’t cover in this evaluation.) 

 

My Summary in Brief: 

Our drug delivery system is a Frankenstein monster built over many years and with many perverse incentives incorporated for non-clinical reasons.  We should consider starting from a clean slate where doing so provides the biggest benefit with the least disruption.  What HCPF concludes then proposes in its Reducing Prescription Drug Costs in Colorado report makes a lot of sense.  However, the two areas, in my opinion, that best fit the bill from the point of view of the state are 1) mandating rebate reform and 2) drawing a hard line on value-based pricing.  We should also develop a scorecard for our state representatives and hold them accountable for their willingness to accept support from prescription drug lobbying groups. 

Here’s a link to the full report:

https://www.colorado.gov/pacific/sites/default/files/Reducing%20Prescription%20Drug%20Costs%20in%20Colorado%20-%20December%2012%2C%202019.pdf

Et Tu, Drug Price Reform?

HealthCare

Drug Prices:  Is Ceding Political Victory No Longer a Showstopper? 

Tuesday, the Congressional Budget Office (CBO) scored the Elijah Cummings Lower Drug Costs Now Act (H.R. 3).  This is the U.S. House of Representatives’ current best effort to provide drug cost relief.  The Senate has its own drug cost bill known as the Prescription Drug Pricing Reduction Act of 2019 (S. 2543); it too has received a preliminary CBO score.  While many are skeptical we will witness the passage of drug pricing legislation in an election year and in light of the vituperative discourse between Democrats and Republicans, I am struck by two observations.  First, it appears legislation can get done, if both sides can claim victory.  On the day that Democrats in the House introduced articles of impeachment, they also announced an agreement with the White House on a revised U.S.-Mexico-Canada Agreement on trade.  Second, the guts of drug price reform don’t appear to be radically different from the House to the Senate to the White House.  Below, I describe some of the key elements of the two lead bills, as well as what the White House has proposed: 

According to the CBO, the Elijah Cummings Act: 

  • Would require the Secretary of Health and Human Services to negotiate prices of selected drugs such that these prices didn’t exceed 120% those paid in a reference group of developed countries.  These prices would be required to be used for Medicare Part D plans, and available to commercial plans.  Manufacturers that failed to comply would be subject to an excise tax that would not be deductible for income tax purposes. 
    • Medicare would spend about $448bn less from 2023 through 2029 as a result.  This is a huge amount of money relative to what is spent today.  For reference, CMS estimates that the Medicare Part D program spent about $155bn on drugs (gross) in 2017.  In 2027 alone, the CBO projects the program would spend $94bn less than if we kept the status quo.  
  • Would limit annual price increases to the rate of inflation in the Consumer Price Index – Urban (CPI-U), with manufacturers rebating back any increases in excess of this rate. 
    • As a result of this change, Medicare would save $37bn over the planning period, according to the CBO. 
  • Would upgrade the benefit Part D beneficiaries receive.  Specifically, the Act would eliminate the coverage gap commonly known as the doughnut hole, introduce an out of pocket maximum at the point at which catastrophic coverage kicks in today, and modify other elements of the benefit. 
    • These changes would increase direct spending by $9bn over the planning period, according to the CBO. 
  • Would require higher levels of cost and price transparency from manufacturers, increase the number of seniors eligible for low-income subsidies, add dental, vision and hearing care benefits to Medicare, and increase government funded research. 

At this time, the CBO has not yet issued an updated cost estimate for S. 2543, which the Senate Finance Committee (SFC) introduced on September 25.  However, the CBO has provided a preliminary estimate for the bill, based on the Description of the Chairman’s Mark provided to the CBO on July 25.   

According to the CBO, S. 2543: 

  • Would require that manufacturers include coupons in their estimate of Average Selling Price for their drugs. 
  • Would modify Medicare Part B reimbursement with a goal of increasing the adoption of biosimilars. 
  • Would require that Part B drug price increases above CPI-U be rebated back to Medicare. 
  • Would upgrade the benefit Part D beneficiaries receive.  Primarily, the Act would introduce an out of pocket maximum at the point at which catastrophic coverage kicks in today. 
  • Would require that manufacturers provide drug payment information to Medicare and Medicaid advisory groups, including certain rebate information.  The Act would also require that HHS publish less sensitive information on pricing and discounts on its website. 
  • Would require that Part D drug price increases above CPI-U be rebated back to Medicare. 
  • Would make modifications to Medicaid requirements, including the use of Pharmacy and Therapeutics committees and Drug Use Review boards, rebate oversight and price calculations. 

The White House: 

While it doesn’t appear that Alex Azar and Seema Verma are likely to sip hot cocoa by the fire together this holiday season, the one thing they have in common is a desire to impress the President with their loyalty.  Thus, I think it’s reasonable to expect that HHS and CMS will tout the President’s initiatives publicly, while working cooperatively with those working to reduce prescription drug prices.   

Specifically, I would remind readers that the President’s Blueprint to Lower Drug Prices: 

  • Was the first to introduce the notion of a reference pricing mechanism. 
  • Promotes the idea of improving transparency through the Medicare pricing dashboard. 
  • Contemplates measures to limit drug price increases, including inflation caps. 
  • Promotes the idea of introducing an out-of-pocket maximum for seniors. 

The President is also in favor of drug importation from countries like Canada and HHS is currently working with several states to establish guidelines for how this might be accomplished more broadly. 

With these various facts in place, I think it’s natural to ask — can legislation be passed, what will it look like, and what are the implications? 

As far as I can tell, reducing the cost of drugs is a bi-partisan issue.  The Republicans certainly view it as a winner for the upcoming elections, and the initial spark for reform actually came from Hillary Clinton in the fall of 2015.  According to a recent Kaiser Family Foundation poll, lowering prescription drug costs is the top health care priority amongst voters.  Obviously, we now have a Democrat-led bill in the House and a bi-partisan bill in the Senate that 1) don’t look to be at odds with one another, and 2) incorporate many of the changes the President would like to see implemented.  The trick, as is customary, is to keep fringe elements from blowing up the final bill while positioning the passage of such a bill as a victory for both political parties and the president. 

Kaiser Family Foundation Tracking Poll (September 12):

I believe that the Senate’s bill will form the corpus of anything that’s likely to get done.  First, it focuses more narrowly on the drug benefit and delivery system.  Second, it contemplates reforms that are limited to government programs, rather than both government and private plans.  Third, it focuses on pragmatic solutions with moderate financial impact and modest operational impact.  Fourth, it arises from the legislative body where consensus matters to a greater degree (i.e., notwithstanding the occasional fringe caucus revolt, the Speaker can usually get her way in the House). 

I think that it should be relatively easy both to implement a price inflation cap and establish an out-of-pocket maximum for Part D beneficiaries (seniors).  Both sides of the aisle generally agree that these wouldn’t be disruptive operationally and would like to see industry pay for a greater percentage of the benefit.  However, both worry that insurers will raise premiums if the government shifts to much of the bill onto their collective backs.  Thus, I envision the government picking on the drug manufacturers when it comes to determining how much of the doughnut hole and catastrophic benefit reforms each entity picks up.  I also think that we should expect the government to demand greater levels of price transparency from insurers, pharmacy benefits managers and manufacturers. 

On the other hand, I don’t think we’ll witness the passage of anything that includes a reference pricing mechanism, direct negotiations between CMS and industry, or the addition of new entitlements (e.g. dental benefits).  These are very disruptive from an operational point of view and are likely to invite much more vociferous and widespread opposition. 

According an article by The Hill1, Mitch McConnell and selected republicans aren’t in favor of certain elements of the Senate bill, including the inflation cap.  While the article goes on to say that opponents equate such a cap to price setting, I think it’s important to note that such a cap already exists under Medicaid.  Thus, this argument represents little more than a straw man, in my opinion.  For now, it doesn’t appear that President Trump is twisting any arms in front of the election cycle (perhaps he’s sensitive to the fact that the impeachment trial is about to begin?).  However, I expect that as the groundswell of support grows amongst voters, we’ll see more jawboning and increasing Congressional support for a simplified proposal, and that we may truly be talking about passage in the Spring. 

If we do get a new drug price reduction act, I don’t think we’ll see a big impact on productivity and access, broadly speaking.  Nor do I think we’ll see a big impact on access one way or another.  However, there could be pockets of pharmaceutical business that become less attractive as a result.  If a bill were to pass along the lines I’ve described above, high priced medicines for the elderly population become less attractive, all else equal.  Let’s take a simple example – a person being treated with a cancer medication beginning January 1st under the standard Part D benefit design.  Here’s the current construct: 

If this medicine costs $10,000 per month and is used for 10 months, the drug company receives $95,680.46 — $3,820 up to the doughnut hole (from the enrollee and plan), 30% of the gross costs up to $8,139.54 (split 25% enrollee and 5% plan), and 100% of everything thereafter (via enrollee, plan and Medicare). 

Under the Senate proposal, which still may change, this same medicine would provide the drug manufacturer only $80,620 – 100% of payments up to $3,100, then 80% of any payments made above this threshold.   

A lot obviously still depends on the final agreed-to split between manufacturers, plans and Medicare above the catastrophic threshold, as does the practical matter of whether a beneficiary is on other medications that count towards the out-of-pocket max.  Still, I think that the companies most affected by these changes would be those already selling oral cancer medications (pills), since those companies would be unable to change prices meaningfully in order to respond.  Injected/infused cancer medications are typically covered under Part B, which is a separate benefit.  Amongst multi-national branded biopharma companies, Pfizer probably has the most to lose, although there are some biotechnology companies that sell only oral cancer medicines.  In addition, any other drugs disproportionately used amongst the elderly would theoretically be affected, subject to pricing and the catastrophic threshold (e.g. certain antiviral medications and anticoagulants).  

Informal Thoughts on BDXA

Investments

As with everything that I will post to the investing section of this blog, the following should not be construed as investment advice.  It is simply meant to be the ramblings of a now-retired individual with some time on his hands.  I am not affiliated with any organization and have no interest in publishing other than for the intellectual exercise.  While I make an effort to be accurate with my facts, I do not assert that any of the following information is 100% reliable.  If I own a stock upon which I comment, I will always say so.  In  this case, I own BD Depository Shares Representing the Mandatory Convertible Preferred Stock (BDXA) in a personal account.

 

The Mouthful:  Becton Dickinson Depository Shares Representing 1/20th of One Share of 6.125% Mandatory Convertible Preferred Stock, Series A

Thoughts on Becton Dickinson

For those who don’t know that much about the company, Becton Dickinson is essentially a medical products supermarket. The company manufactures and distributes a wide variety of products, including the Vacutainer tubes technicians and nurses use when drawing blood, sharps (e.g. pen and safety needles), catheters (e.g. urological catheters for drainage, therapeutic catheters, etc.), diagnostic reagents and instrumentation, infusion pumps, surgical materials, medication management products and others. The company’s operations are well diversified from a geographic point of view, with roughly 44% of revenues generated overseas. Finally, I believe it’s important to recognize that, while BD operates in highly regulated markets, 1) its products don’t typically rise to the level where customers feel the need to “do something” about their costs, and 2) BD is somewhat insulated from the economic cycle, given the amount of business that is reimbursed under fee schedules comprising both medical devices and medical professionals’ reimbursement. While analysts get worked up over whether the company grows its top line 4%, 5%, or 6% in a given year, I think that the ability to grow reliably is more important for long-term, income-oriented investors. In this regard, BD is hard to beat.

Over the years, it appears that BD’s strategy has been to move up the value chain and become more important to its primary customer base – hospitals and clinics. While the organization spends about 6% of net revenues on R&D, its principle method for doing so has been by making acquisitions. Every few years, it seems, BD makes a significant acquisition. Most recently, the company closed the $24bn acquisition of C.R. Bard, in late 2017, bringing the company a host of interventional and surgical products. Before that, it was the infusion pump company, Carefusion, which BD bought in 2015 for $13bn. Given that BD is about a half-turn away from its leverage target post the acquisition of Bard, I think it is reasonable to expect BD to begin shopping for its next target.

Not surprisingly, BD’s willingness to return cash to shareholders ties to its M&A strategy. As debt comes down as a multiple of EBITDA, the company raises its dividend more aggressively. In the early periods post an acquisition, dividend increases are more modest. Most recently, the company announced a 2.6% increase to its quarterly dividend (to $0.79/sh.), suggesting the company is still in debt pay-down mode. The forward yield on common equity is only 1.2%. Over the longer-term, BD ought to be able to grow earnings in the high single digits, organically, and its dividend growth ought to match. This is certainly consistent with the company’s history. Capital intensity has been coming down, and capital expenditures clocked in at 5.5% of net revenues in BD’s Fiscal Year ending 9/30/19.

An Investment in BD

BD’s shares trade at roughly 20x forward earnings. That’s not cheap in an absolute sense, but it’s cheaper on a relative basis than they’ve been in a while. This valuation is also arguably attractive when you consider where “defensive” stocks typically trade and the shrinking list of investable companies that are truly defensive. Consequently, I’m O.K. owning BD common at these levels.

However, when it comes to what I actually own, it’s the Becton Dickinson 6.125% Mandatory Convertible Preferred Stock depository shares (BDXA). Becton Dickinson issued these securities in conjunction with the financing it did in order to complete the C.R. Bard acquisition. The key features of this issue are that the Preferred shares 1) sit higher in the capital structure (not an issue for BD), 2) pay a higher dividend and 3) convert into common according to specified terms. On this latter point, the Preferred converts into BD common according to a fixed ratio when the common trades above $211.80 and below $176.50, but along a sliding scale between these two prices. In other words, as BD common approaches $211.80, the Preferred stock ought to start offering better downside protection.

Today, BD common trades at roughly $257/sh., or roughly 21% above the Threshold Appreciation Price of $211.80. Thus, we’d have to undergo a rather violent correction between now and May 2020, by which date the Preferred shares must be converted into common, for the Preferred shares to stand out. In other words, BD Preferred share receipts really aren’t much more interesting than BD common right here, right now. Still, I bring this security and its feature up in consideration of what I outlined earlier. Specifically, should BD engage in another acquisition of size, this form of the financing might be included and offer total return investors a solid investment opportunity that fits their objectives. If it informs the potential timing of such an event, BD should be at 3.0x D/EBITDA by the third quarter of calendar 2020, at which time significant M&A again becomes a possibility; BD did the financing for Bard roughly a month after having announced the proposed deal.

New Pfizer

Investments

As with everything that I will post to the investing section of this blog, the following should not be construed as investment advice.  It is simply meant to be the ramblings of a now-retired individual with some time on his hands.  I am not affiliated with any organization and have no interest in publishing other than for the intellectual exercise.  While I make an effort to be accurate with my facts, I do not assert that any of the following information is 100% reliable.  If I own a stock upon which I comment, I will always say so.  In  this case, I do own Pfizer in a personal account. 

 

New Pfizer

Barron’s this week decided to write up Pfizer and put the company on its cover page.  Since it’s a company I find interesting, I decided to dig a little deeper and provide some thoughts in something other than financial-rag-speak.  In a summary-up-front, I’d argue Pfizer makes a pretty interesting investment at current levels, albeit with a reliance on what the market will pay for an earnings re-acceleration story that begins sometime in 2020.  Pfizer isn’t yet a loved company, for good reason, but its market cap is too significant to be ignored by institutional investors.  Thus, I think the investing picture is skewed positively (just look at what’s happened with Bristol-Myers Squibb and AbbVie).  I think the idea of hedging out the Viatris (i.e. Upjohn-Mylan) exposure is intriguing if minor in its import. 

Background

For a number of years now, Pfizer has been playing footsie with various ways to unlock value for shareholders, from merging with AstraZeneca to spinning out businesses (most notably its animal health business, Zoetis), to entering into joint ventures like the HIV endeavor, ViiV.  Under the leadership of new CEO Albert Bourla, who will become Chairman and CEO January 1, 2020, it seems that Pfizer will undergo a series of more decisive changes.  Ian Read, who had served as CEO since 2010, will step down. 

Let’s talk a little about Pfizer

Amongst institutional investors, I don’t think Pfizer is taken very seriously.  While Ian Read has put up a respectable strategy and operational legacy, it’s far from stellar.  Under his leadership, the company has acquired companies like Hospira for $15bn and Anacor for $5bn, as well as licensed products like Merck KGaA’s avelumab.  I think the Street would argue these haven’t been value-creating endeavors.  When it comes to R&D productivity – the life blood of any biopharmaceutical company – Pfizer has a checkered past that’s improved marginally of late.  In order to inform this statement, I arbitrarily peeked back at the company’s pipeline in 2016, just to remind myself of where we were.  As of February 2nd, of that year, Pfizer boasted 8 novel agents in Phase 3 development (i.e those that weren’t line extensions, new indications for marketed products or biosimilars).  Here’s the update on those: 

 

 

I think it’s fair to note that the approved drugs were approved only recently.  Thus, one wouldn’t expect sales to be too substantial as of late 2019.  That said, for drugs where there’s multi-blockbuster potential (i.e. >$2bn in peak sales), companies often disclose early figures to satisfy analysts.  From this list, the only candidate I’d characterize as an obvious success is Trumenba. 

Today, Pfizer has a few more interesting candidates in late development, as well as the fruits of some inorganic stratagems (e.g. the $11bn acquisition of Array Biopharma).  Still, I can’t say at this juncture anything’s really changed.  The organization is still led scientifically by Chief Scientific Officer, Mikael Dolsten, whose tenure closely matches that of former CEO, Ian Read. 

So, why are things interesting now? 

Let’s start with the inorganic stuff

On August 1, 2019, Pfizer announced that GSK and Pfizer had closed a joint-venture agreement under which Pfizer and GSK would contribute their consumer health businesses and obtain respective ownership stakes of 32% and 68% in the combined entity.  GSK is taking charge operationally, while Pfizer will step back and simply report its passive financial interest from here.  I won’t spend a lot of time on details other than to say 1) for once, it looks like Pfizer received reasonable value for the business it sold, 2) this is the kind of business where synergies ought to be real and obtainable (e.g. improved negotiations with the trade over shelf space, the elimination of redundancies, better purchasing of fairly standard supply chain items, maybe even some cross selling opportunities, etc.), and 3) GSK ought to improve on Pfizer’s performance (Pfizer Consumer Health Care had been posting flattish results, where GSK has been growing low-to-mid single digits). 

On July 29, 2019, Pfizer and Mylan announced they were merging Pfizer’s aging/legacy brand business, Upjohn, with Mylan to create a new company which will be called Viatris.  The market promptly threw up all over this idea, with Pfizer’s shares dropping nearly six and a half percent.  I think I understand why folks were disappointed.  While Pfizer shareholders stand to receive 57% of Viatris, it will be run by Mylan executives/appointees.  This includes Chairman Robert Coury, whose reputation is controversial to put things gently, President Rajiv Malik and eight members of an eleven-member board.  Beyond this, Pfizer shareholders will still have to worry about the performance of a generic pharma company with much different growth opportunities and capital demands than Pfizer’s remainco – the innovative biopharma company; I’m sure some felt that a split-out or sale would have been much cleaner.  Pfizer and Mylan executives expect the deal to close in mid-2020. 

For better or worse, these two managerial exits will accomplish a couple of objectives.  First, it will make valuing Pfizer’s shares a bit easier.  There will be a public market for Viatris, and Pfizer shareholders will be able to monitor it in real time.  Consumer health, while subsumed in the GSK figures, is a steady business with very reliable metrics on a comparables or transactional basis.  It too should be easy to value.  With perhaps 85% of the value of Pfizer accruing to the remaining biopharma business, investors should also be able to focus their efforts.  Second, Pfizer personnel will be able to focus exclusively on the creation, development and launch of novel medicines addressing high unmet needs.  Perhaps this will have a positive effect on R&D productivity. 

What about the organic stuff?

I’ll state what is obvious to most.  A biopharma company is really just a series of products launched into an existing infrastructure.  In Pfizer’s case, there are a number of growth drivers, a couple of key products, one major product going off patent, and a number of late stage pipeline candidates that will probably set the tone for investors over the coming few years.  As of Q3, Pfizer’s Biopharma business (the innovative stub) boasted an annualized sales rate of roughly $40bn.  Lyrica, the one big product currently being genericized, has already been moved to Upjohn, so its worth is embedded in the inferential value Pfizer shareholders get in the proposed merger with Mylan.  Ibrance, a terrific drug for hormone positive breast cancer, accounts for about 13% of Biopharma sales and grew 27% operationally in the quarter.  Ibrance really faces no obvious competitive threats.  Prevnar, the leading vaccine used to prevent pneumococcal disease, accounts for about 16% of Biopharma sales and declined about 3% operationally.  Biopharma, overall, grew 9% operationally in the quarter.   

Pfizer’s pipeline is “O.K.” (hey — they don’t give two and a half stars to just anybody).  For better or worse, a lot of the dross has already fallen out.  Hence, the late stage pipeline is a bit thin, numerically, but of relatively high quality.  I highlight below four Phase 3 programs that matter, and I am optimistic about three. 

 

  

 

Pfizer has two growth drivers I believe are worthy of added comment.  The first is Xtandi, which I believe will win the war amongst next generation anti-androgens used to treat prostate cancer.  Xtandi looks cleaner than J&J’s Erleada and more flush with data than Bayer’s Nubeqa.  Alliance revenues for this product increased 25% operationally in the quarter (to $225mm) and should benefit from earlier and more extensive use pursuant to anticipated regulatory approvals.  The second is Vyndaqel, a novel treatment for an uncommon heart condition.  This product is off to a very strong start and boasts above average margins.  With time, it has multi-block buster potential. 

Risks?

In my opinion, many of the theoretical risks Pfizer faces are mitigated.   

Merck & Co., is working on a pneumococcal vaccine that will compete with Prevnar.  It does cover a couple of serotypes that are clinically important and which Prevnar doesn’t cover.  However, Pfizer is in advanced testing with a 20 valent vaccine that covers these and 5 additional serotypes.   

Earlier this year, Pfizer’s Xeljanz, an oral medication for arthritis, received added warnings for clotting and related deaths on its prescribing label.  So far, this development hasn’t had a significant impact on sales, and it’s encouraging to see that Pfizer’s pipeline candidates of the same or a related class appear cleaner on side effects. 

If there’s a more existential threat, it’s that of health care reform.  A big chunk of Pfizer’s sales and earnings come from oral anti-cancer medications.  These are used disproportionately in the elderly, and are therefore often reimbursed under Medicare Part D.  While access to anti-cancer medicines is a sensitive topic, there is a lot of dissatisfaction amongst beneficiaries and a lot of government dollars at stake.  If one plans to own Pfizer long-term, the subject bears watching. 

Some numbers and some investing thoughts

In sum, it would appear that Pfizer’s stated target of achieving a 6% CAGR for Biopharma over at least the coming five years appears reasonable.  However, I was surprised to see how little attention was given to the company’s earnings progression on its most recent quarterly call, given the impact of Lyrica and the various moving parts associated with GSK and Mylan. 

Through 9 months of 2019, Pfizer earned $2.39/share on an adjusted basis.  Management has provided guidance of $2.94-3.00/share on an adjusted basis, which means that Q4 guidance is $0.55-0.61/sh.  That’s a pretty big step-down from $0.75/sh. In Q3 and a run rate of roughly $0.80/sh. before the loss of Lyrica.  If there’s a silver lining, it’s that there’s only $200mm/Q of Lyrica left to go in the U.S. 

For Q4, Pfizer has pointed to a few cents in dilution from a full quarter of the Array acquisition, as well as a further deterioration in exchange rates.  Pfizer had also indicated it will move from contemporaneous reporting for its consumer health business to a one quarter lag under the new GSK J.V., and that this would lead to 2019 earnings dilution of roughly $0.03/sh.  Despite all this, I expect there’s also a bit of expectations management built into guidance.  According to Pfizer’s 10Q, Upjohn earned $2.3bn, $2.0bn, and $1.4bn before overhead in Q1, Q2 and Q3, respectively.  Sales declined from $3.1bn to $2.2bn over that stretch.  U.S. Lyrica sales declined from roughly $900mm to $200mm.  Thus, in round numbers, Upjohn’s earnings power probably troughs at $1.2bn before overhead and taxes.  On the flip side, Biopharma earnings have grown from $5.9bn in Q1 to $6.1bn and $6.5bn in Q2 and Q3, respectively.  In Q4, earnings should increase again, if for no other reason than growth in the high margin product, Vyndaqel.  Say Q4 Biopharma is $6.7bn, Upjohn is $1.2bn, and combined Other Business Activities and Corporate is $3.2bn in expense (i.e. on trend).  That would put Q4 earnings in the ballpark of $0.70/sh. at a 16% tax rate.  Add the Array and consumer health care dilution, and Pfizer maybe ends up at $0.65/sh. 

In 2020, consumer health care will normalize and should start to grow.  Biopharm should too.  Thus, I think the current consensus of $2.74/sh. is achievable.  However, this probably isn’t hugely important to the thesis, but rather a bulwark against which value investors can start to gauge their level of optimism for a renaissance at Pfizer Biopharma.   

So, let’s think about that.   

Pfizer includes a table of segment performance in its press release.  From it, you can deduce a few things: 

  • Biopharma and Upjohn both boast attractive gross margins.  In the case of Biopharma, gross margins hit 91.5% in Q3, which CFO Frank D’Amelio attributed to productivity and a contribution from Vyndaqel.  I think it’s reasonable, given a lack of significant patent expiries from here forward, to expect 2020 gross margins for Biopharma to hover in the low 90’s%. 
  • R&D runs nearly $2bn per quarter, and you can be assured that nearly all of that accrues to Biopharma.  The other businesses simply aren’t R&D intensive.  Based on Array’s S.E.C. filings, it appears we should add about a quarter of a billion dollar R&D load to Pfizer Biopharma for that organization, bringing the total to perhaps $8.25bn on an annualized basis. 
  • If points 1 and 2 are in the right ballpark, the key to deriving the base from which to get excited or not for Biopharma depends on the allocation of SI&A.  Here, too, I think it’s safe to assume that most of the bodies and overhead will accrue to biopharma.  I base this on logic (e.g. you don’t run DTC campaigns for generics, biosimilars or soon-to-be extinguished products; you don’t detail aggressively with sales reps and you aren’t willing to pay for market data from iQvia).  What’s more, the numbers make sense.  If we tie 90-95% of unallocated SI&A to Biopharma, we arrive at a figure of roughly $2.7bn, or 27% of net sales.  This is actually on the low side of the average for a pure-play peer set.   

 

 

If those are the right numbers, Biopharma has earnings power in the range of over $19bn before interest and taxes in 2020.   

The last elephant in the room is the balance sheet

As of Q3, Pfizer’s cash, cash equivalents and short-term investments amounted to $9bn.  Long-term investments amounted to $2.7bn.  On the other side of the ledger, interest bearing liabilities totaled $53bn.  On these figures, Pfizer puts up about $60mm in interest income and $400mm n interest expense.  Just prior to the close of the Mylan combination, management contemplates that the new Viatris will make a one-time $12bn payment to Pfizer, and that Pfizer will use this to retire debt.  Thus, subject to variances in cash sources and uses for the coming half year, Pfizer ought to have a proforma debt balance of just over $40bn.   

If we take these figures through the income statement and apply a 16% tax rate, new Biopharma should have base earnings of over $0.65/sh. per quarter coming out of the Mylan transaction, and earnings ought to be growing double digits.   

Investing implications: 

Pfizer shareholders own 32% of a consumer health business with a greater-than $13bn top line.  Consumer health businesses, if run properly, boast 20% operating margins and low-to-mid single digit top line growth.  Typically, they are worth 3-6x sales, depending on moats and the appetite of investors. If we go with 3.5x forward sales, peg the run rate at $13.5bn, and give Pfizer 32%, the value to Pfizer is $15bn. 

Mylan currently trades at around $18/sh. and has just over 500mm shares outstanding.  It doesn’t appear that there’s a big deal-related discount built into the shares, given that the stock traded at $19/sh. before Pfizer and Mylan made their announcement.  Thus, if Mylan’s 43% stake in Viatris is worth $9bn, Pfizer’s is worth $12bn. 

Finally, there’s the payment.  Viatris is going to hit the ground with a ton of debt, but some decent early capacity to generate free cash (Mylan’s presentation says the goal is to get to 2.5x D/EBITDA or less by the end of 2021, while initiating a dividend).  On proforma 2020 sales of $19-20bn in 2020, Viatris will begin with $24.5bn in debt and EBITDA margins in the range of 40% (including synergies).  This $24.5bn includes the debt Upjohn will incur in order to make the one-time $12bn payment to Pfizer. 

If Pfizer has 5.6bn shares outstanding, consumer health is worth $2.7 per share, and Viatris and the payment are each worth $2.1. 

 

 

So, what’s Biopharma worth?

Well, I guess that’s up to the markets.  However, I think 15x isn’t unreasonable, given the pipeline and the lack of patent expiries until 2026.  If the company can put up $0.65/sh. beginning in Q3 2020, I think $2.70-2.90/sh. in 2021 is a good figure (just for Biopharma).  15x that would be $42/sh. at the mid-point, on top of which you could add the $7/sh. described above.  While that sounds like quite attractive a target for a lumbering, unloved biopharmaceutical company, I think it might be realistic to set one’s sights a little lower.  It’s almost never in management’s interest to give away the store all at once.  What’s more, I believe it takes time for companies to go from unloved to, well, something better than unloved.  Finally, it’s an election year, and health care reform is going to be on the agenda.  Thus, Pfizer may not see the upper forties right away.  Nevertheless, the bones of the idea feel right, and Pfizer does offer investors a 3.8% dividend while the broth clears.  One final thought relates to Mylan.  I, for one, am attracted to the Pfizer Biopharma and consumer health businesses to a much greater degree than I am Viatris.  If I were an institutional investor with the ability to hedge, I might short enough Mylan stock to hedge out my exposure to this fledgling entity.  That’s not to make a stock call one way or the other, but simply to focus my energies on the business about which I care. 

 

 

Colorado Public Option Update

HealthCare

Yesterday evening, the Colorado Department of Health Care Policy and Financing (HCPF) and the Colorado Department of Insurance (DOI) submitted a final report to Colorado Legislature regarding the development of a public health insurance option (the Public Option). In short, the final report’s recommendations closely resemble the draft recommendations issued in early October. However, after holding a number of stakeholder meetings, the HCPF and DOI leadership has elected not to move forward with a standard fee schedule but instead with a formula-based fee schedule that takes into account the inherent variability in hospital operations across the state. In addition, the final report provides added detail on proposed future activities, such as the development of an Advisory Board, use of shared savings under a Medicaid 1332 waiver, and the development of a more robust small group market.

Background. Pursuant to the passage of HB19-1004 earlier this year, HCPF and DOI have been working together to make available a Public Option in the Colorado individual health care insurance marketplace. This Public Option would resemble those individual plans offered by various carriers in the State, but would mandate adherence to a fee schedule instead of charges negotiated off a hospital’s chargemaster (an itemized list of gross charges developed by each hospital for various products and services offered by that hospital). Ideally, the Public Option would be anchored to reduced net hospital charges compared to current alternatives, and would therefore be more affordable.

Keys to the Final Report. While yesterday’s final report closely resembles the draft report issued over a month ago, there are some changes and added details worth considering.

  • The Final Report maintains a focus on hospital pricing (and pricing in general) as a lynchpin to the lack of health care affordability in the State. Considering where Colorado ranks in terms of hospital prices and profitability (#12 for the former, according to a John’s Hopkins University report: [https://wusfnews.wusf.usf.edu/sites/wusf/files/201910/hospital_prices_in_the_u.s._report.pdf] and #2 for the latter, according to Medicare cost report analyses conducted by HCPF and DOI), this seems appropriate. Items such as pharmaceutical pricing, physician reimbursement and waste received less attention, but could in theory be addressed in the future. Policy initiatives contained in the report omit those that would specifically enable hospitals to address administrative bloat and medical supply expense, instead leaving that to the hospitals to address on their own.
  • The Final Report maintains the draft recommendations of partnering with health care insurers to launch the Public Option. This also makes sense and will probably work. In an indirect way, the Public Option is essentially a coverage expansion, making health care more affordable for those that can’t or won’t purchase health care insurance for financial reasons. But for a proposed increase in the Medical Loss Ratio (MLR), insurance companies ought to be O.K. with the idea of underwriting more policies while avoiding the threat of wholesale disruption. From the State’s perspective, leadership gets to avoid budgetary expense and risk, as well as potential operational disruption (developing and managing a provider network, ensuring eligibility and claims administration is smooth year-to-year, etc.).
  • Instead of insisting that health care insurers build a network off of a fee schedule that averages between 175% and 225% of Medicare prices (yes, twice what Medicare currently pays hospitals for various services), HCPF and DOI recommend that hospitals be paid according to a formula that takes into key variables, such as 1) payer mix (e.g. does the hospital disproportionately serve the poor and indigent), 2) hospital designation (e.g. is the hospital a critical access hospital that needs to stay in business in the interest of Coloradoans), 3) margins, and 4) administrative expenses. This, in my opinion, is a better approach than “one size fits all”. There are inherent differences in hospital operations that tie to Colorado’s diversity statewide, and driving a universal fee schedule whose prevalence likely increases in the future puts vulnerable hospitals at risk of closure. Of note, the Final Report included an updated actuarial analysis of anticipated savings based on the new inputs highlighted above. Where the Draft Report pegged savings at 9-18%, the Final Report has the Public Option saving about 10% vs. current alternatives.
  • The Final Report speaks more specifically to the use of a Medicaid 1332 waiver to channel public option savings into greater affordability in the future. Under federal law, a state can apply for a waiver to direct savings it creates versus projected federal spending, rather than simply abide by the statutory formula. In this case, the State is contemplating using Public Option savings to improve subsidies for individuals between 200% and 250% of the Federal Poverty level (income of about $24-30K), as well as a create a subsidy for individuals between 250% and 400% of the Federal Poverty Level. As noted in both the Draft- and Final Report, these are the individuals who find it the most difficult to afford health care insurance and access the system, even if they have coverage. According the Final Report, the Public Option will create about $89mm in savings in 2022, the first year of availability.
  • Finally, the Final Report tantalizingly hints at the future of the Public Option. Specifically, the Report speaks to the development of options for employers with up to 100 employees. Today, many small employers do not offer coverage to their employees and there are issues that impede coverage for employees and families of those that do. Over the short-term, the Final Report recommends that small business employees be allowed to avail themselves of the individual Public Option. Further, it recommends that this access be extended to small business owners that choose to self-fund with stop-loss insurance. Over the longer-term, the Final Report speaks to the notion of developing a dedicated Public Option for the small group market with the help of health insurers that are participating in the individual market. While it will take time, the implication here is that the fee-schedule based, transparent model of shopping for health care will grow, and that health insurers will be called upon to act as agents of improved affordability for the State.

Broader Implications. As we head into a presidential election in which several Democratic candidates are recommending dramatic changes to the way in which Americans access health care coverage, it’s probably worth noting that Colorado could serve as a model for where we are headed. Colorado is one of the first states in the country to pursue a public option and, in my mind, one of the states with both a tractable plan and the mandate to get it done. Without question, what happens depends substantially on who is elected and why. However, it’s worth noting that the Trump administration is already moving to increase transparency around hospital operations and the contracts hospitals and doctors have with health insurers. Thus, whether we are negotiating Medicare for all, Medicare for all who want it, or a Trump-driven alternative, I think it’s reasonable to expect change in the coming years. In my mind, there are limits to what can be done about labor-driven savings, considering the availability and compensation of physicians and nurses, as well as structural constraints that govern the training thereof. As a consequence, we will likely focus our reform efforts on hospital pricing and efficiency, pharmaceutical pricing and unnecessary utilization. In that context, especially in light of how much of our health care bill is dedicated to hospital inpatient and outpatient spending, we will not be able to enact stochastic reform, but rather incremental reform; we can’t take a dramatic or one-size-fits-all approach without inadvertently affecting access or quality. In that context, an “opt-in” model underpinned by greater regulatory oversight (i.e. a public option, whether it’s called Medicare or not) is the most likely route forward. Colorado’s plan could certainly serve as a blueprint in this regard.

The full report can be found here:

https://www.colorado.gov/hcpf/proposal-affordable-health-coverage-option